As filed with the Securities and Exchange Commission on July 17, 1998
Registration No. 333-53755
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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
---------------
AMENDMENT NO. 2
TO
FORM SB-2
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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Interactive Magic, Inc.
(Exact name of small business issuer as specified in its charter)
<TABLE>
<CAPTION>
North Carolina 7372 56-2092059
<S> <C> <C>
(State or other jurisdiction (Primary Standard Industrial (I.R.S. Employer
of incorporation or organization) Classification Code Number) Identification Number)
</TABLE>
215 Southport Drive, Suite 1000
Morrisville, North Carolina 27560
(919) 461-0722
(Address and telephone number of principal executive offices)
215 Southport Drive, Suite 1000
Morrisville, North Carolina 27560
(919) 461-0722
(Address of principal place of business or intended principal place of
business)
J. W. STEALEY
Chairman and Chief Executive Officer
Interactive Magic, Inc.
215 Southport Drive, Suite 1000
Morrisville, North Carolina 27560
(919) 461-0722
(Name, address, including zip code, and telephone number,
including area code, of agent for service)
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Copies to:
<TABLE>
<S> <C>
GERALD F. ROACH, ESQ. ROBERT J. MITTMAN, ESQ.
BYRON B. KIRKLAND, ESQ. TENZER GREENBLATT LLP
SMITH, ANDERSON, BLOUNT, 405 Lexington Avenue
DORSETT, MITCHELL & JERNIGAN, L.L.P. New York, New York 10174
2500 First Union Capitol Center Telephone: (212) 885-5000
Raleigh, North Carolina 27601 Facsimile: (212) 885-5001
Telephone: (919) 821-1220
Facsimile: (919) 821-6800
</TABLE>
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Approximate date of commencement of proposed sale to the public: As soon as
practicable after this registration statement becomes effective.
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
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CALCULATION OF REGISTRATION FEE
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<TABLE>
<CAPTION>
Title of Each Class Proposed Maximum Proposed Maximum
of Securities to Amount to be Aggregate Offering Aggregate Amount of
be Registered Registered (1) Price Per Share Offering Price Registration Fee (2)
<S> <C> <C> <C> <C>
Common Stock, $.10 par
value ............... 2,990,000 $ 10.00 $ 29,900,000.00 $ 8,820.80
</TABLE>
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(1) Includes 390,000 shares which the Representatives have the option to
purchase from the Company to cover over-allotments, if any.
(2) A registration fee of $9,499.00 was paid on May 28, 1998.
The registrant hereby amends this registration statement on such date or
dates as may be necessary to delay its effective date until the registrant
shall file a further amendment which specifically states that this registration
statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933 or until the registration statement shall become
effective on such date as the Commission, acting pursuant to said Section 8(a),
may determine.
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<PAGE>
Information contained herein is subject to completion or amendment. A
registration statement relating to these securities has been filed with the
Securities and Exchange Commission. These securities may not be sold nor may
offers to buy be accepted prior to the time the registration statement becomes
effective. This prospectus shall not constitute an offer to sell or the
solicitation of an offer to buy nor shall there be any sale of these securities
in any State in which such offer, solicitation or sale would be unlawful prior
to registration or qualification under the securities laws of any such State.
PRELIMINARY PROSPECTUS DATED JULY 17, 1998
SUBJECT TO COMPLETION
2,600,000 Shares
[LOGO]
Common Stock
Prior to the offering, there has been no public market for the Common
Stock of Interactive Magic, Inc. (the "Company") and there can be no assurance
that any such market will develop. It is anticipated that the Common Stock will
be quoted on the Nasdaq National Market under the symbol "IMGK." It is
currently estimated that the initial public offering price per share will be
between $8.00 and $10.00. For a discussion of the factors considered in
determining the initial public offering price, see "Underwriting."
----------------
THE SECURITIES OFFERED HEREBY ARE SPECULATIVE AND INVOLVE A HIGH DEGREE OF RISK
AND IMMEDIATE AND SUBSTANTIAL DILUTION. SEE "RISK FACTORS" COMMENCING ON PAGE 7
AND "DILUTION" ON PAGE 18 OF THIS PROSPECTUS FOR INFORMATION THAT SHOULD BE
CONSIDERED BY PROSPECTIVE PURCHASERS OF THE COMMON STOCK OFFERED HEREBY.
----------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS
A CRIMINAL OFFENSE.
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<TABLE>
<CAPTION>
Price Underwriting Proceeds
to Discounts and to
Public Commissions (1) Company (2)
<S> <C> <C> <C>
Per Share ......... $ $ $
Total (3) ......... $ $ $
</TABLE>
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(1) Does not include additional compensation to be received by BlueStone
Capital Partners, L.P. ("BlueStone") and Royce Investment Group, Inc., as
representatives of the several Underwriters (the "Representatives"), in
the form of warrants to purchase up to 260,000 shares of Common Stock (the
"Representatives' Warrants"). The Company has also agreed to indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act of 1933, as amended. See "Underwriting."
(2) Before deducting expenses of the offering payable by the Company, estimated
at $900,000.
(3) The Company has granted the Representatives an option, exercisable within
45 days of the date of this Prospectus, to purchase up to 390,000
additional shares of Common Stock, on the same terms as set forth above,
solely for the purpose of covering over-allotments, if any. If the
Representatives' over-allotment option is exercised in full, the total
Price to Public, Underwriting Discounts and Commissions and Proceeds to
Company will be $ , $ and $ , respectively. See
"Underwriting."
The shares of Common Stock are being offered, subject to prior sale, when,
as and if delivered to and accepted by the Underwriters and subject to approval
of certain legal matters by counsel and to certain other conditions. The
Underwriters reserve the right to withdraw, cancel or modify the offering and
to reject any order in whole or in part. It is expected that delivery of the
certificates representing the shares of Common Stock will be made against
payment therefor at the offices of BlueStone Capital Partners, L.P., 575 Fifth
Avenue, New York, New York 10017, on or about , 1998.
BlueStone Capital Partners, L.P. Royce Investment
Group, Inc.
The date of this Prospectus is , 1998.
<PAGE>
Following the Prospectus cover page is a fold-out two page color layout
depicting CD-ROM box cover art for certain of the Company's products:
iF22
iF22 Persian Gulf version 5.0
iPanzer 44
Apache
Hind
The Great Battles of Alexander
Liberation Day
Capitalism Plus
Seven Kingdoms Ancient Adversaries
Industry Giant
iF-16
The Great Battles of Hannibal
American Civil War
iMA2 Abrams
Semper Fi
Air Warrior II
The Great Battles of Caesar
On the foldover leaf, directly inside the front cover, is color artwork
illustrating two aircraft in a simulated battle over land and ocean representing
the Company's WARBIRDS product with the words "WarBirds" and "Worldwide
MEGAplayer Gaming"
Directly beneath the artwork are the following legends:
AVAILABLE INFORMATION
As of the date of this Prospectus, the Company will become subject to the
reporting requirements of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), and, in accordance therewith, will file reports, proxy
statements and other information with the Securities and Exchange Commission
(the "Commission"). The Company intends to furnish its shareholders with annual
reports containing audited financial statements and such other periodic reports
as the Company deems appropriate or as may be required by law.
----------------
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
WHICH STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE MARKET PRICE OF THE COMMON
STOCK, INCLUDING PLACING STABILIZING BIDS OR EFFECTING PURCHASES OF COMMON
STOCK IN THE OPEN MARKET. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE
"UNDERWRITING."
<PAGE>
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by reference to, and
should be read in conjunction with, the more detailed information and
consolidated financial statements, including the notes thereto, appearing
elsewhere in this Prospectus. Each prospective investor is urged to read this
Prospectus in its entirety. In this Prospectus, the term "Company" includes
Interactive Magic, Inc., its Maryland predecessor and its three subsidiaries.
Unless otherwise indicated, the information in this Prospectus, including per
share data and information relating to the number of shares outstanding, (i)
other than the historical financial statements, gives retroactive effect to the
conversion of the Class A and B common stock and Series A, B and C preferred
stock of the Company into Common Stock and the exercise of options for the
purchase of 363,750 shares of Common Stock (the "Recapitalization Options") and
warrants for the purchase of 516,769 shares of Common Stock (the
"Recapitalization Warrants") on or prior to the consummation of this offering
(the "Recapitalization"), (ii) gives retroactive effect to the one-for-two
reverse split of the Common Stock effected on July 1, 1998 in connection with
the Company's reincorporation in North Carolina, and (iii) assumes no exercise
of the Representatives' over-allotment option to purchase up to 390,000
additional shares of Common Stock. See "Description of Securities --
Recapitalization," "Underwriting" and Note 14 of Notes to Consolidated
Financial Statements.
Interactive Magic, I-Magic, the Interactive Magic logo and Star Rangers
are registered trademarks of the Company. WarBirds, MEGAplayer, MEGAvoice,
iM1A2 Abrams, Hind, Seven Kingdoms, DEMON, Malkari and UltraFighters are
trademarks of the Company. Other trademarks appearing herein are trademarks of
their respective owners.
This Prospectus contains forward-looking statements that involve risks and
uncertainties. The Company's actual results may differ materially from the
results discussed in the forward-looking statements. Factors that might cause
such a difference include, but are not limited to, those discussed in "Risk
Factors."
The Company
Interactive Magic, Inc. (the "Company") develops, publishes and
distributes interactive, real-time, 3D entertainment software, focusing on
simulation and strategy games for CD-ROM and online/Internet use. Since
inception, the Company has published 26 titles on CD-ROM which have been
distributed through more than 15,000 retail outlets in over 30 countries.
Additionally, the Company's initial online product, WARBIRDS, a World War II
air combat simulation game, has generated sales of over 1.4 million hours of
online game time to players in more than 70 countries. Since its first product
offering in August 1995, the Company has been recognized each year with awards
or critical acclaim from industry associations and publications, including PC
Games, PC Today, Computer Gaming World, Power Play, PC Gamer, Computer Games
Strategy Plus and the Software Publishers Association ("SPA"). Since such time,
the Company's net revenues have also grown to $16,502,000 and $4,913,000 for
the year ended December 31, 1997 and the three months ended March 31, 1998,
respectively. The Company seeks to benefit from leveraging its development,
marketing and technological synergy across its dual distribution channels.
Most of the Company's CD-ROM products are designed so that users can play
them both as single-player and multiplayer (up to 16 players) games and include
various levels of difficulty so that both novice and experienced players can
enjoy the Company's games. APACHE, the Company's first published CD-ROM
product, is an air-combat simulation of the AH-64D Apache Longbow Helicopter
for players of all experience levels. APACHE received two Codie Award
nominations from the SPA and was named "Best Simulation of 1995" by both PC
Gamer magazine and Strategy Plus magazine. CAPITALISM, the Company's highly
acclaimed business strategy and simulation CD-ROM game, gives players resources
with which to build a global financial empire and was a runner-up to APACHE as
PC Gamer magazine's "Best Simulation of 1995." SEVEN KINGDOMS, one of the
Company's newest strategy CD-ROM games, presents players with a special
challenge of real-time action and strategy set in a medieval fantasy world of
monsters, gods and opposing cultures and was named "Strategy Game of the Year"
by Germany's PC Power Play magazine. iF-22, the Company's internally developed
flight simulation game, and iF-22 PERSIAN GULF, the Company's recently released
sequel, incorporate the Company's DEMON advanced 3D graphics and terrain
technology. By focusing on delivering highly playable, entertaining games with
high quality graphics, the Company believes it has built strong brand
recognition and consumer loyalty among game enthusiasts. The Company intends to
build upon this loyalty by selectively creating franchise titles through the
publication of sequels and add-ons to existing games, as it has done with its
three-game Great Battles series, GREAT BATTLES OF ALEXANDER, GREAT BATTLES OF
HANNIBAL and GREAT BATTLES OF CAESAR.
3
<PAGE>
WARBIRDS, the Company's first commercial online product, was named "Online
Game of the Year" for the past two years by PC Games magazine and is recognized
as one of the world's leading real-time large-scale (hundreds of players)
multiplayer online games. Players from around the world can access WARBIRDS via
the Internet to simultaneously fly missions in a single campaign and, to date,
there have been as many as 350 such WARBIRDS players online at one time. The
incorporation of 3D rolling terrain graphics, the Company's MEGAvoice
technology, which allows groups of up to four online players to engage in
real-time voice communication, and the Company's MEGAplayer technology, which
minimizes the effect of Internet delays (latency), all add to the realism of
the WARBIRDS playing experience. The Company charges subscription fees for
online play plus additional fees for hours played beyond the subscription
allocation. Users can enter and exit the ongoing game 24 hours a day, seven
days a week, enabling the Company to receive recurring revenues. To encourage
such recurring play, the Company promotes the development of "communities" of
regular WARBIRDS flyers who participate in special promotional events such as
squadron conferences, conventions and competitions around the world. The
Company is seeking to increase revenues from its online business by developing
additional real-time large-scale multiplayer games based on other military,
futuristic/space and action-oriented simulation games. Currently, the Company
has two new online products, FIGHTER OPS and RAIDER WARS, which have undergone
beta testing on the Company's online service, and two new products,
ULTRA-FIGHTERS and MALKARI, which are intended to be playable both as CD-ROM
products and as large-scale multiplayer online products and are in the final
stages of development. All of these products are scheduled for release in 1998.
In addition, the Company is seeking to broaden its user base by negotiating
with several major providers of online services in North America, Germany, the
United Kingdom, Japan and Brazil for rights to distribute the Company's online
products. The Company anticipates that, if finalized, such arrangements would
allow subscribers of a particular online service access to play the Company's
online games at an hourly rate, in exchange for which the Company would receive
a royalty.
The Company's objective is to become one of the world's leading providers
of CD-ROM and real-time large-scale multiplayer online simulation and strategy
games. Key elements of the Company's strategy are to: increase online recurring
revenue, focus on simulation and strategy games, expand brand recognition,
manage risk through internal and external product development, expand its
worldwide distribution network, leverage core proprietary technologies and
expand operations through strategic acquisitions. The Company is led by an
experienced management team and key employees with substantial expertise in the
interactive entertainment software and computer game industries as well as
experience in client-server technology, 3D graphics, large networking systems
and U.S. Department of Defense avionic testing systems. See "Business --
Strategy," "Business -- Product Development" and "Management."
The Interactive Digital Software Association ("IDSA") reported that retail
sales of interactive entertainment software in North America reached $3.7
billion in 1996 and were projected to increase to $5.3 billion in 1997 and $8
billion in 2000. Worldwide entertainment software sales were estimated by IDSA
to have exceeded $10 billion in 1996, roughly divided evenly among the United
States, Europe and Asia. A 1997 Forrester Research report estimates that more
than 6.9 million consumers in the United States are currently playing games
over the Internet, generating revenues of $127 million in 1997, and projects
that 18 million consumers will generate $1.6 billion in revenues in 2001. The
Company believes that the continued availability of lower-cost high performance
multimedia personal computers ("PCs") and modems will continue to contribute to
the increase in PC ownership and thereby expand the use of the Internet and
online services for entertainment purposes.
The Company has sales professionals in North America, the United Kingdom
and Germany and expects to increase its marketing and sales staff in these
locations and expand its offices geographically where appropriate.
Additionally, the Company contracts with distribution agencies in Japan,
Singapore, South America, Korea, South Africa and Australia and its products
are sold by retailers such as CompUSA, Wal-Mart and Best Buy in North America
and Karstadt, Dixon's and PC World in Europe.
The Company was incorporated under the laws of the State of Maryland on
June 16, 1994 under the name SP Enterprises, Inc. and changed its name to
Interactive Magic, Inc. in March 1996. On July 1, 1998, the Company
reincorporated in North Carolina. The Company's corporate headquarters are
located in the Research Triangle Park area at 215 Southport Drive, Suite 1000,
Morrisville, North Carolina 27560, and its telephone number is (919) 461-0722.
4
<PAGE>
The Offering
Common Stock offered............... 2,600,000 shares
Common Stock to be outstanding after the
offering.......................... 9,393,699 shares(1)
Use of Proceeds.................... Repayment of indebtedness, research and
development, marketing and distribution,
and working capital and general corporate
purposes, including possible acquisitions.
See "Use of Proceeds."
Risk Factors....................... The securities offered hereby involve a
high degree of risk and immediate
substantial dilution. See "Risk Factors"
and "Dilution."
Proposed Nasdaq National
Market symbol........................................................ "IMGK"
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(1) Does not include: (i) 1,708,045 shares of Common Stock reserved for
issuance upon the exercise of stock options remaining outstanding
following the Recapitalization, and 1,300,000 shares of Common Stock
reserved for issuance upon the exercise of options available for future
grant, under the Company's stock option and purchase plans (collectively,
the "Plans"); (ii) 449,554 shares of Common Stock reserved for issuance
upon the exercise of warrants remaining outstanding following the
Recapitalization; and (iii) 260,000 shares of Common Stock reserved for
issuance upon the exercise of the Representatives' Warrants. See
"Management -- Stock Option Plans," "Description of Securities --
Warrants" and "Underwriting."
5
<PAGE>
Summary Consolidated Financial Information
(Dollars in thousands, except for per share data)
Set forth below is certain summary financial information for the periods
and as of the dates indicated. This information is derived from, and should be
read in conjunction with, the consolidated financial statements of the Company,
including the notes thereto, appearing elsewhere in this Prospectus.
Consolidated Statement of Operations Data:
<TABLE>
<CAPTION>
Three Months Ended March
Year Ended December 31, 31,
----------------------------------------- -------------------------
1995 1996 1997 1997 1998
----------- ----------- ------------- --------- -------------
(unaudited)
<S> <C> <C> <C> <C> <C>
Net revenues .................................. $ 4,121 $ 6,057 $ 16,502 $3,957 $ 4,913
Cost of revenues .............................. 1,669 2,393 6,349 1,415 1,877
Gross profit .................................. 2,452 3,664 10,153 2,542 3,036
Operating expenses:
Sales and marketing ......................... 2,335 5,008 6,760 1,642 1,667
Product development ......................... 1,518 3,788 3,878 859 1,103
General and administrative .................. 828 1,451 1,941 598 449
Total operating expenses ...................... 4,681 10,247 12,579 3,099 3,219
Operating loss ................................ (2,229) (6,583) (2,426) (557) (183)
Interest expense .............................. 175 606 1,675 300 307
Net loss ...................................... (2,451) (7,200) (4,298) (825) (618)
Pro forma net loss per share (1)(2) ........... $ (0.68) $ (0.09)
Number of shares used in computing
pro forma net loss per share (1)(2) ......... 6,343,080 6,619,708
</TABLE>
Consolidated Balance Sheet Data:
<TABLE>
<CAPTION>
December 31, 1997 March 31, 1998 (unaudited)
------------------- ---------------------------------------------------
Pro Forma
Actual Pro Forma (2) As Adjusted (2)(3)
----------- --------------- -------------------
<S> <C> <C> <C> <C>
Working capital (deficiency) ........... $ (1,933) $ 799 $ 899 $16,091
Total assets ........................... 7,747 9,211 9,311 23,003
Long-term debt (4) ..................... 7,229 4,661 4,661 --
Total liabilities ...................... 16,646 12,970 12,651 5,481
Redeemable preferred stock ............. -- 600 -- --
Shareholders' equity (deficit) ......... (8,899) (4,359) (3,340) 17,522
</TABLE>
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(1) See Note 3 of Notes to Consolidated Financial Statements for an explanation
of the number of shares used in computing pro forma net loss per share.
(2) Gives retroactive effect to the Recapitalization, including the $10,335
paid to the Company in connection with the exercise of the
Recapitalization Warrants, as well as cash proceeds of $90,000 paid to the
Company, and the forgiveness of $318,750 of the Company's accrued interest
expense, in connection with the exercise of the Recapitalization Options.
See "Description of Securities -- Recapitalization," "Certain
Transactions" and Notes 3 and 14 of Notes to Consolidated Financial
Statements.
(3) Adjusted to give retroactive effect to the sale of the 2,600,000 shares of
Common Stock offered hereby at an assumed offering price of $9.00 per
share (the mid-point of the currently anticipated range of the initial
public offering price) and the anticipated application of the estimated
net proceeds therefrom, including for the repayment of indebtedness. See
"Use of Proceeds."
(4) Includes long-term debt, less current portion, and notes payable to
related parties.
6
<PAGE>
RISK FACTORS
An investment in the shares of Common Stock offered hereby involves a high
degree of risk. In addition to the other information in this Prospectus,
prospective investors should carefully consider the following risk factors in
evaluating the Company and its business before purchasing shares of the Common
Stock offered hereby.
Limited Relevant Operating History; Historical Losses
The Company began operations in June 1994 and shipped its first CD-ROM
simulation and strategy game for PCs in August 1995 and released its first, and
to date only, real-time large-scale multiplayer simulation game on the Internet
in December 1995. Consequently, the Company has a limited relevant operating
history upon which an evaluation of its prospects can be made. Such prospects
must be considered in light of the risks, expenses and difficulties frequently
encountered in connection with the operation and expansion of a new business
and commercialization of new products, particularly those associated with the
rapidly evolving interactive entertainment software industry, which is
characterized by an increasing number of market entrants, intense competition,
substantial capital requirements and a high failure rate. In addition, the
Company has experienced significant losses in each of its formative years,
resulting primarily from overhead and other costs incurred in the development
and growth of the Company, including losses of approximately $7,200,000,
$4,298,000 and $618,000 for the years ended December 31, 1996 and 1997 and the
three months ended March 31, 1998, respectively, resulting in an accumulated
deficit of approximately $14,828,000 at March 31, 1998. Moreover, the Company
expects to incur substantial up-front expenditures and operating costs in
connection with the expansion of its marketing efforts and product lines, which
may result in significant losses for the foreseeable future. There can be no
assurance that the Company will be able to successfully implement its growth
and business strategies, that its revenues will continue to increase or that it
will ever be able to achieve or sustain profitable operations. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and Consolidated Financial Statements.
Significant Capital Requirements; Negative Cash Flow; Possible Need for
Additional Financing
The Company's capital requirements have been and will continue to be
significant, and, to date, its cash requirements have been exceeding its cash
flow from operations. Since inception, the Company has raised capital of
approximately $17,614,000 (excluding bank debt of which there is currently
outstanding approximately $5,684,000 principal amount), of which $7,070,000
represents debt securities ($2,000,000 of which has been repaid) and
$10,544,000 represents equity securities. The Company has been dependent on
these private financings to fund a portion of its capital requirements. In
addition, based on the Company's current product development plans, the
Company's capital requirements are expected to increase. As a result, the
Company is dependent upon the proceeds of this offering to complete the
development of its currently proposed products and fund its business
strategies. Although the Company anticipates, based on its currently proposed
plans and assumptions relating to its operations (including assumptions
regarding the progress and timing of its new product development efforts), that
the net proceeds of this offering, together with anticipated revenues from
operations, availability under the Company's bank lines of credit and cash and
cash equivalents, will be sufficient to fund the Company's operations and
capital requirements for at least 12 months following the consummation of this
offering, there can be no assurance that such funds will not be expended prior
thereto due to unanticipated changes in economic conditions or other unforeseen
circumstances. In the event the Company's plans change or its assumptions
change or prove to be inaccurate, the Company would be required to seek
additional financing sooner than currently anticipated. The Company has no
current arrangements with respect to, or potential sources of, any additional
financing, and it is not anticipated that existing shareholders will provide
any portion of the Company's future financing requirements. Consequently, there
can be no assurance that any additional financing will be available to the
Company when needed, on commercially reasonable terms, or at all. Any inability
to obtain additional financing when needed would require the Company to delay
or scale back its product development and marketing programs, which could have
a material adverse effect on the Company. In addition, any additional equity
financing may involve substantial dilution to the interests of the Company's
then existing shareholders. See "Use of Proceeds" and "Management's Discussion
and Analysis of Financial Condition and Results of Operations."
Fluctuations in Quarterly Operating Results; Uncertainty of Future Results
The Company's quarterly operating results have fluctuated significantly in
the past and will likely fluctuate significantly in the future depending on a
variety of factors, several of which are not in the Company's control.
7
<PAGE>
Such factors include the demand for the Company's products and the products of
its competitors, the size and rate of growth of the interactive entertainment
software market, development and promotional expenses related to the
introduction of new products or enhancements, the degree of market acceptance
for the Company's new product introductions and enhancements, the timing of
orders from significant customers, delays in shipment, the level of price
competition, changes in computing platforms, the nature and magnitude of
product returns, order cancellations, software defects and other quality
problems, the length of product life cycles, the percentage of the Company's
sales related to international sales and changes in personnel. Products are
generally shipped as orders are received, and, accordingly, the Company
operates with little backlog. Net revenues in any quarter are, therefore,
substantially dependent on orders booked and shipped in that quarter. A
significant portion of the Company's operating expenses is relatively fixed,
and planned expenditures are primarily based on expectations regarding future
sales; as a result, operating results in any given quarter would be
disproportionately adversely affected by a decrease in sales or a failure to
meet the Company's sales expectations. Operating results for future periods are
subject to numerous uncertainties, and there can be no assurance that the
Company will become profitable or sustain profitability on an annual or
quarterly basis. Based on the foregoing, the Company believes that
period-to-period comparisons of operating results should not be relied upon as
indicative of future results. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
Short CD-ROM Product Life Cycles; Dependence On a Limited Number of Products
The market for interactive CD-ROM software games is characterized by short
product life cycles and frequent introduction of new products, most of which do
not achieve sustained market acceptance or do not generate a sufficient level
of sales to offset the costs associated with product development. Generally,
the majority of sales of new products occur within the first six months
following their release. The Company's success will depend upon development of
new, commercially successful products and upon its ability to replace revenues
from products at the later stages of their life cycles. The Company believes
that competition in the interactive entertainment software market requires the
development of higher quality, distinctive products that incorporate
increasingly sophisticated effects and the need to support product releases
with increased marketing, all of which results in higher development,
acquisition and marketing costs. To date, the Company has derived a significant
portion of its revenues from a limited number of software products released
each year, and many of these products have substantial development or
acquisition costs and marketing budgets. Due to this dependence on a limited
number of products, the Company may be adversely affected if one or more of its
principal products fails to achieve anticipated results. During the years ended
December 31, 1996 and 1997, two titles and three titles accounted for
approximately 56.0% and 55.8%, respectively, of the Company's consolidated net
shipments after factoring in product returns. There can be no assurance that
the Company will not remain dependent upon non-recurring sales of a limited
number of products for a substantial portion of its revenues or that any
products introduced by the Company will be commercially viable or have life
cycles sufficient to permit the Company to recoup the development, marketing
and other costs associated with their development. Failure to continuously
introduce new, commercially successful products would have a material adverse
effect on the Company. See "Business -- Products."
Lengthy Development Cycle; Product Development Risks
The Company's success depends on the timely introduction of successful new
products. The development of new interactive entertainment software products is
lengthy, expensive and uncertain, and a product's development typically
requires six to 24 months to complete from the time a new concept is approved.
In addition, product development of online products continues for the life of
the product. Many of the Company's proposed products are in early stages of
development, and the Company will be required to commit considerable time,
effort and resources to complete development of its currently proposed
products. The Company has, in the past, experienced significant delays in the
introduction of certain new products and there will likely be delays in
developing and introducing new products in the future. In addition, because
many of the Company's products are developed for it by third parties, the
Company cannot always control the timing of their introduction. While the
Company maintains production arrangements with its third-party developers,
provides them with certain software tool kits to promote quality control and
monitors their progress, there can be no assurance that delays in the work
performed by third parties or poor quality of such work will not result in
product delays. Unanticipated delays, expenses, technical problems or
difficulties could cause the Company to miss an important selling season with a
corresponding negative impact on revenues and net income or result in
abandonment or material change in product commercialization.
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There can be no assurance that the Company will be able to successfully develop
any new products on a timely basis or that technical or other problems will not
occur which would result in increased costs or material delays. In addition,
software products as complex as those offered by the Company may contain
undetected errors when first introduced. Despite extensive product testing, the
Company has, in the past, released products with defects and has discovered
software errors in certain of its product offerings after their introduction.
In particular, the personal computer hardware environment is characterized by a
wide variety of non-standard peripherals (such as sound cards and graphics
cards) and configurations that make pre-release testing for programming or
compatibility errors very difficult and time-consuming. There can be no
assurance that, despite testing by the Company, errors will not be found in new
products or releases after commencement of commercial shipments. Remedying such
errors may delay the Company's plans, cause it to incur additional costs and
adversely affect its reputation. See "Business -- Technology" and "Business --
Product Development."
Industry Factors; Changing Consumer Preferences; Uncertainty of Market
Acceptance
The level of demand and market acceptance for the Company's newly
introduced products is subject to a high degree of uncertainty. Software
acquisition and development costs, as well as promotion and marketing expenses,
royalties and third-party participations payable to software developers,
creative personnel, musicians and others, which reduce potential revenues
derived from software sales, have increased significantly in recent years. The
Company's future operating results will depend on numerous factors beyond its
control, including the popularity, price and timing of new entertainment
software products being released and distributed, international, national,
regional and local economic conditions (particularly economic conditions
adversely affecting discretionary consumer spending), changes in consumer
demographics, the availability of other forms of entertainment, critical
reviews and public tastes and preferences, all of which change rapidly and
cannot be predicted. The Company's ability to plan for product development and
promotional activities will be significantly affected by its ability to
anticipate and respond to relatively rapid changes in consumer tastes and
preferences, particularly those of the consumers, primarily males over age 25
with annual household incomes of $50,000 or more, comprising the Company's
principal target market. A decline in the popularity of software games or in
the interactive entertainment software industry generally or in particular
market segments could adversely affect the Company's business and prospects. In
addition, the success of the Company's strategy to capitalize on online games
will depend in part upon market acceptance of online games and a "pay-for-play"
model. Online game play is a new and evolving concept, and it is difficult to
assess or predict with any assurance the size of the market for online games or
its prospects for growth. There can be no assurance that a viable market for
online games will develop, that the Company will be successful in developing
additional products for online use or that the Company's products for this
market will achieve widespread market acceptance. See "Business -- Industry
Overview" and "Business -- Distribution."
Infrastructure Risks of Online Game Play
The development of a robust market for online games will depend on several
factors that are outside the Company's control, including the development and
maintenance of an industry infrastructure for providing consumer access to
online games. There can be no assurance that the infrastructure, including a
reliable network foundation, and timely development of complementary products,
such as high-speed modems, necessary to make local or wide area networks or the
Internet a viable medium for use of real-time large-scale multiplayer
simulation and strategy games will be developed, or, if developed, that such
networks will become a viable medium for use of multiplayer simulation and
strategy games. In addition, hardware restrictions, such as bandwidth (amount
of data capable of transmission at a single time) and latency (delays
introduced by the network), which limit use of content via local and wide area
networks, may inhibit such networks from becoming a viable medium for delivery
of multiplayer simulation and strategy games. If the necessary infrastructure
or complementary products are not developed, or if such networks do not become
a viable medium for delivery of multiplayer simulation and strategy games, the
Company's business, operating results and financial condition may be materially
adversely affected. See "Business -- Industry Overview" and "Business --
Technology."
Changes in Technology and Industry Standards
The interactive entertainment software industry is undergoing rapid
changes, including evolving industry standards, frequent new platform
introductions and changes in consumer requirements and preferences. The
introduction of new technologies, technologies that support multiplayer games
and new media formats such as online delivery
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and digital video disks, could render the Company's previously released
products obsolete or unmarketable. The development cycle for products utilizing
new operating systems, microprocessors or formats may be significantly longer
than the Company's current development cycle for products on existing operating
systems, microprocessors and formats and may require the Company to invest
resources in products that may not become profitable. There can be no assurance
that the mix of the Company's future product offerings will keep pace with
technological changes or satisfy evolving consumer preferences or that the
Company will be successful in developing and marketing products for any future
operating system or format. Failure to develop and introduce new products and
product enhancements in a timely fashion could result in significant product
returns and inventory obsolescence and could have a material adverse effect on
the Company's business, operating results and financial condition.
The overall market for the Internet is characterized by rapidly changing
technology, evolving industry standards, emerging competition and frequent
product and service introductions. There can be no assurance that the Company
can successfully identify new product opportunities for Internet use and
develop and bring such new products to market in a timely manner, or that
products or technologies developed by others will not render the Company's
products or technology obsolete. The Company also is at risk to fundamental
changes in the way Internet connectivity services are delivered. Currently,
Internet services are accessed primarily by computers and are delivered by
telephone lines. If the Internet becomes accessible by screen-based telephones,
television or other consumer electronic devices, or becomes deliverable through
other means such as coaxial cable or wireless transmission, the Company may
have to develop new technology or modify its existing technology to accommodate
these developments. The Company's pursuit of such technological advances may
require substantial time and expense, and there can be no assurance that the
Company will succeed in adapting its products to alternate access devices and
conduits. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations," "Business -- Products" and "Business -- Technology."
Intense Competition; Competition for Shelf Space
The interactive entertainment software industry is intensely and
increasingly competitive. Industry competition is based primarily upon product
quality and features, the compatibility of products with popular platforms,
access to distribution channels (including access to retail shelf space),
marketing effectiveness, reliability and ease of use, price and the quality of
user support services. Many of the companies with which the Company currently
competes or may compete against in the future have greater financial,
technical, marketing, sales and customer support and other resources than the
Company and have established reputations for success in the development,
licensing and sale of their products and technology. Current and future
competitors with greater financial resources than the Company may be able to
carry larger inventories, undertake more extensive marketing campaigns, adopt
more aggressive pricing policies and make higher offers or guarantees to third
party software developers and licensors than the Company. As competition
increases, significant price competition, increased production costs and
reduced profit margins may result. 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 have a material
adverse effect on its future operations.
Retailers of the Company's CD-ROM products typically have a limited amount
of shelf space and promotional resources, and there is intense competition
among entertainment software producers for adequate levels of desirable shelf
space and promotional support from retailers. As the number of entertainment
software products has increased, the competition for shelf space has
intensified, resulting in greater leverage for retailers and distributors in
negotiating terms of sale, including price discounts, marketing and display
fees and product return policies. The Company's CD-ROM products constitute a
relatively small percentage of any retailer's sales volume, and there can be no
assurance that retailers will continue to purchase the Company's products or
provide the Company's products with adequate levels of shelf space and
promotional support. See "Business -- Distribution" and "Business --
Competition."
Ability to Manage and Sustain Growth; Risks Associated with Future Acquisitions
The Company intends to use a portion of the proceeds of this offering to
implement the next phase of its business strategy in an effort to expand its
current level of operations and grow the Company's business. In addition to its
internal growth strategies, the Company intends to evaluate, on an ongoing
basis, potential acquisitions of, or investments in, other software publishers
or developers, distributors or other businesses which the Company believes will
complement or enhance its existing business. The success of such strategy thus
will depend upon,
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among other things, the Company's ability to hire and retain skilled
management, marketing, technical and other personnel and to successfully manage
its growth (which also will require it to develop and improve upon its
operational, management and financial systems and controls in order to properly
monitor its expanded operations, control its costs and maintain effective
quality controls). There can be no assurance that the Company will be able to
expand its operations or that it will be able to effectively manage any such
expansion or anticipate and satisfy all of the changing demands and
requirements that growth will impose upon its operations. In addition,
acquisitions involve numerous additional risks, including difficulties in the
assimilation of the operations and products of the acquired companies, the
expenses incurred in connection with the acquisition and subsequent
assimilation of operations and products, the diversion of management's
attention from other business concerns and the potential loss of key employees
of the acquired company. Acquisitions of foreign companies also may involve the
additional risks of assimilating differences in foreign business practices and
overcoming language barriers. If the Company consummates any acquisition in the
future, there can be no assurance that the Company will be able to integrate
the acquired operations successfully, and any inability to do so could
adversely affect the Company's business. See "Use of Proceeds."
In addition, while the Company will explore acquisitions of businesses and
assets that it believes are compatible with its business strategy and regularly
evaluates possible acquisition opportunities, as of the date of this
Prospectus, the Company has no current agreements, commitments, understandings
or arrangements with respect to any potential acquisition. Consequently, there
is no basis for investors in this offering to evaluate, prior to their
investment in the Company, the specific merits or risks of any potential
acquisition that the Company may undertake following the consummation of the
offering. Moreover, under North Carolina law, various forms of business
combinations can be effected without shareholder approval; accordingly,
investors in this offering will, in some instances, neither receive nor
otherwise have the opportunity to evaluate any financial or other information
which may be made available to the Company in the future in connection with any
acquisition and must rely entirely upon the ability of management in selecting,
structuring and consummating acquisitions that are consistent with the
Company's business objectives. Although the Company will endeavor to evaluate
the risks inherent in a particular acquisition, there can be no assurance that
the Company will properly ascertain or assess all significant risk factors
prior to consummating any acquisition.
Dependence on Third-Party Software Developers
The Company relies on third-party software developers for the development
of a significant number of its products. Due primarily to increased demand for
quality interactive entertainment software programs, the Company's payment of
advances and guaranteed royalties to such independent software developers has
increased and may continue to increase. There can be no assurance that the
sales of products associated with such royalties will be sufficient to cover
the amount of the Company's prepayment expenditures. Moreover, as independent
developers are in high demand, there can be no assurance that such developers,
including those that have developed products for the Company in the past, will
be available to develop products for the Company in the future. The failure to
obtain or renew product development agreements with such developers could have
a material adverse effect on the Company's future operations. In addition, many
independent developers have limited financial resources, which also could
expose the Company to the risk that such developers may go out of business
prior to completing a project. See "Business -- Product Development -- External
Development."
Dependence on Third-Party Distribution Channels
The Company currently sells its CD-ROM software products primarily through
software distributors and to major computer and software retailing
organizations. Sales of CD-ROM games to a limited number of distributors and
retailers constitute a substantial majority of the Company's net revenues. For
the year ended December 31, 1996, sales of products to two distributors, Tech
Data Corp. ("Tech Data") and Navarre Corporation ("Navarre"), accounted for
approximately 26.5% and 11.3%, respectively, of the Company's net revenues. For
the year ended December 31, 1997, sales of products to Tech Data and
Electronics Boutique, Inc. accounted for 19.0% and 10.0% of the Company's net
revenues, respectively.
Certain mass market retailers have established exclusive buying
relationships under which such retailers will buy consumer software only from
one intermediary. In such instances, the price or other terms on which the
Company sells to such retailers may be adversely affected by the terms imposed
by such intermediary, or the Company may be unable to sell to such retailers on
terms which the Company deems acceptable. There can
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be no assurance that the Company's relationships with its current distributors
and retailers will continue or that the Company will be able to find other
means to market and distribute its CD-ROM products. The loss of, or a
significant reduction in sales attributable to, any of the Company's principal
distributors or retailers, in the absence of comparable new relationships or
the development of independent means of marketing and distributing its CD-ROM
games, could have a material adverse effect on the Company's revenues and
operating results. In addition, the Company maintains a reserve for
uncollectible receivables that it believes to be adequate, but the actual
reserve maintained may not be sufficient in every circumstance. A payment
default by a significant customer could have a material adverse effect on the
Company's business, operating results and financial condition. The Company also
intends to expand the distribution of its online products by seeking out
relationships with third-party providers of online or Internet services in the
United States and abroad. There can be no assurance that the Company will
successfully negotiate relationships with providers of online or Internet
services or, if completed, that such arrangements will generate significant
revenues. The Company could be materially adversely affected if the cost to the
Company of any proposed online or Internet distributor relationship exceeds
expectations or if the Company incurs significant costs in anticipation of the
arrangement and the arrangement is delayed or abandoned. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Results of Operations," and "Business -- Distribution" and Note 11 of Notes to
Consolidated Financial Statements.
Risk of Product Returns
The Company accepts product returns or provides markdowns or other credits
in the event that customers hold excess inventory of the Company's products.
The Company also accepts returns of defective, damaged or shelf-worn products
at any time. At the time of product shipment, the Company establishes reserves
for stock-balancing, price protection and returns of defective, damaged and
shelf-worn products, based on historical return rates, retailer inventories of
the Company's products and other factors. Although the Company maintains
reserves which it believes to be adequate, if market acceptance is not
achieved, the Company could be forced to accept substantial product returns to
maintain favorable relationships with retailers and access to distribution
channels. There can be no assurance that actual returns to the Company will not
exceed the reserves established. Product returns that exceed the Company's
reserves could materially and adversely affect the Company's operating results.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operation."
Dependence on Key Personnel
The Company's success depends to a significant extent on the performance
and continued service of its senior management and certain key employees.
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 or
retaining such personnel. Specifically, the Company may experience increased
costs in order to attract and retain skilled employees. Although the Company
generally enters into term employment agreements with its senior management,
there can be no assurance that such employees or any other employees will not
leave the Company or compete against the Company. The Company's failure to
attract or retain qualified employees could have a material adverse effect on
the Company's business, operating results and financial condition. See
"Management."
Limited Protection of Proprietary Information
The Company regards its software technology as proprietary and holds
copyrights on its internally developed products, manuals, advertising and other
materials and maintains trademark rights in the Company name, the Interactive
Magic logo and the names of products owned by the Company. The Company does not
acquire the copyrights for works developed by third parties under license which
the Company publishes. Although the Company has applied for a patent on its
MEGAplayer technology that enables its online products to function more
effectively on the Internet, there can be no assurance that a patent will be
issued by the United States Patent and Trademark Office. While the Company
relies on a combination of trademark, trade secret, copyright and other
proprietary rights laws, license agreements, employee and third-party
non-disclosure agreements and other methods to establish and protect its
proprietary rights, there can be no assurance that the steps taken by the
Company will be adequate to prevent misappropriation of the technology or
independent development by others of software products with features based
upon, or otherwise similar to, those of the Company's products. To license its
products to end users, the Company primarily relies on "shrink wrap" licenses
that are not signed by the end-user and, therefore, may be unenforceable under
the laws of certain jurisdictions. In addition, effective copyright and trade
secret
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protection may be unavailable or limited in certain foreign countries, and the
global nature of certain wide area networks, particularly the Internet, makes
it virtually impossible to control the ultimate destination of the Company's
products. Despite the Company's efforts to protect its proprietary rights,
unauthorized parties may attempt to copy aspects of the Company's products or
to obtain and use information that the Company regards as proprietary.
Unauthorized copying is common within the software industry, and if a
significant amount of unauthorized copying of the Company's products were to
occur, the Company's business, operating results and financial condition could
be adversely affected. As the number of software products in the industry
increases and the functionality of these products further overlaps, software
developers may become increasingly subject to infringement claims. There can be
no assurance that third parties will not assert infringement claims against the
Company in the future with respect to current or future products. As is common
in the industry, from time to time, the Company receives notices from third
parties claiming infringement of intellectual property rights of such parties.
The Company investigates these claims and responds as it deems appropriate.
Litigation may be necessary in the future to enforce the Company's intellectual
property rights, to protect the Company's trade secrets, to determine the
validity and scope of the proprietary rights of others, or to defend against
claims of infringement or invalidity. Any such litigation could result in
substantial costs and diversion of resources and could have a material adverse
effect on the Company. See "Business -- Intellectual Property and Other
Proprietary Rights."
Risks Related to International Revenues and Operations
The Company distributes its products in over 30 countries worldwide and
maintains sales offices in the United Kingdom and Germany in addition to its
facilities and operations in the United States. International sales and
licensing (excluding online revenue) accounted for 23% and 37% of the Company's
net revenues in 1996 and 1997, respectively. International operations and sales
of CD-ROM products are subject to inherent risks, including fluctuations in
exchange rates, the impact of possible recessionary environments in economies
outside the United States, the costs of transferring and localizing products
for foreign markets, longer accounts receivable collection periods and
difficulty in collection of accounts receivable, unexpected changes in
regulatory requirements, tariffs and other barriers, difficulties and costs of
staffing and managing foreign offices and potential political and economic
instability. Revenues and expenses from the Company's foreign operations
generally are denominated in local currencies, and, as a result, exchange rate
fluctuations between such local currencies and the U.S. dollar will subject the
Company to currency translation risk from the reported results of its foreign
operations. The Company intends to continue to expand its direct and indirect
sales and marketing activities worldwide; however, there can be no assurance
that the Company will be able to maintain or increase international market
demand for its products or that these or other factors will not have a material
adverse effect on the Company's future international sales and, consequently,
on the Company's operating results. See "Business -- Distribution."
Manufacturing Risks
The production of the Company's published products for retail sale
involves duplicating software programs onto CD-ROM disks, printing user manuals
and product packaging materials and packaging finished products. The foregoing
activities are performed for the Company by third-party vendors in accordance
with the Company's specifications. While these services are available from
multiple parties and at multiple sites, there can be no assurance that an
interruption in the manufacture of the Company's products will not occur and,
if it does occur, that it could be remedied without undue delay. In addition,
the Company must compete for CD-ROM duplication services with its competitors,
as well as publishers of music and video CDs. While the Company engages in
ongoing efforts to ensure an adequate and timely supply of CD-ROMs, there can
be no assurance that the future supply of CD-ROMs will be sufficient to meet
the Company's requirements. The Company must place advance orders for finished
goods based on forecasts of the sales volume of the product; there can be no
assurance that the Company's forecasts will prove accurate, and any resulting
over-production or under-production of the Company's CD-ROM products could have
a material adverse effect on the Company. See "Business -- Production and
Manufacturing."
Outstanding Indebtedness; Consequences of Default and Covenants Under Lines of
Credit
Following this offering, the Company intends to continue to maintain its
line of credit of up to $5,000,000 with Greyrock Business Credit, a division of
NationsCredit Commercial Corporation ("Greyrock"). Amounts borrowed under this
credit line bear interest at prime (as adjusted monthly) plus 2% per year. The
credit line remains in effect until April 30, 1999, after which time it
automatically renews unless either party gives notice of termination. To date,
the Company has borrowed $2,684,000 under this line, which will remain
outstanding
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after this offering. The Company also will continue to have $1,057,000 (based
on amounts outstanding at March 31, 1998) outstanding under its lines of credit
and $250,000 pursuant to a promissory note, each with Branch Banking & Trust
Company ("BB&T"), which bear interest at BB&T's prime rate per annum. In
addition, the Company will continue to owe $77,060 and $72,446 to J. W. Stealey
and Robert L. Pickens, respectively, for accrued interest through March 31,
1998 on prior loans converted to capital stock in 1998. The Company's ability
to meet its debt service obligations will depend on the Company's future
operations, which are subject to prevailing industry conditions and other
factors, many of which are beyond the Company's control. Because indebtedness
under the Company's lines of credit bear interest at rates that fluctuate with
prevailing interest rates, increases in such prevailing rates would increase
the Company's interest payment obligations and could adversely affect the
Company's financial condition and results of operations. Furthermore, the
Company's indebtedness under its line of credit with Greyrock is secured by
substantially all of the Company's assets, as well as the assets of its
wholly-owned subsidiary, iMagic Online Corporation. In the event of a violation
by the Company of any of its loan covenants or any other default by the Company
on its obligations relating to its indebtedness, Greyrock could declare such
indebtedness to be immediately due and payable and, in certain cases, Greyrock
could then foreclose on the pledged collateral. Although the Company expects
that it will be in compliance with all of its loan covenants upon the
consummation of this offering, there can be no assurance that the Company will
be able to maintain such compliance in the future. A default relating to the
Company's indebtedness, in the absence of a waiver, could have a material
adverse effect upon the Company's business and financial condition. Moreover,
to the extent that the accounts receivable, inventory and intellectual property
of the Company (excluding its foreign subsidiaries) continue to be pledged to
secure its outstanding indebtedness under the credit facility, such assets will
not be available to secure additional indebtedness, which may affect the
Company's ability to borrow in the future. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations," "Certain
Transactions" and Notes 4 and 14 of Notes to Consolidated Financial Statements.
Substantial Use of Proceeds to Repay Indebtedness; Proceeds Used to Benefit
Related Parties; Broad Discretion in Application of Proceeds
The Company has allocated approximately $7,170,000 of the net proceeds of
this offering to repay outstanding indebtedness. Accordingly, such proceeds
will not be available to fund future growth of the Company. The indebtedness to
be repaid includes, among other things, $870,000 payable to Laura M. Stealey,
the former spouse of J. W. Stealey, the Chairman of the Company, as well as
$1,500,000 payable to BB&T, each of which is guaranteed by J. W. Stealey. The
Company also will pay $117,175, $371,404 and $111,421 to Laura M. Stealey, J.
W. Stealey and Robert L. Pickens, respectively, in payment of certain interest
accrued in connection with their loans to the Company. In addition,
approximately $7,392,000 (35.4%) of the estimated net proceeds of this offering
has been allocated to working capital and general corporate purposes, thus
management will have broad discretion as to the application of such proceeds.
The Company also intends to use $400,000 of the net proceeds to fulfill its
obligations under a marketing agreement with General Capital, an affiliate of
Vertical Financial Holdings, a principal shareholder of the Company. See "Use
of Proceeds" and "Certain Transactions."
Concentration of Ownership
Following completion of this offering, the Company's executive officers
will own beneficially approximately 32.8% of the outstanding shares of Common
Stock, and the Company's non-executive directors and their affiliated entities
together will beneficially own approximately 28.6% of the outstanding shares of
Common Stock. Accordingly, such persons will be in position to influence the
election of the Company's directors and the outcome of corporate actions
requiring shareholder approval. The concentration of ownership may have the
effect of delaying or preventing a change in control of the Company. See
"Management," "Principal Shareholders" and "Description of Securities."
Absence of Prior Market; Possible Volatility of Stock Price
Prior to this offering, there has been no public market for the Company's
Common Stock, and there can be no assurance that an active trading market will
develop or be sustained after this offering. The initial public offering price
will be determined through negotiations between the Company and the
Underwriters and may not represent prices which will prevail in the trading
market. The market price of the Company's Common Stock could be subject to wide
fluctuations in response to variations in quarterly operating results and other
factors, such as announcements of new products by the Company or its
competitors and failures to meet or exceed the expectations of securities
analysts or investors or other events. Furthermore, the stock market has
experienced
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significant price and volume fluctuations that have particularly affected the
market prices of many high technology companies and that have often been
unrelated or disproportionate to the operating performance of such companies.
These market fluctuations, as well as economic conditions generally and in the
entertainment software industry specifically, may have an adverse effect on the
market price of the Company's Common Stock. There can be no assurance that the
market price of the Common Stock will not decline below the initial public
offering price. See "Underwriting."
Immediate and Substantial Dilution to Investors in this Offering
Investors in this offering will experience immediate and substantial
dilution in the net tangible book value of their shares of Common Stock. After
giving effect to this offering and the use of the net proceeds therefrom and to
the Recapitalization, the Company's net tangible book value as of March 31,
1998 would have been $17,522,336 or $1.87 per share (based on an assumed
offering price of $9.00 per share, the midpoint of the currently anticipated
range of the initial public offering price). This represents an immediate
dilution in net tangible book value of $7.13 (79.2%) per share. See "Dilution."
Dividends
The Company has never paid any cash dividends on its Common Stock and does
not anticipate paying cash dividends in the foreseeable future as it intends to
retain any net income for use in connection with the expansion of its business.
See "Dividend Policy."
Shares Eligible for Future Sale; Registration Rights
Sales of substantial amounts of Common Stock in the public market after
this offering could adversely affect prevailing market prices for the Common
Stock. Upon completion of this offering, the Company will have 9,393,699 shares
of Common Stock outstanding. Of these shares, the 2,600,000 shares offered
hereby will be freely tradable without restrictions or further registration
under the Securities Act of 1933, as amended (the "Securities Act"), except for
any shares purchased by "affiliates" of the Company, as that term is defined in
Rule 144 under the Securities Act, which will be subject to the resale
limitations imposed by Rule 144. All of the remaining 6,793,699 shares of
Common Stock outstanding will be "restricted securities" within the meaning of
Rule 144. Of such restricted securities, 3,218,114 shares are subject to
certain registration rights, and the Company has granted the Representatives
demand and piggyback registration rights with respect to the shares of Common
Stock issuable upon exercise of the Representatives' Warrants. In addition,
77,648 shares of Common Stock underlying outstanding warrants are subject to
certain registration rights. No prediction can be made as to the effect, if
any, that sales of such securities or the availability of such securities for
sale will have on the market prices prevailing from time to time. While the
Company's officers, directors and substantially all of the 1% or greater
shareholders of the Company's currently outstanding Common Stock have agreed
not to sell or otherwise dispose of any shares of Common Stock or exercise any
registration rights for a period of nine months following the date of this
Prospectus without the Representatives' prior written consent, the possibility
that a substantial number of the Company's securities may be sold in the public
market may adversely affect prevailing market prices for the Common Stock and
could impair the Company's ability to raise capital through the sale of its
equity securities. See "Description of Securities," "Shares Eligible For Future
Sale" and "Underwriting."
Year 2000 Compliance
Many currently installed computer systems and software products are coded
to accept only two digit entries in the date code field. These date code fields
will need to accept entries to distinguish 21st century dates from 20th century
dates. As a result, in less than two years, computer systems and software used
by many companies may need to be upgraded to comply with such Year 2000
requirements. The Company believes that its products, which are self-contained
software programs that run independently of external systems, will not be
significantly affected by Year 2000 issues. The Company is currently in the
process of investigating whether its internal accounting systems and other
operational systems will be affected by the Year 2000 issue. In addition, the
Company is assessing the readiness of third-party customers and suppliers for
the Year 2000 issue. There can be no assurance that these third parties will
timely convert their systems or that their systems will not have an adverse
effect on the Company, or that Year 2000 issues or the cost of addressing them
will not have a material impact on the
15
<PAGE>
Company's financial statements, business or operations. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
Limited Lead Underwriting Experience
Although BlueStone has engaged in the investment banking business since
its formation as a broker-dealer in March 1996, and its principals have had
extensive experience in the underwriting of securities in their capacities with
other broker-dealers, this offering constitutes one of the first public
offerings for which BlueStone has acted as lead underwriter. See
"Underwriting."
Forward-Looking Information May Prove Inaccurate
This Prospectus contains various forward-looking statements that are based
on the Company's beliefs as well as assumptions made by and information
currently available to the Company. When used in this Prospectus, the words
"believe," "expect," "anticipate," "estimate" and similar expressions are
intended to identify forward-looking statements. The accuracy of such
forward-looking statements is subject to certain risks, uncertainties and
assumptions, including those identified above under "Risk Factors." Should one
or more of these risks or uncertainties materialize, or should underlying
assumptions prove incorrect, actual results may vary materially from those
anticipated, estimated, or projected. The Company cautions potential purchasers
not to place undue reliance on any such forward-looking statements.
16
<PAGE>
USE OF PROCEEDS
The net proceeds to the Company from the sale of the 2,600,000 shares of
Common Stock offered hereby are estimated to be approximately $20,862,000
($24,126,300 if the Representatives' over-allotment option is exercised in
full), assuming an initial public offering price of $9.00 per share (the
midpoint of the currently anticipated range of the initial public offering
price) and after deducting the underwriting discount and estimated offering
expenses payable by the Company. The Company expects to use the net proceeds
approximately as follows:
<TABLE>
<CAPTION>
Approximate
Approximate Percentage of
Anticipated Use of Net Proceeds Dollar Amount Net Proceeds
- --------------------------------------------------------------- --------------- --------------
<S> <C> <C>
Repayment of indebtedness(1) .............................. $ 7,170,000 34.4%
Research and development(2) ............................... 3,800,000 18.2
Marketing and distribution(3) ............................. 2,500,000 12.0
Working capital and general corporate purposes(4) ......... 7,392,000 35.4
----------- -----
Total .................................................. $20,862,000 100.0%
=========== =====
</TABLE>
- ------------
(1) Includes $1,500,000 outstanding under the Company's revolving line of
credit with BB&T, which bears interest at BB&T's prime rate per annum, as
adjusted daily; $3,000,000 outstanding under the Company's promissory note
to Petra Capital, LLC ("Petra"), due March 24, 2002, which bears interest
at 13.5% per annum; $1,200,000 outstanding under the Company's promissory
note to Oberlin Capital, L.P. ("Oberlin"), due August 30, 2002, which
bears interest at 11% per annum through September 30, 1998, after which
time the interest rate increases; $870,000 principal amount, plus $117,175
in accrued interest, outstanding under the Company's line of credit from
Laura M. Stealey, which terminates January 1, 1999 and bears interest at
10% per annum; and $371,404 and $111,421 of the amounts owed to J.W.
Stealey and Robert L. Pickens, respectively, for accrued interest on prior
loans that were converted into capital stock in 1998. The Company used the
proceeds of the Petra promissory note and the Oberlin promissory note to
fund inventory and receivables, advance royalties and certain product
development and other infrastructure expenses. See "Certain Transactions."
(2) Includes approximately $1,800,000 for investments in external development
to provide the Company with future products and $2,000,000 for the growth
of internal research and development efforts, including the hiring of
additional developers to fill out the Company's product teams, and the
purchases of computer hardware and software to accommodate the Company's
anticipated growth in research and development. See "Business -- Product
Development."
(3) Includes approximately $2,100,000 for marketing and promotions, the hiring
of additional marketing staff and the expansion of the Company's
infrastructure for online delivery in Europe, in connection with the
Company's expansion of its international operations, and $400,000 for the
satisfaction of the Company's obligations under its marketing agreement
with General Capital, an affiliate of Vertical, a principal shareholder of
the Company. See "Business -- Distribution" and " -- Marketing,"
"Principal Shareholders" and "Certain Transactions."
(4) The Company intends to use these funds as necessary in the ordinary course
of the Company's business, including for increased inventories and
receivables associated with increased revenues and for the continued
growth of the Company. In addition, the Company may use portions of these
proceeds to acquire businesses which the Company believes are compatible
with its business strategy; however, while the Company regularly evaluates
possible acquisition opportunities, as of the date of this Prospectus, the
Company has no agreements, commitments, understandings or arrangements
with respect to any particular acquisition and there can be no assurance
that any future acquisitions will be consummated. See "Business --
Strategy."
If the Representatives exercise their over-allotment option in full, the
Company will realize additional net proceeds of approximately $3,264,300. Such
proceeds, if received, are expected to be used for working capital and general
corporate purposes. Pending their uses as set forth above, the Company intends
to use the net proceeds of this offering either to make short-term reductions
in the Company's working capital lines of credit or to invest in short-term,
investment grade, interest-bearing securities.
The allocation of the net proceeds set forth above represents the
Company's best estimates based on its proposed plans and assumptions relating
to its operations and growth strategy and on general economic conditions.
17
<PAGE>
The amounts actually expended for the above purposes may vary significantly,
however, depending upon numerous factors, including development and promotional
expenses related to the introduction of new products, the progress and timing
of its new product development efforts, changes in technology and the
availability of desirable acquisition opportunities. The Company believes that
the proceeds of this offering, together with anticipated revenues from
operations, availability under the Company's bank lines of credit, and cash and
cash equivalents, will be sufficient to satisfy its contemplated cash
requirements for at least 12 months following the consummation of this
offering. In the event that the Company's plans change (due to changes in
market conditions, competitive factors or new opportunities that may become
available in the future), its assumptions change or prove to be inaccurate or
if the proceeds of this offering or cash flows prove to be insufficient to
implement its business plans (due to unanticipated expenses, technical
difficulities or otherwise), the Company could, however, be required to seek
additional financing prior to such time. There can be no assurance that the
proceeds of this offering will be sufficient to permit the Company to implement
its business plans, that any assumptions relating to the implementation of such
plans will prove to be accurate or that any additional financing would be
available to the Company on commercially reasonable terms, or at all.
DIVIDEND POLICY
The Company has never declared or paid any cash dividends on its Common
Stock. The Company does not anticipate paying any cash dividends in the
foreseeable future and intends to retain future earnings for the development
and expansion of its business. In addition, certain of the Company's loan
agreements prohibit the payment or declaration of cash dividends.
DILUTION
The difference between the initial public offering price per share of
Common Stock and the net tangible book value per share of Common Stock after
this offering constitutes the dilution to investors in this offering. Net
tangible book value per share on any given date is determined by dividing the
net tangible book value of the Company (total tangible assets less total
liabilities) on such date by the number of then outstanding shares of Common
Stock.
At March 31, 1998, net tangible book deficit of the Company was
$(4,358,749), or $(0.95) per share of Common Stock. After giving retroactive
effect to the Recapitalization (see "Description of Securities --
Recapitalization"), the pro forma net tangible book deficit of the Company at
March 31, 1998 would have been $(3,339,664), or $(0.49) per share. After also
giving effect to the sale of the 2,600,000 shares of Common Stock offered
hereby at an assumed price of $9.00 per share (the midpoint of the currently
anticipated range of the initial public offering price) and the receipt and
anticipated application of the estimated net proceeds therefrom, including for
the repayment of certain outstanding indebtedness, the as adjusted net tangible
book value of the Company at March 31, 1998 would have been $17,522,336, or
$1.87 per share, representing an immediate increase in net tangible book value
of $2.36 per share to existing shareholders and an immediate dilution of $7.13
(79.2%) per share to investors in this offering. If the initial public offering
price is higher or lower, the dilution to new investors will be, respectively,
greater or less.
The following table illustrates the foregoing information with respect to
dilution to new investors on a per share basis:
<TABLE>
<S> <C> <C>
Assumed initial public offering price ............................ $ 9.00
Net tangible book deficit before Recapitalization ............... $ (0.95)
Increase attributable to Recapitalization ....................... 0.46
-------
Pro forma net tangible book deficit before the offering ......... $ (0.49)
Increase attributable to investors in the offering .............. 2.36
-------
Adjusted net tangible book value after the offering .............. 1.87
-------
Dilution to investors in the offering ............................ $ 7.13
=======
</TABLE>
18
<PAGE>
The following table sets forth, with respect to existing shareholders and
the investors in this offering, a comparison of the number of shares of Common
Stock as of March 31, 1998 (giving retroactive effect to the Recapitalization)
purchased from the Company, the percentage ownership of such shares, the
aggregate consideration paid, the percentage of total consideration paid, and
the average price paid per share.
<TABLE>
<CAPTION>
Shares Purchased Total Consideration
----------------------- -------------------------- Average Price
Number Percent Amount Percent Per Share
----------- --------- -------------- --------- --------------
<S> <C> <C> <C> <C> <C>
Existing shareholders ......... 6,793,699 72.3% $11,117,342 32.2% $ 1.64
New investors ................. 2,600,000 27.7 23,400,000 67.8 $ 9.00(1)
--------- ----- ----------- -----
Total ........................ 9,393,699 100.0% $34,517,342 100.0%
========= ===== =========== =====
</TABLE>
- ------------
(1) Based on the midpoint of the currently anticipated range of the initial
public offering price.
The foregoing tables assume no exercise of the Representatives'
over-allotment option. If such option is exercised in full, the new investors
will have paid $26,910,000 (based on an assumed price of $9.00 per share, the
midpoint of the currently anticipated range of the initial public offering
price) for 2,990,000 shares of Common Stock representing approximately 70.8% of
the total consideration for 30.6% of the total number of shares outstanding. In
addition, computations set forth in the above tables exclude (i) 1,708,045
shares of Common Stock reserved for issuance upon the exercise of options
remaining outstanding after the Recapitalization, at a weighted average
exercise price of $2.54 per share, and 1,300,000 shares of Common Stock
reserved for issuance upon the exercise of options available for future grant,
under the Plans, (ii) 449,554 shares of Common Stock reserved for issuance upon
exercise of warrants remaining outstanding after the Recapitalization at a
weighted average exercise price of $3.79 and (iii) 260,000 shares of Common
Stock reserved for issuance upon the exercise of the Representatives' Warrants.
See "Management -- Stock Option Plans," "Description of Securities -- Warrants"
and "Underwriting."
19
<PAGE>
CAPITALIZATION
The following table sets forth the consolidated capitalization of the
Company as of March 31, 1998, (i) on an actual basis, (ii) on a pro forma basis
giving effect to the Recapitalization (see "Description of Securities --
Recapitalization") and (iii) as further adjusted to give effect to the sale by
the Company of the 2,600,000 shares of Common Stock offered hereby at an
assumed price of $9.00 per share (the midpoint of the currently anticipated
range of the initial public offering price) and the anticipated application of
the estimated net proceeds therefrom. This table should be read in conjunction
with the consolidated financial statements, including the notes thereto,
appearing elsewhere in this Prospectus.
<TABLE>
<CAPTION>
March 31, 1998 (unaudited)
------------------------------------------------------
Pro Forma
Actual Pro Forma as Adjusted
---------------- ---------------- ----------------
<S> <C> <C> <C>
Long-term debt:
Long-term debt less current portion.................. $ 3,791,000 $ 3,791,000 $ --
Notes payable to related parties .................... 870,000 870,000 --
------------- ------------- -------------
Total long-term debt .............................. 4,661,000 4,661,000 --
------------- ------------- -------------
Series C Redeemable Convertible Preferred Stock, $.10
par value; 132,744 shares issued and outstanding
(actual) ............................................ 600,000 -- --
------------- ------------- -------------
Shareholders' equity (deficit):
Series A Convertible Preferred Stock, $.10 par value;
82,634 shares authorized, issued and outstanding
(actual) .......................................... 8,263 -- --
Series B Convertible Preferred Stock, $.10 par value;
778,746 shares authorized, issued and outstanding
(actual) .......................................... 77,875 -- --
Class A Common Stock, $.10 par value; 30,000,000
shares authorized, 3,145,696 shares issued and
outstanding (actual) .............................. 314,570 -- --
Class B Common Stock, $.10 par value; 20,000,000
shares authorized, 457,853 shares issued and
outstanding (actual) .............................. 45,785 -- --
Common Stock, $.10 par value; 50,000,000 shares
authorized, 6,793,699 shares issued and outstanding
(pro forma) and 9,393,699 shares issued and
outstanding (as adjusted) (1) ..................... -- 679,370 939,370
Additional paid in capital .......................... 10,101,771 10,887,979 31,489,979
Cumulative currency translation adjustment .......... (78,724) (78,724) (78,724)
Accumulated deficit ................................. (14,828,289) (14,828,289) (14,828,289)
------------- ------------- -------------
Total shareholders' equity (deficit) .............. (4,358,749) (3,339,664) 17,522,336
------------- ------------- -------------
Total capitalization ............................. $ 902,251 $ 1,321,336 $ 17,522,336
============= ============= =============
</TABLE>
- ------------
(1) Does not include (i) 1,708,045 shares reserved for issuance upon the
exercise of stock options remaining outstanding following the
Recapitalization, and 1,300,000 shares of Common Stock reserved for
issuance upon the exercise of options available for future grant, under
the Plans; (ii) 449,554 shares of Common Stock reserved for issuance upon
exercise of warrants remaining outstanding following the Recapitalization;
and (iii) 260,000 shares of Common Stock reserved for issuance upon
exercise of the Representatives' Warrants. See "Management -- Stock Option
Plans," "Description of Securities -- Warrants" and "Underwriting."
20
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
(Dollars in thousands, except per share data)
The following selected consolidated financial data as of and for each of
the three years in the period ended December 31, 1997 are derived from the
audited consolidated financial statements of the Company included elsewhere
herein, which statements have been audited by Ernst & Young LLP, independent
auditors, whose report is included elsewhere herein. The consolidated financial
data of the Company as of March 31, 1997 and 1998 and for the three months then
ended are derived from the unaudited consolidated financial statements of the
Company included in this Prospectus and were prepared by management of the
Company on the same basis as the audited consolidated financial statements
included elsewhere in this Prospectus and, in the opinion of the Company,
include all adjustments (consisting of only normal recurring adjustments)
necessary to present fairly the information set forth therein. The results for
the three months ended March 31, 1998 are not necessarily indicative of the
results to be expected for the full fiscal year ending December 31, 1998. The
following information should be read in conjunction with the consolidated
financial statements of the Company, including the notes thereto, and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included elsewhere in this Prospectus.
Consolidated Statement of Operations Data:
<TABLE>
<CAPTION>
Three Months Ended March
Year Ended December 31, 31,
---------------------------------------- --------------------------
1995 1996 1997 1997 1998
----------- ----------- ------------ ---------- -------------
(unaudited)
<S> <C> <C> <C> <C> <C>
Net revenues:
CD-ROM product sales .................... $ 3,950 $ 4,852 $ 14,067 $ 3,399 $ 4,057
Online sales ............................ 6 733 1,615 357 358
Royalties and licenses .................. 165 472 820 201 498
-------- -------- ---------- ------- ----------
Total net revenues .................... 4,121 6,057 16,502 3,957 4,913
Cost of revenues:
Cost of products sold ................... 790 1,349 3,715 766 968
Royalties and amortized software
costs ................................. 879 1,044 2,634 649 909
-------- -------- ---------- ------- ----------
Total cost of revenues ................ 1,669 2,393 6,349 1,415 1,877
-------- -------- ---------- ------- ----------
Gross profit ............................. 2,452 3,664 10,153 2,542 3,036
Operating expenses:
Sales and marketing ..................... 2,335 5,008 6,760 1,642 1,667
Product development ..................... 1,518 3,788 3,878 859 1,103
General and administrative .............. 828 1,451 1,941 598 449
-------- -------- ---------- ------- ----------
Total operating expenses ................. 4,681 10,247 12,579 3,099 3,219
-------- -------- ---------- ------- ----------
Operating loss ........................... (2,229) (6,583) (2,426) (557) (183)
Other expense ............................ 175 606 1,905 299 307
-------- -------- ---------- ------- ----------
Loss before income taxes ................. (2,404) (7,189) (4,331) (856) (490)
Income tax (expense) benefit ............. (47) (11) 33 31 (128)
-------- -------- ---------- ------- ----------
Net loss ................................. $ (2,451) $ (7,200) $ (4,298) $ (825) $ (618)
======== ======== ========== ======= ==========
Pro forma net loss per share (1) ......... $ (0.68) $ (0.09)
Number of shares used in computing pro
forma net loss per share (1) ............ 6,343,080 6,619,708
</TABLE>
(footnotes on following page)
21
<PAGE>
Consolidated Balance Sheet Data:
<TABLE>
<CAPTION>
December 31, 1997 March 31, 1998
------------------- ---------------
(unaudited)
<S> <C> <C>
Working capital (deficiency) ........... $ (1,933) $ 799
Total assets ........................... 7,747 9,211
Long-term debt (2) ..................... 7,229 4,661
Total liabilities ...................... 16,646 12,970
Redeemable preferred stock ............. -- 600
Stockholders' equity (deficit) ......... (8,899) (4,359)
</TABLE>
- ------------
(1) See Note 3 of Notes to Consolidated Financial Statements for an explanation
of the number of shares used in computing pro forma net loss per share.
(2) Includes long-term debt, less current portion, and notes payable to related
parties.
22
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
The Company develops, publishes and distributes interactive real-time 3D
simulation and strategy entertainment software. The Company generates revenues
primarily from delivering its CD-ROM products for retail sale through its
worldwide distribution network and from subscription and hourly fees for play
of its online product. The Company also generates revenues from licensing its
CD-ROM products to OEMs, distributors outside of North America and other third
parties. Since inception, the Company has published 26 CD-ROM products which
have been distributed through more than 15,000 retail outlets in over 30
countries. Additionally, the Company has sold over 1.4 million hours of online
game time over the Internet to players in more than 70 countries.
From the commencement of operations on June 16, 1994 through December 31,
1994, the Company was in a development stage. During this period, the Company
was engaged primarily in recruiting personnel, establishing a corporate
headquarters, designing products to be developed internally and licensing
products from external developers for future publication. The Company published
four CD-ROM products during its first full year of operation in 1995. To expand
international distribution of its CD-ROM products, the Company established
sales and marketing operations in the United Kingdom and Germany in 1996. In
1996, the Company published five CD-ROM products.
In April 1997, the Company acquired Interactive Creations, Inc, ("ICI"), a
leader in the development and delivery of interactive large-scale multiplayer
real-time online games. The Company exchanged 655,696 shares of the Company's
Common Stock for all of the outstanding shares of ICI. This transaction was
accounted for as a pooling of interests; accordingly, the Company restated all
historical financial data to include the historical financial data of ICI. In
connection with the ICI acquisition, the Company acquired ICI's WARBIRDS
product and the associated MEGAplayer technology for which a patent application
has been filed. In 1997, the Company published 11 CD-ROM products while
developing new products incorporating the technology acquired from ICI.
The Company recognizes net revenues from the sale of CD-ROM products at
the time of product shipment. Net revenues from CD-ROM product sales are
reflected after the deduction of what management believes to be an appropriate
allowance for returns, markdowns, price protection and warranty costs. Revenue
from usage of its online product is recognized at the time the game is played
and is based upon actual usage by the customer on an hourly basis. Revenues
from licenses to OEMs, international distributors and other third parties are
recognized when earned under the terms of the relevant agreements. Subject to
certain limitations, the Company accepts product returns and provides price
protection on certain unsold merchandise. With respect to license agreements
that provide customers the right to multiple copies in exchange for guaranteed
amounts, net revenues are recognized upon delivery of the product master or the
first copy. Per copy royalties on sales that exceed the guarantee are
recognized as earned.
The Company's internal product development costs incurred prior to
establishing technological feasibility are expensed in accordance with the
Financial Accounting Standards Board Statement of Financial Accounting
Standards ("SFAS") No. 86, "Accounting for the Costs of Computer Software to be
Sold, Leased or Otherwise Marketed." In accordance with SFAS No. 86, the
Company capitalizes product development costs subsequent to establishing
technological feasibility and amortizes previously capitalized product
development costs by using: (i) the revenue curve method; or (ii) the
straight-line method over the estimated economic life of the product, which
typically ranges from six months to two years.
In addition to the internal development of products, the Company enters
into publishing agreements with third-party developers pursuant to which the
Company typically advances royalties before the product is published. After
product release, the Company expenses advance royalties based on product sales
and pays the developer incremental royalties after the advance royalties have
been fully expensed. The Company also incurs internal costs related to product
development by third parties, including costs related to supervising the
development process for quality assurance and developing technology for
incorporation into third-party products. The Company typically expenses these
costs as a product development expense.
The Company believes that an increasing percentage of its revenues will be
generated by real-time large-scale multiplayer online games. However, the
extent and timing of revenues generated by online games are uncertain because
this market is emerging and depends upon a number of variables, including the
availability of an infrastructure
23
<PAGE>
for providing local access to wide area networks with acceptable response times
and consumer acceptance of such networks as a medium for playing multi-user
simulation and strategy games.
The Company has experienced significant losses in each of its formative
years, resulting primarily from overhead and other costs incurred in the
development and growth of the Company. Moreover, the Company expects to incur
substantial up-front expenditures and operating costs in connection with the
expansion of its marketing efforts and product lines, which may result in
significant losses for the foreseeable future. The Company's plan of operation
is to increase its online and retail product lines and to expand its
distribution network. This plan is intended to increase sales volume in both
online and retail products and to enable the Company to improve financial
results. The Company intends to increase net revenues from online products by
offering additional content over the Company's online service and to utilize
distribution partners, primarily online service providers ("OSPs") and Internet
service providers ("ISPs") to enable the Company to access additional
customers. The Company intends to increase net revenues from CD-ROM sales by
offering more titles and increasing the Company's brand awareness. Although the
Company believes that this plan of operation will lead to improved financial
results, there can be no assurance that the Company will be able to
successfully implement its growth and business strategies, that its revenues
will continue to increase in the future or that it will be able to achieve or
sustain profitable operations.
Results of Operations
Three Months Ended March 31, 1998 Compared to Three Months Ended March 31,
1997
Net revenues. Net revenues increased by 24.2% from $3,957,000 for the
three months ended March 31, 1997 to $4,913,000 for the three months ended
March 31, 1998. The increase was attributable to increases in net revenues from
CD-ROM product sales, licensing agreements with third parties and royalties
paid by international distributors on foreign sales of certain of the Company's
CD-ROM products. Revenue attributable to the Company's online service remained
relatively constant from $357,000 in the three months ended March 31, 1997 to
$358,000 in the three months ended March 31, 1998. During 1997, the Company
focused on building the infrastructure for delivery of additional games and
developing those games.
Cost of revenues. Cost of revenues consists of cost of products sold
(including cost of Internet access) and royalties and amortization of
capitalized software development costs. Cost of revenues increased by 32.7%
from $1,415,000 for the three months ended March 31, 1997 to $1,877,000 for the
three months ended March 31, 1998. Cost of products sold increased by 26.4%
from $766,000 to $968,000 over the two periods due to an increase in the number
of units sold. Royalties and amortized costs increased 40.1% from $649,000 to
$909,000 over the two periods primarily due to the increase in the amortization
of capitalized development costs associated with a greater percentage of sales
attributable to internally developed products. As a percentage of net revenues,
cost of revenues increased from 35.8% to 38.2% over the two periods, primarily
because in the 1998 period, the Company generated greater unit sales of
products carrying lower wholesale prices and an increase in internally
developed products.
Gross profit. Due to the increase in the number of CD-ROM units sold,
gross profit increased by 19.4% from $2,542,000 for the three months ended
March 31, 1997 to $3,036,000 for the three months ended March 31, 1998. Gross
margin declined from 64.2% to 61.8% over the two periods due to a change in
product mix and increased amortization of software development costs.
Sales and marketing. Sales and marketing expenses increased by 1.5% from
$1,642,000 for the three months ended March 31, 1997 to $1,667,000 for the
three months ended March 31, 1998. As a percentage of net revenues, sales and
marketing expenses decreased from 41.5% to 33.9% over the two periods due to a
decrease in market development expenditures relating to product positioning in
retail stores. In addition, an increasing percentage of the Company's revenues
was generated from online sales, royalties and licenses during the 1998 period,
which have less associated sales and marketing expenses than CD-ROM product
sales.
Product development. Product development expenses increased by 28.4% from
$859,000 for the three months ended March 31, 1997 to $1,103,000 for the three
months ended March 31, 1998. As a percentage of net revenues, product
development expenses increased from 21.7% to 22.5% over the two periods due to
the hiring of additional game designers, artists, programmers and developers.
The increase in product development expenses was partially offset by an
increase in the amount of capitalized product development expenses. The Company
capitalized $255,000
24
<PAGE>
(22.9% of gross product development costs) for the three months ended March 31,
1997 and $583,000 (34.6% of gross product development costs) for the three
months ended March 31, 1998.
General and administrative. General and administrative expenses decreased
by 24.9% from $598,000 for the three months ended March 31, 1997 to $449,000
for the three months ended March 31, 1998. As a percentage of net revenues,
general and administrative expenses decreased from 15.1% to 9.1% over the two
periods primarily because the Company incurred certain one-time expenses during
the 1997 period for new employee recruitment fees and the acquisition of ICI.
Other expense. Other expense, comprised primarily of interest expense,
increased by 2.7% from $299,000 for the three months ended March 31, 1997 to
$307,000 for the three months ended March 31, 1998.
Income tax (expense) benefit. The Company recorded a $31,000 tax benefit
for the three months ended March 31, 1997 and recorded $128,000 of income tax
expense for the three months ended March 31, 1998. The Company reported a tax
benefit in 1997 due to a refund from a net operating loss carryforward. The
Company recorded income tax expense in the first quarter of 1998 because its
United Kingdom subsidiary generated taxable income during such period. The
Company recorded a valuation allowance of $5,486,000 for the full amount of its
deferred income tax assets as of March 31, 1998 in accordance with SFAS No.
109, "Accounting for Income Taxes." This allowance is composed primarily of
domestic net operating loss carryforwards that expire beginning in 2011. Use of
these net operating loss carryforwards may be subject to limitations in the
event of significant changes in stock ownership of the Company.
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
Net revenues. The Company's net revenues increased by 172.4% from
$6,057,000 in 1996 to $16,502,000 in 1997. The increase was attributable to
increased sales of CD-ROM products, online usage, and revenues from royalties
and licenses paid by third parties. In 1997, the Company released more products
which sold on average a greater number of units per product. Net revenues from
the Company's WARBIRDS online product increased by 120.3% from $733,000 in 1996
to $1,615,000 in 1997, due to an increase in the number of subscribers.
Revenues from licenses to OEMs, international distributors and other third
parties increased by 73.7% from $472,000 in 1996 to $820,000 in 1997, primarily
because the Company granted licenses on more products from its expanded product
library.
Cost of revenues. Cost of revenues increased by 165.3% from $2,393,000 in
1996 to $6,349,000 in 1997. Cost of products sold increased by 175.4% over the
two periods from $1,349,000 to $3,715,000, due to (i) the costs of
manufacturing, duplicating, assembling, packaging and shipping a greater number
of CD-ROM products and (ii) an increase in the cost of Internet access
resulting from added capacity to handle the greater number of subscribers.
Royalties and amortized software costs increased by 152.3% from $1,044,000 in
1996 to $2,634,000 in 1997 primarily because the Company published more
third-party-developed products in 1997. As a percentage of net revenues, cost
of revenues decreased from 39.5% to 38.5% over the two periods primarily
because of the economies of scale associated with larger production runs
created by higher total unit sales.
Gross profit. Gross profit increased by 177.1% from $3,664,000 in 1996 to
$10,153,000 in 1997 primarily due to the sale of more CD-ROM products and
increased revenue from the Company's online product and license arrangements in
1997. As a percentage of net revenues, gross profit increased from 60.5% in
1996 to 61.5% in 1997 primarily because the products released by the Company in
1997 achieved higher average unit sales than the products released in 1996 due
to the success of the Company's iF-22 product.
Sales and marketing. Sales and marketing expenses increased 35.0% from
$5,008,000 in 1996 to $6,760,000 in 1997 primarily due to the release of more
products and the associated expenses required to market, promote and sell the
products, including additional personnel expenses. As a percentage of net
revenues, sales and marketing expenses decreased from 82.7% to 41.0% over the
two periods because, during a portion of 1996, the Company paid fees to an
independent sales organization based upon the number of units of CD-ROM
products sold while concurrently incurring expenses related to the development
of an internal sales organization. In addition, the Company incurred expenses
in 1996 to establish its international distribution network and sales
operations in the United Kingdom and Germany.
Product development. Product development expenses increased by 2.4% from
$3,788,000 in 1996 to $3,878,000 in 1997 primarily due to the hiring of
additional game designers, artists, programmers and developers. The Company
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capitalized $79,000 (2.0% of gross product development costs) in 1996 and
$849,000 (18.0% of gross product development costs) in 1997. As a percentage of
net revenues, product development expenses decreased from 62.5% to 23.5% over
the two periods.
General and administrative. General and administrative expenses increased
by 33.8% from $1,451,000 in 1996 to $1,941,000 in 1997 primarily due to
increases in staff, hiring costs, ICI acquisition expenses and debt financing
expenses. As a percentage of net revenues, general and administrative expenses
decreased from 24.0% to 11.8% primarily due to a higher sales volume.
Other expense. Other expense, comprised primarily of interest expense,
increased by 214.4% from $606,000 in 1996 to $1,905,000 in 1997 because the
Company incurred $5,161,000 of additional debt during 1997 to fund increases in
inventory and receivables, certain product development, advance royalties and
other infrastructure expenses.
Income tax (expense) benefit. Income tax expense was $11,000 in 1996, and
the Company recorded a $33,000 tax benefit in 1997. The Company recorded income
tax expense in 1996 despite the Company's consolidated operating loss because
of income taxes paid by the Company's subsidiary in the United Kingdom which
reported taxable income. The Company has recorded a valuation allowance of
$5,304,000 for the full amount of its deferred income tax assets as of December
31, 1997 in accordance with SFAS No. 109.
Year Ended December 31, 1996 Compared to Year Ended December 31, 1995
Net revenues. The Company's net revenues increased 47.0% from $4,121,000
in 1995 to $6,057,000 in 1996 due to increased sales of CD-ROM products, sales
of online product and royalties paid by third parties. Revenues from the
Company's online product increased from $6,000 in 1995 to $733,000 in 1996
because 1996 was the first year in which the Company had an online product
available for an entire year. The Company introduced its first online product,
WARBIRDS, in December 1995. Revenues from licenses to OEMs, international
distributors and other third parties increased by 186.1% from $165,000 in 1995
to $472,000 in 1996 primarily because the Company had more products to license.
Cost of revenues. Cost of revenues increased by 43.4% from $1,669,000 in
1995 to $2,393,000 in 1996. Cost of products sold increased by 70.8% from
$790,000 in 1995 to $1,349,000 in 1996 due to an increase in the total number
of units of CD-ROM products sold. Royalties and amortized costs increased by
18.8% from $879,000 in 1995 to $1,044,000 in 1996 because of increases in the
total number of products developed by third parties and published by the
Company in 1996. Also, the Company amortized or wrote off previously
capitalized product development costs of $69,000 in 1995 and $147,000 in 1996.
As a percentage of net revenues, cost of revenues decreased from 40.5% in 1995
to 39.5% in 1996 primarily because the cost of revenues generated by sales of
online products and licenses to OEMs, international distributors and other
third parties is significantly less than the cost of revenues generated by
sales of CD-ROM products. Revenues generated by these sources increased from
4.1% of net revenues in 1995 to 19.9% of net revenues in 1996.
Gross profit. Gross profit increased by 49.4% from $2,452,000 in 1995 to
$3,664,000 in 1996. As a percentage of net revenues, gross profit increased
from 59.5% to 60.5% primarily because the cost of revenues associated with the
sales of its online product and licenses to OEMs, international distributors
and other third parties is significantly less than the cost of revenues
generated by sales of CD-ROM products, and the revenues generated by those
sources increased from 4.1% of net revenues in 1995 to 19.9% of net revenues in
1996.
Sales and marketing. Sales and marketing expenses increased by 114.5% from
$2,335,000 in 1995 to $5,008,000 in 1996 primarily due to expenses related to
building an internal sales organization, while concurrently paying an
independent sales organization to sell the Company's products, as well as a
higher number of product releases. Sales and marketing expenses also increased
because the Company incurred expenses in 1996 to establish its international
distribution network, which included the costs associated with establishing
operating subsidiaries in the United Kingdom and Germany. As a percentage of
net revenues, sales and marketing expenses increased from 56.7% in 1995 to
82.7% in 1996.
Product development. Product development expenses increased by 149.5% from
$1,518,000 in 1995 to $3,788,000 in 1996 primarily because the Company hired
additional game designers, artists, programmers and developers with experience
developing technology used in online content delivery, 3D graphics and
artificial intelligence. As a percentage of net revenues, product development
expenses increased from 36.8% in 1995 to 62.5% in 1996.
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<PAGE>
The Company capitalized $289,000 (16.0% of gross product development costs) in
1995 and $79,000 (2.0% of gross product development costs) in 1996.
General and administrative. General and administrative expenses increased
by 75.2% from $828,000 in 1995 to $1,451,000 in 1996 primarily because the
Company incurred professional fees to implement and test an automated
accounting system, added administrative personnel, established the Company's
United Kingdom operations and relocated its headquarters to a larger facility.
As a percentage of net revenues, general and administrative expenses increased
from 20.1% in 1995 to 24.0% in 1996 because the Company was investing in its
infrastructure to handle the anticipated growth in revenues.
Other expense. Other expense, comprised primarily of interest expense,
increased 246.3% from $175,000 in 1995 to $606,000 in 1996 because the Company
incurred $6,451,000 in additional debt during 1996 to fund certain product
development, advance royalties and other infrastructure expenses.
Income tax (expense) benefit. Income tax expense was $47,000 in 1995 and
$11,000 in 1996. The Company recorded income tax expense despite the Company's
consolidated operating loss because of income taxes paid by the Company's
subsidiary in the United Kingdom which reported taxable income in each year.
The Company has recorded a valuation allowance of $3,472,000 for the full
amount of its deferred income tax assets as of December 31, 1996 in accordance
with SFAS No. 109.
Liquidity and Capital Resources
The Company's capital requirements have been and will continue to be
significant, and, to date, its cash requirements have exceeded its cash flow
from operations. The Company historically has satisfied cash requirements
through borrowings, the sale of equity securities, customer advances and
capital lease financings.
Net cash used in operating activities was $2,205,000 for 1995, $6,641,000
for 1996 and $3,773,000 for 1997. The Company had a $799,000 working capital
surplus as of March 31, 1998.
Net cash used in investing activities for the purchase of property and
equipment and software development costs was $972,000 during 1995. Net cash
used in investing activities for the purchase of property and equipment, other
investments (of which $120,000 was written off in 1997) and software
development costs was $762,000 in 1996. Net cash used in investing activities
for the purchase of property and equipment and software development costs was
$1,231,000 during 1997 and $634,000 in the three months ended March 31, 1998.
The Company funded its operations during 1997 through the issuance of a
subordinated note to Petra on March 24, 1997 in the amount of $3,000,000,
borrowings of $500,000 from notes payable issued to related parties, borrowings
of $469,000 under its line of credit with BB&T and the issuance of a junior
subordinated debenture to Oberlin on September 29, 1997 in the amount of
$1,200,000. On February 4, 1998, the Company raised $3,500,000 in connection
with the sale of its Series B Preferred Stock.
The Company has a $2,750,000 revolving line of credit with BB&T which is
secured by the personal guaranty of the Company's principal shareholder. The
principal balance outstanding is payable on demand with interest payable
monthly at prime. At March 31, 1998, the Company had $2,461,000 in borrowings
against this line of credit. The Company also has a $150,000 equipment line of
credit with BB&T which is secured by certain of the Company's property and
equipment and a $250,000 promissory note with BB&T secured by the guaranty of
the Company's principal shareholder. The principal balance outstanding is
payable on demand with interest payable monthly at prime. At March 31, 1998,
the Company had outstanding balances of $96,000 under the $150,000 line of
credit and $250,000 under the promissory note. See "Certain Transactions."
On April 30, 1998, the Company established a one-year $5,000,000 revolving
line of credit with Greyrock. Borrowings under this line of credit accrue
interest at prime plus 2%. Borrowings on the Greyrock line of credit are
limited to the lesser of $5,000,000 or 65% of the Company's outstanding
eligible receivables and are collateralized by accounts receivable, inventory
and intellectual property of the Company (excluding its foreign subsidiaries).
As of July 8, 1998, borrowings on the line were $2,684,000, which amounts were
used by the Company to extinguish certain existing debt and provide additional
working capital.
The Company intends to use proceeds from this offering to repay the
$4,200,000 due to Petra and Oberlin, $1,500,000 of the amount outstanding under
its $2,750,000 revolving line of credit with BB&T, the $870,000 principal
amount, plus $117,175 accrued interest, outstanding under the Company's line of
credit from Laura M.
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<PAGE>
Stealey, and $371,404 and $111,421 of the interest owed to J.W. Stealey and
Robert L. Pickens, respectively, for accrued interest on prior loans that were
converted by them into capital stock of the Company in 1998. See "Certain
Transactions."
The Company's future liquidity and capital requirements will depend upon
numerous factors, including the costs and timing of expansion of research and
product development efforts and the success of these efforts, the costs and
timing of expansion of sales and marketing activities, the extent to which the
Company's existing and new products gain market acceptance, competing
technological and market developments, the costs involved in maintaining and
enforcing patent claims and other intellectual property rights, available
borrowings under line of credit arrangements and other factors. The Company is
dependent upon the proceeds of this offering to complete the development of its
currently proposed products and fund its business strategies. Although the
Company anticipates, based on its currently proposed plans and assumptions
relating to its operations (including assumptions regarding the progress and
timing of its new product development efforts), that the net proceeds of this
offering, together with anticipated revenues from operations, availability
under the Company's bank lines of credit and cash and cash equivalents, will be
sufficient to fund the Company's operations and capital requirements for at
least 12 months following the consummation of this offering, there can be no
assurance that such funds will not be expended prior thereto due to
unanticipated changes in economic conditions or other unforeseen circumstances.
In the event the Company's plans change or its assumptions change or prove to
be inaccurate, the Company could be required to seek additional financing
sooner than currently anticipated. The Company has no current arrangements with
respect to, or potential sources of, any additional financing, and it is not
anticipated that existing shareholders will provide any portion of the
Company's future financing requirements. Consequently, there can be no
assurance that any additional financing will be available to the Company when
needed, on commercially reasonable terms, or at all. Any inability to obtain
additional financing when needed would require the Company to delay or scale
back its product development and marketing programs, which could have a
material adverse effect on the Company. In addition, any additional equity
financing may involve substantial dilution to the interests of the Company's
then existing shareholders.
The Company's forecast of the period of time through which its financial
resources will be adequate to support its operations is a forward-looking
statement that involves risks and uncertainties, and actual results could vary.
The factors described in the preceding paragraph and in the Risk Factors
section of this document will impact the Company's future capital requirements
and the adequacy of its available funds.
Fluctuations in Operating Results
The Company's quarterly operating results have fluctuated significantly in
the past and will likely fluctuate significantly in the future depending on a
variety of factors, several of which are not in the Company's control. Such
factors include the demand for the Company's products and the products of its
competitors, the size and rate of growth of the interactive entertainment
software market, development and promotional expenses related to the
introduction of new products or enhancements, the degree of market acceptance
for the Company's new product introductions and enhancements, the timing of
orders from significant customers, delays in shipment, the level of price
competition, changes in computing platforms, the nature and magnitude of
product returns, order cancellations, software defects and other quality
problems, the length of product life cycles, the percentage of the Company's
sales related to international sales and changes in personnel. Based on the
foregoing, the Company believes that period to period comparisons of operating
results should not be relied upon as indicative of future results.
Income Taxes and Conversion from Subchapter S to Subchapter C Corporation
From the Company's inception in June 1994 through October 1995, the
Company operated under the provisions of Subchapter S of the Internal Revenue
Code of 1986, as amended (the "Code"), and consequently, was not subject to
federal income tax. On October 31, 1995, the Company terminated its Subchapter
S election and began operation under the provisions of Subchapter C of the
Code.
Impact of Adoption of New Accounting Standards
In June 1997, the Financial Accounting Standards Board issued SFAS No.
130, "Reporting Comprehensive Income" and SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information." In addition, the American
Institute of Certified Public Accountants issued Statement of Position ("SOP")
97-2, "Software
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Revenue Recognition, SOP 98-4, Deferral of the Effective Date of a Provision of
SOP 97-2, `Software Revenue Recognition' and SOP 98-1, "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use." SFAS Nos.
130 and 131 and SOP 97-2 and 98-4 are effective for fiscal years beginning
after December 15, 1997. SOP 98-1 is effective for fiscal years beginning after
December 15, 1998. The Company does not believe that adoption of these
standards will have a material impact on the Company's results of operations.
Year 2000 Issue
Many currently installed computer systems and software products are coded
to accept only two digit entries in the date code field. These date code fields
will need to accept entries to distinguish 21st century dates from 20th century
dates. The inability to recognize or properly treat the Year 2000 may cause the
Company's systems and applications to process critical financial and
operational information incorrectly. The Company continues to assess the impact
of the Year 2000 issue on its reporting system and operations. In addition, the
Company is assessing the readiness of its customers and suppliers for the Year
2000 issue; however, there can be no assurance that these third parties will
timely convert their systems or that their systems will not have an adverse
effect on the Company. While uncertainty exists concerning the potential
effects associated with such compliance, the Company does not believe that Year
2000 compliance will result in a material adverse effect on its financial
condition or results of operations.
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BUSINESS
General
The Company develops, publishes and distributes interactive real-time 3D
entertainment software, focusing on simulation and strategy games for CD-ROM
and online/Internet use. Since inception, the Company has published 26 titles
on CD-ROM that have been distributed through more than 15,000 retail outlets in
over 30 countries. Additionally, the Company's initial online product,
WARBIRDS, a World War II air combat simulation game, has generated sales of
over 1.4 million hours of online game time to players in more than 70
countries. Since its first product offering in August 1995, the Company has
been recognized each year with awards or critical acclaim from industry
associations and publications, including PC Games, PC Today, Computer Gaming
World, Power Play, PC Gamer, Computer Games Strategy Plus and the SPA. Since
such time, the Company's net revenues have also grown to $16,502,000 and
$4,913,000 for the year ended December 31, 1997 and the three months ended
March 31, 1998, respectively. The Company seeks to benefit from leveraging its
development, marketing and technological synergy across its dual distribution
channels.
Industry Overview
Background
The interactive entertainment software market is composed of software
primarily created for use on PCs and software created for video game consoles,
such as the Sony Playstation and Nintendo 64 entertainment systems. IDSA
reported that retail sales of interactive entertainment software in North
America reached $3.7 billion in 1996 and were projected to increase to $5.3
billion in 1997 and $8 billion in 2000. Worldwide entertainment software sales
were estimated by IDSA to have exceeded $10 billion in 1996, roughly divided
evenly among the United States, Europe and Asia. According to IDSA, market
penetration exceeded 40% of households in the United States in 1997, and PC
owners are increasing their purchases of game software. The Company believes
that the availability of lower-cost high performance multimedia PCs and modems
has contributed to and is expected to contribute to the increase in PC
ownership and thereby expand the use of the Internet and online services for
entertainment purposes.
Market for PC Simulation and Strategy CD-ROM Products
PC Data, an industry research firm, estimated that 1997 retail sales of PC
games were approximately $1.3 billion in North America. The simulation and
strategy segments had unit sales increases of 46.7% and 15.7%, respectively,
over 1996 sales. In 1997, simulation and strategy games represented
approximately 34.9% of the North American market for PC games. Simulation and
strategy products require sophisticated 3D graphics capabilities, advanced
artificial intelligence technology and significant research abilities to model
real-life military situations, historical scenarios or other strategy and
simulation subjects. In a simulation game, the player, acting as a pilot,
commander, captain or driver, controls a vehicle such as a plane, submarine,
ship or tank. A strategy game establishes the player as manager of a given set
of resources who must produce maximum results through discriminating use of
limited resources. The Company believes that the simulation and strategy
product market has a loyal domestic and international following of enthusiasts
who generally purchase multiple products throughout the year. According to a
market study conducted on behalf of the publisher of Computer Gaming World, a
leading industry magazine, the typical user of computer games is a male age 30
with an annual household income of $60,000. The Company believes that these
users are also prime candidates to participate in online games, as they tend to
be early adopters of new technology and equipment.
Market for Online Games
A 1997 Forrester Research report estimates that more than 6.9 million
consumers in the United States are currently playing games over the Internet,
generating revenues of $127 million in 1997, and projects that 18 million
consumers will generate $1.6 billion in revenues in 2001. These revenues
encompass direct pay-for-play online game play, online CD-ROM sales,
advertising and sponsorships. The emerging popularity of online games is
evidenced by the recent appearance of dedicated game networks, such as Mplayer,
America Online's Game Channel, Microsoft's Internet Gaming Zone, Kesmai's
Gamestorm, Total Entertainment Network and the Company's pay-for-play service,
iMagic Online. While a number of multiplayer games are available over the
Internet, generally only four, eight, or 16 players can play simultaneously
with or against each other. By contrast, large-scale multiplayer games permit a
significantly greater number of simultaneous players (frequently hundreds).
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The Company's Market Position
The Company believes it is well-positioned to capitalize on the emerging
market for online large-scale multiplayer games by leveraging its experience in
the growing market for high-quality strategy and simulation products on CD-ROM.
To date, five of the Company's titles have been nominated or selected as either
simulation or strategy game of the year by major industry magazines. In April
1997, the Company acquired ICI, which was among the first to introduce a
real-time large-scale multiplayer game on the Internet, permitting hundreds of
players to play simultaneously with or against each other, when it released its
WARBIRDS simulation game in 1995. WARBIRDS has been named best online game for
1996 and 1997 by PC Games magazine.
Strategy
The Company's objective is to become one of the world's leading providers
of CD-ROM and real-time large-scale multiplayer online simulation and strategy
games. Key elements of the Company's strategy are to:
Increase online recurring revenue. The Company was among the first to
enter the emerging market for real-time large-scale multiplayer online games.
The Company intends to leverage its experience in online games to strengthen
its position as a leading content provider by developing and delivering
sophisticated real-time large-scale multiplayer simulation games through its
online service on a subscription basis, plus additional fees for hours played
beyond the subscription allocation, and thereby increase the Company's
recurring revenues. In addition, the Company intends to leverage the marketing
resources of third parties and broaden its user base by partnering with
selected Internet service providers, online service providers and foreign
licensees to distribute its online products.
Focus on simulation and strategy games and expand brand recognition. The
Company focuses primarily on the simulation and strategy markets. The Company
intends to capitalize on management's extensive experience and knowledge of
these particular markets and on the favorable demographic profile of simulation
and strategy enthusiasts. The Company believes the typical user of its products
is a male over age 25 with sufficient disposable income to buy the latest
games. By focusing on delivering highly playable, entertaining games with high
quality graphics, the Company believes it has built strong brand recognition
and consumer loyalty among game enthusiasts. The Company intends to build upon
this loyalty by selectively creating franchise titles through publication of
sequels and add-ons to existing games.
Manage risk through internal and external product development. The Company
believes that using both internal and external development sources and keeping
the product development pipeline full assists in managing risk, maximizing
creativity and ensuring the consistent release of future products. Toward that
end, the Company currently works with 11 external development teams, which
complement the Company's internal development efforts. External development
teams provide leverage in that full development expenses generally are not
absorbed by the Company, advance royalties are fixed and development cycles
that may result in late delivery of a particular product do not affect the
delivery of other products planned for release. The Company intends to remain a
"value added" publisher of externally developed titles, ensuring product
quality by providing independent developers with access to its technology,
software tools and libraries, software design assistance, product design advice
and other services. In doing so, the Company intends to control the cost of
product development and spread the risk of product development across a number
of titles.
Expand worldwide distribution network. The Company currently sells its
CD-ROM products through leading software distributors and retailers in North
America and abroad. The Company intends to increase penetration within the
channels that can enhance the distribution of its CD-ROM products to its core
customer base worldwide, including computer and software retailers, consumer
electronics retailers and mass merchandisers. The Company currently distributes
its online products via the Internet through its iMagic Online game service and
intends to expand its distribution through relationships with third-party
providers of online and Internet services, both in the United States and
abroad. Maintaining strong and focused distribution channels enhances the
Company's ability to attract and retain employees and external development
partners.
Leverage core technologies. The Company maintains a dedicated research and
development staff which focuses on developing core technologies that can be
applied across multiple titles. The Company has filed a patent application with
respect to its MEGAplayer technology, which is a method of and system for
minimizing the effect of time latency in multiplayer electronic games played on
interconnected computers. The Company
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has developed graphics engines, game engines and communication technologies
which can be used in a number of different games in a cost-effective manner.
Specifically, the Company has five core technologies which it currently employs
to maximize efficiencies and cost effectiveness across its product line: (1)
MEGAplayer -- an architecture for enhancing Internet game play; (2) DEMON -- 3D
terrain optimization model; (3) TALON -- a dynamic mission generation system;
(4) MEGAvoice -- real-time voice communication technology; and (5) iMOL/SDK --
a software toolkit to provide a common interface among various communication
protocols for online game play. See " -- Technology."
Expand operations through strategic acquisitions. The Company intends to
expand its operations through strategic acquisitions as potential opportunities
become available. While the Company is not engaged in any acquisition
negotiations at present, potential targets may include other interactive
entertainment software publishers, game developers or distributors,
particularly distributors with international networks.
Products
General
The Company's products consist of sophisticated real-time, 3D simulation
and strategy games that are available on CD-ROM or, for its online products,
accessed on iMagic Online, the Company's online game service. To date, the
Company has published 27 products, one of which is a real-time large-scale
multiplayer online game, and has two additional real-time large-scale
multiplayer online games in the pre-release testing stage. Over one quarter of
these products have won awards or achieved other critical acclaim from industry
publications, including PC Games, PC Today, Computer Gaming World, Power Play,
PC Gamer and Computer Games Strategy Plus. The Company intends to expand the
distribution of its online large-scale multiplayer games through third-party
providers of online and Internet services to access a broader market base of
subscribers. Most of the Company's CD-ROM products are designed for play as
both single-player and multiplayer (up to 16 players) games and include various
levels of difficulty, so that both novice and experienced players can enjoy the
Company's games.
Simulation Products
A simulation product puts the player in control of a vehicle, such as a
helicopter, tank, or airplane, and allows the player to conduct missions in a
replicated real-world environment. These products are characterized by the
authenticity of the simulated vehicle, reproduction of enhanced performance
criteria and a realistic perspective using real-time rendered 3D graphics,
providing the player with a 360- view of the external environment. For example,
iF-22 utilizes the Company's proprietary DEMON 3D terrain technology, which can
incorporate thousands of square miles of satellite photography for a realistic
depiction of actual terrain. The Company's simulation titles are listed below,
followed by a brief description of several of the Company's most popular
simulation titles.
Simulation Products
<TABLE>
<CAPTION>
Title Release Date
- ------------------------- ---------------
<S> <C>
APACHE August 1995
- -------------------------------------------
STAR RANGERS November 1995
- -------------------------------------------
WARBIRDS December 1995
- -------------------------------------------
HIND September 1996
- -------------------------------------------
AIR WARRIOR II February 1997
- -------------------------------------------
iM1A2 ABRAMS March 1997
- -------------------------------------------
iF-22 July 1997
- -------------------------------------------
iF-16 September 1997
- -------------------------------------------
AIR WARRIOR III December 1997
- -------------------------------------------
iF-22 PERSIAN GULF March 1998
- -------------------------------------------
iPANZER 44 March 1998
- -------------------------------------------
</TABLE>
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WARBIRDS, the Company's first online product offering, recreates World War
II air combat. WARBIRDS, named "Online Game of the Year" for both 1996 and 1997
by PC Games magazine, allows hundreds of players from around the world to
simultaneously fly air combat missions in a single campaign. After logging on
to iMagic Online, players choose to fly for one of four teams, select an
airplane from an array of 50 historically accurate bombers or fighters and
choose a role as a pilot, gunner or bomber. Individual combatants then engage
in dogfights or fly bombing missions over enemy territories, with the outcome
of each individual mission affecting the outcome of the overall campaign. For
example, successfully destroying the air defenses of and landing on an enemy's
airfield results in a country capturing that airfield. Airfields can be lost
and recaptured, providing a strategic as well as a tactical aspect to WARBIRDS.
Game play is broken up into three-week campaigns with a dogfighting and bombing
"ace" named for each campaign. A campaign starts with a limited array of planes
and more advanced planes become available as the campaign progresses to
incorporate the effect of technological advances. 3D rolling terrain graphics,
as well as the incorporation of the Company's MEGAvoice technology, which
provides real-time voice communications with groups of up to four game
participants, add to the realism of WARBIRDS. Through its proprietary
MEGAplayer technology, the Company is able to deliver via the Internet the full
3D graphics and action of WARBIRDS in real time to large numbers of players who
can enter the game 24 hours a day, seven days a week.
APACHE was the Company's first published product. APACHE is an air-combat
simulation of the AH-64D Apache Longbow Helicopter for players of all
experience levels. APACHE uses 3D visual technology optimized to provide
low-altitude detail and clarity and includes a multiplayer networking feature
to permit up to eight players and two teams to engage in simultaneous combat.
Since its release in August 1995, the Company has sold more than 175,000 copies
of APACHE. APACHE received two Codie Award nominations from the SPA and was
named "Best Simulation of 1995" by both PC Gamer magazine and Strategy Plus
magazine.
iM1A2 ABRAMS simulates the U.S. Army's main battle tank, the M1A2 Abrams.
The user is able to command a platoon of four tanks, or an entire company,
including other vehicles, artillery helicopters and artillery in a variety of
battles or campaigns of linked battles set in the Persian Gulf, the Balkans and
the former Soviet Ukraine against the latest Russian equipment. iM1A2 ABRAMS
uses advanced 3D graphics technology and contains multiple difficulty levels.
iPANZER 44 is the recently released follow-up to iM1A2 ABRAMS, allowing players
to command World War II Russian, American and German tanks. iPANZER 44 takes
advantage of Microsoft's Direct 3D technology to allow support for many 3D
graphic accelerator cards.
iF-22 is an internally developed simulation of the U.S. Air Force's newest
air-superiority fighter. The player is able to command a squadron of four F-22
aircraft executing single missions or protracted campaigns. iF-22 incorporates
the Company's DEMON advanced 3D graphics and terrain technology, multiple
difficulty levels, multiple flight models and a multiplayer option. Released in
July 1997, sales of iF-22 have exceeded 150,000 units to date. iF-22 PERSIAN
GULF, the recently released sequel to iF-22, includes the Company's TALON
(Total Air & Land Operations Network) campaign system, which generates new
mission assignments each time the game is played. The iF-22 PERSIAN GULF
release is compatible with computers equipped with Intel's new AGP (Advanced
Graphics Port) technology.
Strategy Products
A strategy product requires the player to achieve maximum results through
management of a specific set of resources. The Company produces sophisticated
strategy games that include historical military scenarios, empire building and
tactical strategy products. The Company's existing strategy products generally
are characterized by historically accurate databases and advanced artificial
intelligence. Strategy games generally have lower initial shipment quantities
but generally sustain prices longer and maintain longer shelf-lives than
simulation products. Strategy games also can utilize the same core components
across a number of different products, which facilitates the creation of a
franchise, such as the Company's three-game Great Battles series, GREAT BATTLES
OF ALEXANDER, GREAT BATTLES OF HANNIBAL and GREAT BATTLES OF CAESAR. The
Company's strategy titles are listed below, followed by a brief description of
several of the Company's strategy titles.
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<PAGE>
Strategy Products
<TABLE>
<CAPTION>
Title Release Date
- ------------------------------------------- ---------------
<S> <C>
EXPLORATION September 1995
- -------------------------------------------------------------
CAPITALISM October 1995
- -------------------------------------------------------------
AMERICAN CIVIL WAR June 1996
- -------------------------------------------------------------
BRUCE JENNER'S WORLD CLASS DECATHLON July 1996
- -------------------------------------------------------------
DESTINY September 1996
- -------------------------------------------------------------
HARPOON CLASSIC '97 November 1996
- -------------------------------------------------------------
FALLEN HAVEN March 1997
- -------------------------------------------------------------
CAPITALISM PLUS May 1997
- -------------------------------------------------------------
GREAT BATTLES OF ALEXANDER June 1997
- -------------------------------------------------------------
WAR, INC. September 1997
- -------------------------------------------------------------
SEVEN KINGDOMS November 1997
- -------------------------------------------------------------
GREAT BATTLES OF HANNIBAL November 1997
- -------------------------------------------------------------
SEMPER FI February 1998
- -------------------------------------------------------------
GREAT BATTLES OF CAESAR March 1998
- -------------------------------------------------------------
LIBERATION DAY March 1998
- -------------------------------------------------------------
INDUSTRY GIANT April 1998
- -------------------------------------------------------------
</TABLE>
CAPITALISM, the Company's highly acclaimed business strategy and
simulation product, was a runner-up to APACHE as the "Best Simulation of 1995"
by PC Gamer magazine. CAPITALISM gives the player resources with which to build
a global financial empire. CAPITALISM sold in excess of 100,000 units by the
end of 1997. CAPITALISM PLUS, an update of CAPITALISM, includes a new
interface, improved graphics, maps and a soundtrack. A second sequel to
CAPITALISM is planned for release in 1999.
AMERICAN CIVIL WAR, the Company's highly acclaimed strategic Civil War
battle simulation, covers the entire Civil War from the opening guns of Bull
Run to the final surrender of the army of Northern Virginia. This strategy
product allows players to command forces from either side, recruit troops,
build ships, form armies, corps and fleets. AMERICAN CIVIL WAR includes an
historically accurate database featuring over 125 Union and Confederate
commanders.
SEVEN KINGDOMS, one of the Company's newest strategy games, has won
various awards, including "Strategy Game of the Year" by Germany's PC Power
Play magazine. SEVEN KINGDOMS presents players with a special challenge of
real-time action and strategy set in a medieval fantasy world of monsters, gods
and opposing cultures. Two sequels to SEVEN KINGDOMS are planned, with the
first scheduled for release in 1998.
Future Products
The Company has 19 products in development for release over the next 18
months, including five internally-developed products and 14 under contract with
external developers. Two of these products, FIGHTER OPS and RAIDER WARS, are
online games which have undergone beta testing on the Company's online service.
There can be no assurance that, if introduced, such products will achieve
market acceptance or generate significant revenues. A significant delay in the
introduction of, or the presence of a defect in, one or more of such titles or
other new products or the failure of such titles to generate significant
revenues could have a material adverse effect on the success of such titles and
on the Company's business, operating results and financial condition. The
Company plans to develop certain of its future products both as CD-ROM games
and large-scale multiplayer online products. The Company believes that a
carefully planned release date on both delivery platforms can increase sales of
the product. ULTRAFIGHTERS and MALKARI, each of which is intended to be
playable both as a CD-ROM product and as a large-scale multiplayer online
product, are scheduled for release in 1998. There can be no assurance that such
products will be released on schedule for either delivery platform or that the
release of such titles on either CD-ROM or online will achieve market
acceptance or generate significant revenues for the Company. In
34
<PAGE>
addition, the Company intends to offer its online products to third-party
providers of online and Internet services and licensees to reach a larger
audience. There can be no assurance that satisfactory arrangements with other
distributors and licensees can be negotiated, or that its online products will
be successful or generate significant revenues for the Company.
Distribution
The Company uses a dual channel distribution strategy by delivering its
CD-ROM products for retail sale through its worldwide distribution network and
its online games via the Internet.
Distribution of CD-ROM Products
The Company's CD-ROM products are distributed in over 30 countries through
more than 15,000 retail outlets. In North America, the Company sells its
products both through distributors and directly to large retailers. The Company
maintains distribution relationships with seven major distributors, including
Navarre, Tech Data, Merisel, Inc., Guillemot, GT Interactive Software
Corporation and Beamscope Canada, Inc. The Company's products are sold by many
of the larger retailers, such as Wal-Mart, Best Buy and CompUSA in North
America and Karstadt, Dixon's and PC World in Europe. Although such retailers
may purchase the Company's products through distributors, the Company believes
that it is important to maintain favorable relationships with the retailers in
order to promote the visibility of its products. The Company's products
constitute a relatively small percentage of a retailer's sales volume, however,
and there can be no assurance that retailers will continue to purchase the
Company's products or provide the Company's products with adequate levels of
shelf space and promotional support. For the year ended December 31, 1997,
sales to the Company's distributors accounted for approximately 65% of the
Company's net revenues. In 1996, Tech Data and Navarre accounted for 27% and
11%, respectively, of the Company's net revenues; in 1997, Tech Data and
Electronics Boutique, Inc. accounted for 19% and 10%, respectively, of the
Company's net revenues; and in the three months ended March 31, 1998, Navarre,
Guillemot, Tech Data and Electronics Boutique, Inc. accounted for 15%, 16%, 12%
and 10%, respectively, of the Company's net revenues.
Simulation and strategy products have a large international following.
Accordingly, the Company has established wholly-owned subsidiaries in the
United Kingdom and Germany which serve the European market. Approximately
one-third of the Company's sales are generated in the European marketplace. In
addition, the Company contracts with distribution agencies in Japan, Singapore,
South America, Korea, South Africa and Australia. In certain territories
(Spain, Italy and France, for example) the Company may elect to license its
products to a local publisher in exchange for guaranteed volume requirements
and a committed royalty.
Alternate distribution channels such as direct mail to consumers, direct
ordering through a toll-free phone number and the Company's web site and
OEM/bundling arrangements, account for less than 6% of the Company's net
revenues.
Distribution of Online Games
The Company currently delivers its online games via iMagic Online, the
Company's online game service. The Company's host software runs on a UNIX-based
system and to date has been operated on Sun workstations and Pentium-based
systems. Reliability is enhanced by RAID systems for data storage, access to
the Internet via multiple T-1 lines from various providers and software
backups.
The Company emphasizes sophisticated online games for which users pay a
subscription fee, plus additional hourly fees for time played beyond the
subscription allocation. The Company believes that with the continued
proliferation of Internet usage, providers of online and Internet services will
become an increasingly important channel for global distribution of its
real-time large-scale multiplayer games. The Company presently has one game
available on a pay-for-play basis on its online game service with plans to add
four additional games in the next 12 months. Currently, the Company is
negotiating with several major providers of online and Internet services in
North America, Germany, the United Kingdom, Japan, and Brazil for rights to
distribute certain of the Company's online products. There can be no assurance
that the Company will successfully negotiate relationships with providers of
online and Internet services or, if completed, that such arrangements will
generate significant revenues. The Company could be materially adversely
affected if the cost to the Company of any proposed online distributor
relationship exceeds expectations or if the Company incurs significant costs in
anticipation of the arrangement and the arrangement is delayed or abandoned.
35
<PAGE>
The Company seeks to leverage its CD-ROM sales by including the front-end
software for its online products (currently WARBIRDS) in its CD-ROM releases.
Customers can download the program from the iMagic Online web site or access it
from the CD-ROM distributed by the Company. To play online, users subscribe for
a fixed number of hours on a monthly basis and may pay to play additional hours
beyond the level included in the subscription agreement. The software can be
played alone offline or head-to-head against another player at no charge. Game
play from WARBIRDS has now exceeded 1.4 million paid hours. The Company has
additional online products in development and intends to continue to update its
existing and future online games in order to continue the flow of recurring
revenue from this distribution channel. There can be no assurance that the
Company will be able to develop new products or enhancements to existing online
products, or that such products or enhancements will be successful or continue
to produce recurring revenues.
Marketing
The Company pursues different marketing strategies for its CD-ROM game
sales and online game sales, while seeking to capitalize on the synergy of the
two strategies.
CD-ROM Game Sales
The Company believes that marketing and product positioning are critical
factors to the success of its retail games and focuses much of its effort on
the creation of market awareness surrounding its upcoming product releases. The
Company utilizes a wide range of consumer marketing techniques to position its
products. These techniques include online marketing on the Company's web site,
placement of demonstration versions on Internet game sites, print and web
advertising, distribution of demonstration disks and appearances at industry
trade shows.
The Company supports its retail products through market development funds.
These funds are used primarily for in-store promotions, point-of-purchase
displays and other advertising and promotional techniques coordinated with the
Company's retail partners. The Company maintains a database of existing and
potential customers through reader response cards and buyer registration cards
for use in direct marketing efforts.
Online Game Sales
The Company's online marketing focuses on strategies for increasing
recurring revenues from the current customer base while recruiting new
customers. The Company seeks to increase revenues from the current customer
base through community building programs, such as regular e-mail updates to
subscribers, training programs and sponsorship of online events, contests and
conventions attended by subscribers. For example, the Company is promoting the
development of "communities" of regular WARBIRDS flyers who participate in
special promotional events, such as squadron conferences, conventions and
competitions around the world. To date, over 100 of these informal squadrons or
communities exist. In addition, the Company is committed to providing extensive
technical support to its customers. The Company believes that as a result of
these efforts, it has developed significant customer loyalty, encouraging long
term customer game play.
The Company seeks to attract new customers by increasing its Internet
presence through a targeted marketing plan. This plan includes an Internet
advertising campaign, an Internet-based public relations campaign, and special
promotions with key industry partners, such as web sites and specialized
magazines. In addition, the Company intends to increase its visibility and that
of its products by seeking to establish relationships with third party
providers of Internet and online services.
Marketing Synergy
The Company continually seeks to develop the synergy of its retail and
online marketing strategies, a key component of which is building a common
brand awareness. The Company has developed brand awareness through the success
of its award-winning releases, the reputation and visibility of the Company's
Chairman (including his past experience in the interactive entertainment
software industry), its focus on simulation and strategy products, the easily
recognizable color-block design of its product packaging and its distinctive
corporate logo. Other marketing synergy includes cross-promotion of its games
at retail and online. On the retail side, this includes bundling the software
for WARBIRDS and other large-scale multiplayer games on CD-ROMs of retail
product releases. The Company is developing a web-based lobby service to match
up players of its CD-ROM games to participate in multiplayer (up to 16 players)
games. By bringing these players to its web site, the Company intends to use
this opportunity to market its online and other retail games.
36
<PAGE>
As of March 31, 1998, the Company's marketing and sales staff included 30
employees in four offices located in the Research Triangle Park area, North
Carolina; Grapevine, Texas; Bracknell, United Kingdom; and Guetersloh, Germany.
The Company expects to increase its marketing and sales staff in these
locations and expand its offices geographically where appropriate.
Technology
The Company focuses on developing technologies that can be applied across
the Company's product line or shared among similar types of products.
The Company has filed a patent application on its MEGAplayer technology,
which addresses problems inherent in high and variable latency networks such as
the Internet. The Company's online games allow more than 250 simultaneous
Internet users to play in a single arena with less "warping." Warping occurs
when other players appear to jump or "warp" across the computer screen instead
of moving smoothly. The Company believes that its technology allows a player to
enjoy a more realistic experience, which greatly enhances game play. The
Company intends to incorporate MEGAplayer technology in future real-time online
products.
The Company also has developed its MEGAvoice technology, which allows
groups of up to four players to engage in real-time voice communication over
the Internet while playing the Company's simulations. This technology utilizes
bandwidth efficiently while limiting any impact on simultaneous game play.
The Company's proprietary 3D graphics engine, DEMON, is a highly
optimized, real-time terrain rendering system for use in the development of
flight simulation and other 3D products. DEMON, utilizing satellite photography
and matching real world elevation data, produces strikingly authentic views
with near-realistic depiction of mountains, rivers, forests, fields, cities,
roads and other terrain features, just as a pilot would see if he or she were
actually flying over that area of the world. DEMON, in conjunction with other
proprietary data processing tools, is capable of handling large amounts of
data, such as the 80,000 square miles of terrain present in a single combat
theater in the iF-22 product. The engine was jointly developed with Numerical
Design Limited ("NDL"). The Company owns the code for DEMON, however, NDL has
retained rights to use the code in non-competitive markets, subject to the
payment of royalties to the Company. The Company intends to continually upgrade
this technology to add new features that will become available as a result of
rapidly changing hardware technology.
TALON is a dynamic mission generation system that enhances the replay
value of the Company's simulation games. TALON generates new mission
assignments each time the game is played. The Company believes that the TALON
system adds significant value to its products when compared to games with a
limited number of static missions.
The Company has developed a proprietary software toolkit to provide
interfaces that will allow online game play across different communications
protocols, such as varying local area networks and wide area networks. This
toolkit is intended to facilitate the communications capabilities of games,
freeing the product developers' time to focus on content. The Company intends
to update and supplement this toolkit as technology changes.
Product Development
General
The Company seeks to publish high quality content developed by both
internal and external sources. By releasing a variety of products and keeping
the product development pipeline full, the Company seeks to spread its risk and
development costs across a number of products, rather than focusing all of its
development efforts and funds on a single product or a small group of products
in an effort to produce the next blockbuster title. The Company anticipates
that in the next 18 months, approximately one-third of the Company's products
will be internally developed.
External Development
The Company typically enters into development agreements with external
software developers around the world. These development agreements generally
include an up-front payment as an advance on future royalties owed as well as
certain milestone payments and bonus or penalty clauses for early and late
product delivery, respectively. The Company generally pays a royalty of 15% to
25% of the Company's net revenues from sales
37
<PAGE>
of the licensed product. Most contracts include exclusive worldwide
distribution rights. The Company currently has 11 strategic relationships with
external developers from around the world.
The Company is continuously evaluating product proposals submitted by
third-party developers and may enter into contracts with such third parties for
one or more products. For example, in March 1998, the Company signed a
five-year development agreement with Enlight Software, developer of CAPITALISM,
CAPITALISM PLUS, and SEVEN KINGDOMS, the Company's best-selling strategy games.
The agreement calls for the development of at least three major new projects
and four upgrades to existing products. The Company will have exclusive
worldwide distribution rights to games developed under this agreement.
The Company considers itself to be a "value-added" publisher of products
developed by third parties, as the Company routinely provides developers with
software tools and libraries, software design assistance, product design and
other services to ensure the quality of the licensed products. The Company's
internal development staff closely monitors the progress of external developers
to ensure the quality of the licensed products, including all final testing
prior to a product's release.
Internal Development
Internally developed products use a combination of proprietary and
licensed software technology. The Company also supplements its in-house
development capabilities with third-party music composition, technical writing
services and select technical consulting. As of March 31, 1998, the Company's
research and development staff consisted of 79 employees. The Company believes
it has recruited talented employees with significant experience in the computer
game industry and complementary industries. The Company's development team
includes professionals experienced in client-server technology, 3D graphics,
imaging, video and audio technology, large networking systems and U.S.
Department of Defense avionic testing systems.
The Product Development Process
The development cycle for new products ranges from six to 24 months and,
for online products, continues for the life of the products. Consequently, the
Company believes that discipline is critical to management of the software
development process and requires both internal and external development efforts
to adhere to a scheduled process. Generally, each new internally developed
product begins as a brief design document proposed by the Company's internal
development staff. Following management approval, the product's designer drafts
a detailed product design specification, programmers develop the software
design and create a schedule based on that design, and artists develop
storyboards and the art production schedule. The Company then develops the
overall project schedule and budget, including a scheduled release date and a
marketing and sales plan. The Company typically reviews externally developed
products in various stages of development, and, once the Company has selected
and contracted for a product, the Company's product development staff then
manages the product development process with the external developer in a manner
similar to the Company's internal development process.
Throughout the development phase of each product, whether internally or
externally developed, the Company implements a number of quality control
procedures. The software is carefully designed, implemented and tested by the
programmers, followed by frequent testing releases. Each product is played and
critiqued by the Company's in-house playtest staff and other Company employees.
Products are then submitted to groups of up to 50 external playtesters. This
product test process reduces implementation defects and provides design and
playability feedback in a timely manner for incorporation into the finished
product.
The introduction of new products is subject to the inherent risks of
development delays. Many of the Company's products are in early stages of
development, and the Company will be required to commit considerable time,
effort and resources to complete development of its currently proposed
products. The Company has, in the past, experienced significant delays in the
introduction of certain new products and there will likely be delays in
developing and introducing new products in the future. In addition, because
many of the Company's products are developed for it by third parties, the
Company cannot always control the timing of their introduction. While the
Company maintains production arrangements with its third-party developers,
provides them with certain software toolkits to promote quality control and
monitors their progress, there can be no assurance that delays in the work
performed by third parties or poor quality of such work will not result in
product delays.
38
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Production and Manufacturing
The Company contracts with independent fulfillment vendors to produce,
ship and manage inventory of the Company's CD-ROM products, including returns.
For each published product, the Company prepares a master software disk,
artwork, camera-ready user manual and collateral materials which are sent to
such fulfillment vendors for duplication, assembly and packaging. The Company
inspects randomly selected copies of finished products prior to authorization
of shipment. Upon Company approval, the fulfillment vendor ships the finished
goods directly to the distribution channels specified by the Company via a
purchase order. The Company maintains relationships with several fulfillment
vendors to ensure access to supply and competitive pricing.
Competition
The interactive entertainment software market is intensely and
increasingly competitive. The market is characterized by the continual
introduction of new software products and technologies. The ability to compete
successfully depends primarily on the ability to develop and market high
quality products, access to distribution channels, including retail shelf
space, the availability and quality of support services for the products and
price. The Company believes that it competes favorably with respect to each of
these factors. In addition, the Company believes that online games represent an
important emerging segment of the interactive entertainment software market.
While other companies currently offer online games, few companies offer
real-time large-scale multiplayer simulation games via the Internet.
At present, the Company competes primarily against other companies
offering high-end simulation and strategy products. In particular, the
Company's competitors for its CD-ROM products include NovaLogic, Inc.,
Electronic Arts, Inc., MicroProse, Inc., Interplay Entertainment Corp.,
Activision, Inc. and Cendant Corp. (formerly CUC/Sierra On-Line). The Company
also competes with companies providing online games, including Kesmai
Corporation, VR1 Inc., Simutronics Corporation and NovaLogic, Inc. Many of the
Company's existing and future competitors have greater financial, technical,
marketing, sales and customer support resources, as well as greater name
recognition and better access to consumers, than the Company. There can be no
assurance that the Company will respond effectively to market or technological
changes or compete successfully in the future.
Intellectual Property and Other Proprietary Rights
The Company holds copyrights on its products, manuals, advertising and
other materials and has received federal trademark protection for the Company
name, the form of the Company logo and the names of certain products published
by the Company. The Company does not acquire the copyrights for works developed
by third parties under license that the Company publishes. The Company has
applied for a patent on its MEGAplayer technology that enables its online
products to function more effectively on the Internet. There can be no
assurance that the patent application for the Company's MEGAplayer technology
will result in the issuance of a patent with the United States Patent and
Trademark Office.
The Company has received registrations with respect to the following
trademarks: Interactive Magic, I-Magic, the Interactive Magic logo and Star
Rangers, and has applied for trademark registrations with respect to iM1A2
Abrams and Hind. The Company relies on common law to protect its other
trademarks. The Company believes that registered and common law trademarks and
common law copyrights are important, but are less significant to the Company's
success than factors such as the knowledge, ability and experience of the
Company's personnel, research and development, name recognition and product
quality.
The Company has developed proprietary technologies in the areas of 3D
graphics and client/server architecture. The Company protects its proprietary
technologies through various security practices. Each employee must sign a
confidentiality agreement which includes a provision that grants the Company
ownership of all intellectual property. As an additional protective measure,
only a limited number of development personnel have access to the source code
for the Company's software. While the Company relies on a combination of
trademark, trade secret, copyright and other proprietary rights laws, license
agreements, employee and third-party non-disclosure agreements and other
methods to establish and protect its proprietary rights, there can be no
assurance that the steps taken by the Company will be adequate to prevent
misappropriation of the technology or independent development by others of
software products with features based upon, or otherwise similar to, those of
the Company's products. To license its products to end users, the Company
primarily relies on "shrink wrap" licenses that are not signed by the end-user
and, therefore, may be unenforceable under the laws of certain jurisdictions.
In addition,
39
<PAGE>
effective copyright and trade secret protection may be unavailable or limited
in certain foreign countries, and the global nature of certain wide area
networks, particularly the Internet, makes it virtually impossible to control
the ultimate destination of the Company's products. Despite the Company's
efforts to protect its proprietary rights, unauthorized parties may attempt to
copy aspects of the Company's products or to obtain and use information that
the Company regards as proprietary. Unauthorized copying is common within the
software industry, and if a significant amount of unauthorized copying of the
Company's products were to occur, the Company's business, operating results or
financial condition could be adversely affected. As the number of software
products in the industry increases and the functionality of these products
further overlaps, software developers may become increasingly subject to
infringement claims. There can be no assurance that third parties will not
assert infringement claims against the Company in the future with respect to
current or future products. As is common in the industry, from time to time,
the Company receives notices from third parties claiming infringement of
intellectual property rights of such parties. The Company investigates these
claims and responds as it deems appropriate. Litigation may be necessary in the
future to enforce the Company's intellectual property rights, to protect the
Company's trade secrets, to determine the validity and scope of the proprietary
rights of others, or to defend against claims of infringement or invalidity.
Any such litigation could result in substantial costs and diversion of
resources and could have a material adverse effect on the Company's business,
operating results or financial condition.
Employees
As of March 31, 1998, the Company employed 121 people, including 72 on a
full-time basis and 7 on a part-time basis in research and development, 30 on a
full-time basis in sales and marketing and 12 on a full-time basis in finance
and administration. Competition for highly skilled employees with technical,
management, marketing, sales, product development and other specialized
training is intense. There can be no assurance that the Company will be
successful in attracting and retaining such personnel. The Company and its
employees are not parties to any collective bargaining agreements. The Company
believes that its relations with its employees are good.
Properties
The Company leases 18,452 square feet of office space in the Research
Triangle Park area, North Carolina, which it uses as its principal executive
offices. The Company leases 4,895 square feet of office space in Grapevine,
Texas as a regional development office. The Company also leases 1,520 square
feet of office space in Bracknell, United Kingdom, and 700 square feet of
office space in Guetersloh, Germany, for the Company's foreign operations. The
Company believes that its existing facilities are adequate to meet its current
needs and that suitable additional or substitute space will be available as
needed to accommodate any expansion of operations.
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MANAGEMENT
Directors and Executive Officers
The directors and executive officers of the Company are as follows:
<TABLE>
<CAPTION>
Name Age Position
- -------------------------------------- ----- ------------------------------------------------------------------
<S> <C> <C>
J. W. Stealey(2) .................... 50 Chairman of the Board of Directors and Chief Executive Officer
Robert L. Pickens ................... 51 President and Chief Operating Officer
Joseph Rutledge ..................... 46 Senior Vice President -- Development
Raymond Rutledge .................... 56 Vice President -- Licensing
Joseph R. Mannes .................... 39 Vice President and General Manager, Online Games
William H. Marks .................... 46 Chief Financial Officer, Vice President -- Finance, Secretary and
Treasurer
David H. Kestel(2) .................. 65 Director
J. Nicholas England(1) .............. 50 Director
W. Joseph McClelland(1)(2) .......... 52 Director
Avi Suriel(1) ....................... 38 Director
</TABLE>
- ------------
(1) Member of Audit Committee.
(2) Member of Compensation Committee.
J. W. Stealey has been Chairman of the Board of Directors and Chief
Executive Officer of the Company since January 1995. Previously, he was
founder, Chairman and Chief Executive Officer of MicroProse, Inc., a leading
developer and publisher of flight simulation and strategy software titles from
1982 to 1993. Prior to 1982, Mr. Stealey was Group Director of Business
Development of General Instruments. Prior to joining General Instruments
Corporation, Mr. Stealey held management consulting positions with Cresap,
McCormick and Paget and McKinsey & Co. in New York, New York. Mr. Stealey
earned a B.S. degree in Aeronautical Engineering from the United States Air
Force Academy. After graduation from the Academy, Mr. Stealey spent six years
as an operational pilot in the United States Air Force. Mr. Stealey also
received an M.B.A. in finance and strategic management from the Wharton School
of Business of the University of Pennsylvania.
Robert L. Pickens has been President and Chief Operating Officer of the
Company since its incorporation in May 1994. From 1986 to 1994, Mr. Pickens was
President and Chief Executive Officer of Washington Aluminum Company, where he
was responsible for the operations and business administration of its five
divisions. From 1970 to 1986, Mr. Pickens held various operations and sales
positions at Kaiser Aluminum and Chemical Corporation, including managing
Kaiser Aluminum and Chemical Corp.'s Carbon Division. Mr. Pickens earned a B.A.
degree in Psychology from Davidson College. Mr. Pickens has completed extensive
M.B.A. work and is a candidate for a master's degree in Applied Behavioral
Science at Johns Hopkins University.
Joseph Rutledge has been Senior Vice President of Development for the
Company since September 1994. Mr. Rutledge oversees the Company's internal
software development activities. Prior to joining the Company, Mr. Rutledge
founded and operated JR Associates, a private software consulting company which
designed multimedia and "edutainment" products. From 1978 to 1994, Mr. Rutledge
served as a technical systems consultant for Honeywell Inc., McDonnell Douglas
Corp. and other defense technology companies. Mr. Rutledge is a graduate of the
University of Pittsburgh with a B.S. degree in Mathematics. Mr. Rutledge is the
brother of Raymond Rutledge.
Raymond Rutledge has served as the Company's Vice President of Licensing
since February 1995. Mr. Rutledge oversees product development from external
sources. From 1993 to 1995, Mr. Rutledge served as Vice President of
Development for MicroProse, Inc., where he was responsible for overseeing
development of hit releases such as F-15 Strike Eagle III, F-14 Fleet Defender,
1942 Pacific Air War and Ultimate Football. From 1988 to 1992, Mr. Rutledge
served as Executive Vice President of RJO Enterprises, Inc., a systems
engineering and software company. Mr. Rutledge graduated from the University of
Pittsburgh with a B.S. degree in Electrical Engineering. He also earned a
master's degree in Computer Science from Adelphi University. Mr. Rutledge is
the brother of Joseph Rutledge.
41
<PAGE>
Joseph R. Mannes has served as Vice President and General Manager, Online
Games for the Company since April 1997, when it acquired ICI. From 1996 until
1997, Mr. Mannes served as a Director, Chief Financial Officer, Secretary and
Treasurer of ICI. From 1987 to 1996, Mr. Mannes was First Vice President in the
Corporate Finance Department of Rauscher Pierce Refsnes, Inc., a Dallas, Texas
investment bank. From 1982 to 1987, he served as an Assistant Vice President at
the First National Bank of Boston, where he worked as a commercial lender in
both the Special Industry Group and the High Technology Group. Mr. Mannes
received an A.B. degree in Philosophy and French from Dartmouth College and
graduated with an M.B.A. degree in Accounting and Finance from the Wharton
School of Business of the University of Pennsylvania. Mr. Mannes is a Chartered
Financial Analyst.
William H. Marks was appointed Chief Financial Officer, Vice President --
Finance, Secretary and Treasurer of the Company effective June 1, 1998. Mr.
Marks served as Executive Vice President and Chief Financial Officer since May
1996, and served as Senior Vice President -- Finance and Accounting, from June
1995 to May 1996, of Fleer/SkyBox International, a subsidiary of Marvel
Entertainment Group, Inc. in Mt. Laurel, New Jersey. From 1990 to 1995, Mr.
Marks served as Controller of SkyBox International Inc. (a subsidiary of Brooke
Group Ltd.) in Durham, North Carolina. From 1981 to 1990, Mr. Marks served as
Senior Manager of Coopers & Lybrand L.L.P. in Richmond, Virginia and Raleigh,
North Carolina. Mr. Marks received a B.S. in Accounting from Virginia
Commonwealth University in 1978 and completed various courses in Masters of
Taxation there in 1984-1985.
David H. Kestel, CLU, has served as a Director of the Company since
February 1997. Since 1992, Mr. Kestel has served as President of The Kestel
Group, Inc., an estate planning, executive compensation and employee benefits
company based in Potomac, Maryland. From 1978 to 1992, he worked at Blue Cross
and Blue Shield of the National Capital Area, most recently as Senior Vice
President, Marketing, and served as President of two domestic life insurance
companies and two offshore reinsurance companies. Mr. Kestel received a B.B.A.
and an M.B.A. from the University of Michigan. Mr. Kestel is a Member,
Chartered Life Underwriter.
J. Nicholas England has served as a Director of the Company since February
1997. Since 1993, Mr. England has been a Research Professor in the Department
of Computer Science at the University of North Carolina at Chapel Hill. From
1987 to 1993, he worked as Director of Product Development for advanced
graphics, imaging and visualization hardware and software for Sun Microsystems,
Inc. Previously, Mr. England founded two computer graphics companies. Mr.
England is a Director of Numerical Design Limited in Chapel Hill, North
Carolina, a private software company. He received a B.S. in Electrical
Engineering from North Carolina State University.
W. Joseph McClelland has served as a Director of the Company since
February 1997. Since 1990, Mr. McClelland has been Vice President and a Member
of the Board of GEC-Marconi Defense Systems Inc., an Arlington, Virginia-based
subsidiary of GEC-Marconi Ltd., which produces and sells electronic warfare
equipment to government customers. From 1988 to 1990, he was Director,
Avionics, Armament and Electronic Combat, at the HQ United States Air Force
Systems Command at Andrews Air Force Base in Maryland, where he supervised
headquarters staff and provided corporate oversight of advanced programs. From
1986 to 1988, he was Director, United States Air Force Research and Development
Liaison Office in London, England, where he initiated and managed U.S./U.K.
cooperative research and development programs. Mr. McClelland received a B.S.
in Engineering Mechanics and Mathematics from the United States Air Force
Academy. He received an M.S. in Applied Mechanics from the University of Utah.
Mr. McClelland is a graduate of the United States Air Force Test Pilot School.
Avi Suriel has served as a Director of the Company since February 1998.
Since 1996, Mr. Suriel has been a Director of Vertical Financial Holdings, a
European-based merchant banking firm focusing primarily on investments in the
high technology industry. From 1993 to 1996, Mr. Suriel was a Director in the
Investment Banking Division of Salomon Smith Barney. From 1990 to 1993, he was
a Senior Associate in the Fixed Income Division at Morgan Stanley & Co.
Incorporated. From 1988 to 1990, he was a Research Analyst in the Fixed Income
Division at Merrill Lynch, Pierce, Fenner & Smith. Mr. Suriel also provides
consulting services as a principal of Suriel Financial Consulting, which he
founded. Mr. Suriel received a B.A. degree in Economics and International
Relations from Hebrew University, Israel, and an M.B.A. in Finance from Fordham
University.
All directors currently hold office until the next annual meeting of
shareholders or until their successors have been duly elected and qualified.
Executive officers are elected by, and serve at the discretion of, the Board of
Directors.
The Company has obtained key man life insurance on the life of Mr. Stealey
in the amount of $4,200,000.
42
<PAGE>
Key Employees
Douglas Kubel has been Vice President of Engineering and Technology of the
Company since October 1994. Mr. Kubel manages the development of 3D graphics
and audio technology and is responsible for incorporating hardware and software
technologies into the Company's planning processes. From 1987 to 1994, Mr.
Kubel was a Senior Software Manager for imaging, video, audio and visualization
for Sun Microsystems, Inc., where he developed 3D graphics software for
photorealistic rendering and computer-aided design. Mr. Kubel served as a
Software Engineer for General Electric from 1985 to 1987. Mr. Kubel graduated
summa cum laude from North Carolina State University where he earned a B.S.
degree in Electrical Engineering. He later graduated from the Program for
Technology Managers at the Kenan-Flagler School of Business at the University
of North Carolina.
Dale Addink has been Vice President of Development, Online Games, since
April 1997, when the Company acquired ICI. Mr. Addink serves as the lead
developer of online games. From 1995 to 1997, Mr. Addink was President of ICI,
which he co-founded in 1995. Mr. Addink served as Senior Project Engineer at
Rapistan Demag Corp., a manufacturer of software for industrial electrical
controls, from 1994 to 1995. From 1988 to 1994, Mr. Addink operated a
consulting company through which he developed industrial control systems. Mr.
Addink received a B.A. degree in Math and Computer Science from the University
of Northern Iowa.
Committees of the Board of Directors
The Board of Directors has established two standing committees, the Audit
Committee and the Compensation Committee. The Audit Committee recommends the
appointment of auditors and reviews the results and scope of the audit and
other services provided by the Company's independent auditors. The Compensation
Committee is responsible for the approval of compensation arrangements for the
officers of the Company, the review of the Company's compensation plans and
policies and the administration of the Company's employee benefit plans.
Directors' Compensation
The Company reimburses each director for out-of-pocket expenses incurred
in connection with the rendering of services as a director. The Company has
granted warrants to purchase 25,000 shares of Common Stock to each non-officer
director at an exercise price equal to fair market value at the date of grant.
In addition, the Company has granted warrants to purchase an additional 500
shares to each director at an exercise price equal to fair market value at the
date of grant as compensation for each Board meeting attended. In addition,
directors are eligible to participate in the Company's 1998 Stock Plan. See "
- -- Stock Option Plans."
Executive Compensation
The following tables show annual and long-term compensation paid or
accrued by the Company for services rendered for the year ended December 31,
1997 by the Company's Chief Executive Officer and the Company's other executive
officers whose salary and bonus exceeded $100,000 in the most recent fiscal
year.
Summary Compensation Table
<TABLE>
<CAPTION>
Annual Compensation
---------------------------------------
Other Annual All Other
Name and Principal Position Year Salary Compensation Compensation
- ----------------------------------------------------- ------ ----------- ---------------- ---------------
<S> <C> <C> <C> <C>
J. W. Stealey ...................................... 1997 $160,000 $ 25,380(1) $ --
Chairman of the Board and Chief Executive Officer
Robert L. Pickens .................................. 1997 $114,000 (2) $ 3,833(3)
President and Chief Operating Officer
William J. Kaluza .................................. 1997 $120,000 (2) $ --
Chief Financial Officer, Treasurer and Secretary(4)
</TABLE>
- ------------
(1) Includes $16,832 in payments for an automobile used by Mr. Stealey and
$8,548 in club dues.
(2) Perquisites and other personal benefits did not exceed the lesser of
$50,000 or 10% of salary compensation for the named executive officers.
(3) Represents payments for term life insurance of which certain family members
of Mr. Pickens are beneficiaries.
(4) Mr. Kaluza resigned from the Company for personal reasons effective May 21,
1998.
43
<PAGE>
Aggregated Fiscal Year-End Option Values
<TABLE>
<CAPTION>
Number of Securities Underlying Value of Unexercised
Unexercised Options at Fiscal In-The-Money
Year-End Options at Fiscal Year-End (1)
------------------------------- ------------------------------
Name Exercisable Unexercisable Exercisable Unexercisable
- --------------------------- ------------- --------------- ------------- --------------
<S> <C> <C> <C> <C>
J. W. Stealey ............. 206,250 293,750 $1,031,250 $1,468,750
Robert L. Pickens ......... 70,813 106,688 354,065 533,440
William J. Kaluza ......... 42,188 107,813 168,752 431,252
</TABLE>
- ------------
(1) The value of the options is based upon the difference between the exercise
price per share and the estimated fair market value per share at December
31, 1997, as determined by the Board of Directors, multiplied by the
number of shares subject to the option.
Employment Agreements
The Company is party to an employment agreement with each of the named
executive officers. The Company entered into employment agreements with J. W.
Stealey, Robert L. Pickens and William J. Kaluza, effective January 3, 1995,
January 3, 1995 and March 25, 1996, respectively. Mr. Kaluza has resigned from
the Company for personal reasons effective May 21, 1998. Each of Mr. Stealey's
and Mr. Pickens' employment agreements has an initial term of three years that
automatically renews for an additional one year term beginning on the second
anniversary of the effective date unless either party provides written notice
of intent not to extend the term for an additional year. During the term of
employment, the parties may terminate the employment for any reason upon
notice.
If the termination is for any reason other than voluntary termination by
the employee or by the Company for cause, the Company will make the following
payments to the employee: (i) any unpaid base compensation for services
performed prior to the date of termination, (ii) the amount of any accrued
annual vacation pay and other accrued but unpaid benefits and (iii) an amount
as liquidated damages equal to twice the amount of the employee's (A) annual
base salary then in effect; (B) any earned incentive compensation due but
unpaid; and (C) such incentive compensation as would have been earned from
January 1 of the year of termination through the date of termination pursuant
to performance criteria established by the Board of Directors. With respect to
Mr. Pickens, the Company's failure to extend his employment agreement for an
additional year on an anniversary of the effective date will constitute a
termination by the Company without cause.
If the termination is voluntary by the employee or by the Company for
cause, the Company will pay the employee (i) any unpaid compensation for
services performed prior to the date of termination, (ii) the amount of any
accrued annual vacation pay and (iii) such incentive compensation as would have
been earned from January 1 of the year of termination through the date of
termination pursuant to performance criteria established by the Board of
Directors. Voluntary termination does not include termination by the employee
as a result of (i) a material change in the employee's duties, responsibilities
or authority, including the sale or other disposition of a substantial part of
the business of the Company that would decrease the scope of the employee's
position, (ii) failure to obtain the assumption of the obligation to perform
the agreement by any successor, (iii) breach of the employment agreement by the
Company or (iv) relocation of the employee's office to a location more than
fifty (50) miles from the employee's residence or the Company's principal
offices.
The employment agreements each include a non-competition provision,
effective during the term of the employment agreement and for a period of one
year (two years for Mr. Stealey) following termination of employment, pursuant
to which the employee cannot compete with the Company within 250 miles of any
location at which the Company maintains its principal administrative
headquarters by becoming interested, directly or indirectly, as a partner,
officer, director, stockholder, advisor, employee or in any other capacity with
any competitive business engaged in the design, manufacture or sale of games
used on personal computers. The employment agreements each prohibit disclosure
of any confidential information about the Company.
Stock Option Plans
1995 Employees' Incentive Stock Option Plans
Effective January 2, 1995, the Company adopted two employee incentive
stock option plans (the "1995 Plans"). One plan provided for the granting of
options to purchase Class A Common Stock which was voting
44
<PAGE>
stock, and one plan provided for the granting of options to purchase Class B
Common Stock which was non-voting. In connection with the Recapitalization, all
options to purchase shares of Class A Common Stock and Class B Common Stock
under the 1995 Plans will be automatically converted into options to purchase
Common Stock. The 1995 Plans are intended as incentives to induce key employees
of the Company to remain in the employ of the Company or of any subsidiary of
the Company, and to encourage such employees to own stock in the Company. This
purpose is carried out by granting options to purchase shares of Common Stock.
The Company may grant incentive stock options ("ISOs") within the meaning of
Section 422 of the Code to eligible participants under the 1995 Plans. The
exercise price of an ISO may not be less than 100% of the fair market value of
the underlying shares at the time the ISO is granted. An ISO granted must be
exercised in whole or in part from time to time within 10 years from date of
grant, or such shorter time as specified by the Board of Directors. The
aggregate fair market value of the stock for which a participant may exercise
incentive options during any calendar year may not exceed $100,000. The Company
reserved 2,875,000 shares of Common Stock for issuance upon the exercise of
stock options granted pursuant to the 1995 Plans, which number may be adjusted
to reflect any stock dividend, stock split, share combination or
recapitalization.
The 1995 Plans are administered by the Board of Directors. The Board has
the authority to administer the 1995 Plans and determine, among other things,
the interpretation of any provisions of the 1995 Plans, the eligible employees
who are to be granted stock options, the number of shares which may be issued
and the option exercise price.
Incentive Stock Options. As of the date of this Prospectus (giving effect
to the Recapitalization), the Company had outstanding incentive options to
purchase 1,194,295 shares of Common Stock of which options to purchase 570,202
shares were currently exercisable, at exercise prices ranging from $1.00 to
$6.00 per share. Incentive stock options vest over time with 20% being first
exercisable during the second year after the date of grant or, if earlier, the
participant's hire date, with an additional 5% vesting each calendar quarter
thereafter. Incentive stock options generally may only be exercised if the
participant has been employed by the Company continuously for at least one year
as of the last day of the first 12-month period following the date of option
grant. The option is only exercisable if the participant is employed by the
Company and for limited periods of time after the participant's termination of
employment. If the participant ceases to be employed on account of termination
by the Company for cause or resignation (other than retirement as defined in
the option agreement), the right to exercise any unexercised portion of the
option terminates. If the participant is terminated by the Company without
cause, the participant shall be entitled to purchase, within three months,
option shares equal to an additional 25% of the participant's option shares
that were not exercisable as of the termination date. The option becomes
immediately and fully exercisable in the event of a change in control. A change
in control shall occur if, during any period of 12 consecutive calendar months,
any individual who, at the beginning of such period, holds a majority of the
Company's issued and outstanding shares of voting stock ceases for any reason
to hold a majority of shares; provided, however, it shall not be deemed to be a
change in control if the individual ceases to hold a majority of shares because
of either the issuance or other transfer of Company voting stock to a director,
officer, employee or previous shareholder of the Company or the issuance of
voting stock in connection with a financing so long as the individual continues
to own at least 20% of the Company's outstanding voting stock and remains an
executive officer or director.
Performance Incentive Stock Options. As of the date of this Prospectus
(giving effect to the Recapitalization), the Company had outstanding
performance incentive stock options to purchase 501,250 shares of Common Stock,
151,938 of which were currently exercisable, at exercise prices ranging from
$1.00 to $2.00 per share. The performance incentive stock options are
exercisable during the period commencing from March 31, 1997 and ending March
31, 2005. Performance options vest upon the earlier of the Company's
achievement of certain performance standards or seven years from the date of
grant. Options are exercisable only in the event the participant is employed by
the Company and for limited periods of time after the participant's termination
of employment. If the participant ceases to be an employee on account of
resignation (other than retirement as defined in the option agreement) or
termination for cause, the right to exercise any unexercised portion of the
option shall terminate. The option becomes immediately and fully exercisable as
of a change in control date. A change in control shall occur if, during any
period of 12 consecutive calendar months, any individual who, at the beginning
of such period, holds a majority of the Company's issued and outstanding shares
of voting stock, ceases for any reason to hold such a majority of outstanding
shares.
45
<PAGE>
1998 Stock Plan. The Company's 1998 Stock Plan (the "Plan") was adopted by
the Board of Directors and approved by the shareholders of the Company in May
1998. The Company anticipates that no future grants will be made under the 1995
Plans after the effective date of the Plan. A total of 800,000 shares of Common
Stock have been reserved for issuance under the Plan. The Plan provides for
grants to employees of the Company of ISOs. In addition, the Plan provides for
grants of nonqualified stock options and stock purchase rights to employees,
directors and consultants of the Company. The Plan is administered by the Board
of Directors or by a committee appointed by the Board. The administrator
determines the terms of options and stock purchase rights granted, including
the exercise price and the number of shares subject to the option or stock
purchase right. The exercise price of incentive stock options granted under the
Plan must be at least equal to the fair market value of the Company's Common
Stock on the date of grant. The maximum term of options granted under the Plan
is 10 years. As of the date of this Prospectus, there were no outstanding
options under the Plan.
In the event of a merger of the Company with or into another corporation,
all outstanding options may be assumed or equivalent options substituted by the
successor corporation. If the successor corporation does not assume or
substitute for outstanding options, such options will automatically become
fully vested and exercisable.
1998 Employee Stock Purchase Plan. The Company's 1998 Employee Stock
Purchase Plan (the "Purchase Plan") was adopted by the Company's Board of
Directors and approved by the Company's shareholders in May 1998. The Purchase
Plan is intended to qualify under Section 423 of the Code. The Company has
reserved 500,000 shares of Common Stock for issuance under the Purchase Plan.
Under the Purchase Plan, an eligible employee may purchase shares of Common
Stock from the Company at the end of a six-month offering period through
payroll deductions of up to 10% of his or her base compensation (excluding
bonuses, overtime and sales commissions) not to exceed $25,000 per year, at a
price per share equal to 85% of the fair market value of a share of the
Company's Common Stock on the last day of the offering period. The maximum
number of shares that an employee may purchase in any offering period is 2,500
shares. Each six-month offering period will commence the first day on which the
national stock exchanges and the Nasdaq National Market are open for trading on
or after May 1 and November 1 of each year, except that the first offering
period will begin on the date of the Company's initial public offering and will
end on October 31, 1998. In the event of a merger or asset sale, the offering
period then in progress will be shortened so that the stock purchases will
occur before the date of the merger or sale. Any employee who is customarily
employed for at least 20 hours per week and more than five months per calendar
year and who is employed on or before the commencement date of an offering
period is eligible to participate in the Purchase Plan. As of the date of this
Prospectus, there were no outstanding options under the Purchase Plan.
Compensation Committee Interlocks and Insider Participation
Since the Company began doing business in June 1994, all matters
concerning executive compensation have been addressed by the entire Board of
Directors. Messrs. Stealey and Pickens are executive officers of the Company
and prior to 1997 constituted the entire Board of Directors. On May 6, 1998,
the Company established a Compensation Committee which is responsible for the
approval of compensation arrangements for the officers of the Company, the
review of the Company's compensation plans and the administration of the
Company's employee benefit plans.
Limitation of Liability and Indemnification Matters
As permitted by North Carolina law, Article IX of the Company's Articles
of Incorporation provides for the limitation of the personal liability of
directors for monetary damages for breach of duty as a director provided that
the limitation of liability does not apply to (i) acts or omissions not made in
good faith that the director at the time of such breach knew or believed were
in conflict with the best interests of the corporation; (ii) any liability
under the North Carolina Business Corporation Act for unlawful distributions;
(iii) any transaction from which the director derived an improper personal
benefit or (iv) acts or omissions occurring prior to the date the provision
became effective.
The North Carolina Business Corporation Act also contains provisions
prescribing the extent to which present or former directors, officers, or
employees of a corporation shall or may be indemnified against liabilities
which they may incur in those capacities. Under those provisions, the
availability or requirement of indemnification or reimbursement of expenses is
dependent upon numerous factors, including whether the action is brought by the
46
<PAGE>
corporation or by outsiders and the extent to which the potential indemnitee is
successful in his defense. The statute also permits a corporation to purchase
and maintain insurance on behalf of its directors and officers against
liabilities which they may incur in their capacities as such, whether or not
the corporation would have the power to indemnify them under other provisions
of the statute.
As permitted by North Carolina law, Article IX of the Bylaws of the
Company provides for the indemnification of directors and officers, employees
or agents of the Company within the limitations permitted by North Carolina
law. It is the position of the Commission that indemnification for liability
arising out of violations of the federal securities laws is against public
policy and is unenforceable.
PRINCIPAL SHAREHOLDERS
The following table sets forth as of July 15, 1998 (giving retroactive
effect to the Recapitalization, see "Description of Securities --
Recapitalization"), and as adjusted to reflect the sale of the 2,600,000 shares
offered hereby, certain information known to the Company concerning the
beneficial ownership of the Common Stock by (i) each person known by the
Company to own beneficially more than five percent of the outstanding Common
Stock, (ii) each director of the Company, (iii) each officer of the Company
named in the Summary Compensation Table and (iv) all directors and executive
officers as a group. Unless otherwise indicated, each person has sole voting
and investment power with respect to the shares beneficially owned by such
person.
<TABLE>
<CAPTION>
Name and Address Number of Shares Percentage of Outstanding
of Beneficial Owner (1) Beneficially Owned (2) Shares Beneficially Owned (2)
- ----------------------------------------- ------------------------ -----------------------------------
Before Offering After Offering
----------------- ---------------
<S> <C> <C> <C>
J. W. Stealey ........................... 2,700,617 (3) 38.3% 28.0%
Robert L. Pickens ....................... 287,401 (4) 4.2% 3.0%
William J. Kaluza ....................... 86,562 (5) 1.3% *
J. Nicholas England ..................... 13,500 (6) * *
David H. Kestel ......................... 613,500 (7) 9.0% 6.5%
W. Joseph McClelland .................... 13,500 (6) * *
Avi Suriel .............................. 2,058,149 (8) 30.2% 21.9%
Vertical Financial Holdings (9) ......... 2,045,649 (10) 30.1% 21.8%
Pampero Limited (11) .................... 460,271 (12) 6.8% 4.9%
Ludwig Ruppert (13) ..................... 460,271 (12) 6.8% 4.9%
All directors and executive officers as
a group (10 persons) .................... 6,060,878 (14) 81.1% 60.2%
</TABLE>
- ------------
*Less than one percent
(1) The address of each beneficial owner listed is the address of the Company
unless otherwise provided.
(2) Based on 6,793,699 shares of Common Stock outstanding prior to this
offering and 9,393,699 shares of Common Stock outstanding immediately
after this offering. Pursuant to the rules of the Commission, certain
shares of the Company's Common Stock that a person has the right to
acquire within 60 days of the date hereof pursuant to the exercise of
stock options or warrants are deemed to be outstanding for the purpose of
computing the percentage ownership of such person but are not deemed
outstanding for the purpose of computing the percentage ownership of any
other person.
(3) Includes 236,389 shares subject to warrants exercisable within 60 days of
July 15, 1998, and 25,000 shares subject to options exercisable within 60
days of July 15, 1998. Excludes 600,000 shares held in a trust for Mr.
Stealey's children over which Mr. Kestel is the trustee. Mr. Stealey has
neither voting power nor dispositive power over the shares held in the
trust. Mr. Stealey disclaims beneficial ownership of the shares held in
the trust.
(4) Includes 13,845 shares subject to warrants exercisable within 60 days of
July 15, 1998, and 49,813 shares subject to options exercisable within 60
days of July 15, 1998.
(5) Includes 21,562 shares subject to stock options exercisable within 60 days
of July 15, 1998.
(6) Includes 13,500 shares subject to warrants exercisable within 60 days of
July 15, 1998.
47
<PAGE>
(7) Includes 13,500 shares subject to warrants exercisable within 60 days of
July 15, 1998. Also includes 600,000 shares held in a trust for Mr.
Stealey's children over which Mr. Kestel is the trustee. Mr. Kestel has
sole voting power and dispositive power over the shares held in the trust.
Mr. Kestel disclaims beneficial ownership of the shares held in the trust.
(8) Includes 146,117 shares owned by Suriel Financial Consulting, of which Mr.
Suriel is the founder and a principal. Also includes 12,500 shares subject
to warrants exercisable within 60 days of July 15, 1998 and 1,899,532
shares of Common Stock beneficially owned by Vertical Financial Holdings.
Vertical Financial Holdings has voting power over the shares owned by
Suriel Financial Consulting pursuant to a proxy agreement. Mr. Suriel is a
Director of Vertical Financial Holdings. Mr. Suriel disclaims beneficial
ownership of shares beneficially owned by Vertical Financial Holdings.
(9) Vertical Financial Holdings is beneficially owned by Derungs
Treuhandgesellschaft AG. Jacob Agam serves as Chairman of Vertical
Financial Holdings, and Bruno Derungs, who is the principal of Derungs
Treuhandgesellschaft AG, serves as its Managing Director. Mr. Suriel and
Viscount William Lewisham serve as directors of Vertical Financial
Holdings. The address of Vertical Financial Holdings is
Hambrechtikerstrasse 61, CH-8640 Rapperswil, Switzerland.
(10) Includes 1,647,478 shares owned by the other investors in the Company's
Series B Preferred Stock financing over which Vertical Financial Holdings
has voting power pursuant to a proxy agreement.
(11) Pampero Limited is owned by Margaretha Dewert, and Ullrich Angersbach is
its sole director. The address of Pampero Limited is c/o Vertical
Financial Holdings, Hambrechtikerstrasse 61, CH-8640 Rapperswil,
Switzerland.
(12) Vertical Financial Holdings has voting power over these shares pursuant to
a proxy agreement.
(13) The address of the beneficial owner is c/o Vertical Financial Holdings,
Hambrechtikerstrasse 61, CH-8640 Rapperswil, Switzerland.
(14) Includes 303,234 shares subject to warrants exercisable within 60 days of
July 15, 1998 and 373,755 shares subject to options exercisable within 60
days of July 15, 1998.
CERTAIN TRANSACTIONS
The Company, Mr. Stealey and Mr. Pickens are parties to a January 3, 1995
Stock Purchase and Stockholder Agreement (the "Co-Sale Agreement"). The Co-Sale
Agreement grants Mr. Pickens a co-sale right to participate in any transfer of
shares of Common Stock by Mr. Stealey on the same terms and conditions as
offered to the third party by Mr. Stealey. The co-sale right entitles Mr.
Pickens to participate in such transfer in the same proportion to the number of
shares to be sold by Mr. Stealey that the number of shares of Common Stock
owned by Mr. Pickens prior to the transfer bears to the number of shares of
Common Stock owned by Mr. Stealey prior to the transfer.
The Company has also entered into a marketing agreement, dated January 3,
1995, with Mr. Stealey, pursuant to which Mr. Stealey makes his T-28 Trojan
aircraft and his services as a pilot available to the Company in consideration
for which the Company pays all of the expenses to store, operate and maintain
such aircraft and to maintain Mr. Stealey's pilot license.
On March 6, 1995, the Company issued a demand Promissory Note to Mr.
Pickens in the principal amount of $600,000 at an annual interest rate of 12%,
which increased to 14% on June 30, 1996 because the balance thereunder exceeded
$400,000 on that date. In consideration of this loan, the Company issued
warrants to Mr. Pickens to purchase 13,845 shares of Common Stock at an
exercise price of $1.00 per share. In connection with the Company's Series B
Preferred Stock financing, Mr. Pickens, on February 4, 1998, converted the
outstanding principal of $600,000 into 132,744 shares of Series C Preferred
Stock, which shares will be converted into 132,744 shares of Common Stock in
connection with the Recapitalization. Also in connection with the
Recapitalization, Mr. Pickens has forgiven $50,000 of the accrued interest
outstanding in connection with this loan in payment of the $1.00 per share
exercise price of his 50,000 Recapitalization Options. The Company has agreed
to pay Mr. Pickens $111,421 of the remaining $183,864 in accrued interest due
to him under this loan upon the consummation, and out of the proceeds, of this
offering.
On April 11, 1995, the Company entered into a joint development agreement
with NDL for the development of the Company's DEMON technology. J. Nicholas
England, a director of the Company, is a director of NDL.
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To date, the Company has paid $322,500 to NDL for the rights to the technology
which includes amounts paid pursuant to a royalty of 1% of net sales based on
products that incorporate the DEMON technology.
On December 4, 1995, the Company entered into a leasehold agreement with
Southport Business Park Limited Partnership ("Southport") for the Company's
principal executive offices located at 215 Southport Drive in Morrisville,
North Carolina. The term of the lease is for a period of five years commencing
April 1, 1996 at a monthly rent of $13,962, subject to adjustment in certain
circumstances. J. W. Stealey has executed a personal guarantee in favor of
Southport in connection with the leasehold agreement.
Since the Company's inception, Mr. Stealey has executed several personal
guaranties and pledges of personal collateral in favor of BB&T, one of the
Company's primary bank creditors, in connection with revolving and term loans
extended by BB&T to the Company. On January 24, 1997, the Company issued a
$2,500,000 Promissory Note to BB&T secured by Mr. Stealey's guarantee and
pledge of collateral. The January 24, 1997 note has been paid in full, and Mr.
Stealey's guarantee and pledge in respect thereof have been extinguished. On
August 25, 1997, the Company issued a $2,750,000 Promissory Note to BB&T
secured by Mr. Stealey's guarantee and pledge of collateral in replacement of
the January 24, 1997 note. On November 25, 1997, the Company issued a $250,000
Promissory Note to BB&T secured by Mr. Stealey's guarantee and pledge of
collateral. The November 25, 1997 note has been paid in full, and Mr. Stealey's
guarantee and pledge in respect thereof have been extinguished. On March 27,
1998, the Company issued a $250,000 Promissory Note to BB&T secured by Mr.
Stealey's guarantee and pledge of collateral. In connection with his guaranties
to BB&T, the Company is obligated to pay Mr. Stealey a fee equal to 6% per
annum of the indebtedness borrowed. As of March 31, 1998, the Company owed Mr.
Stealey an aggregate of $210,284 in consideration of his guaranties to BB&T.
On May 20, 1996, the Company issued a Promissory Note to Mr. Stealey in
the principal amount of $1,000,000, payable on November 17, 1996, with interest
at the annual rate of 15%, increasing to 17% if the Company did not repay Mr.
Stealey by November 17, 1996. In connection with this loan, the Company issued
warrants to Mr. Stealey to purchase 25,000 shares of Common Stock at a price of
$2.00 per share. Under the original terms of the note, if the note was not
repaid by November 17, 1996, the Company was obligated to issue additional
warrants to Mr. Stealey to purchase 25,000 shares of Common Stock per 180 days
prorated over the time until repayment occurred. On March 20, 1997, in
connection with a loan to the Company made by Petra, Mr. Stealey waived his
right under the note to accrue additional warrants after November 16, 1997. On
February 4, 1998, in connection with the Company's Series B Preferred Stock
financing, Mr. Stealey converted the $1,000,000 principal outstanding under the
May 20, 1996 note into 221,239 shares of Common Stock. In connection with the
Recapitalization, Mr. Stealey has forgiven $268,750 of the accrued interest
outstanding under this note in payment of the $1.00 per share exercise price of
his 268,750 Recapitalization Options. The Company remains obligated to pay Mr.
Stealey approximately $3,451 in interest that accrued under this note through
February 4, 1998.
On July 10, 1996, the Company issued a Promissory Note to Mr. Stealey in
the principal amount of $1,000,000, payable on January 6, 1997, with interest
at the annual rate of 15%, increasing to 17% if the Company did not repay Mr.
Stealey by January 6, 1997. In connection with this loan, the Company issued
warrants to Mr. Stealey to purchase 50,000 shares of Common Stock at a price of
$6.00 per share. Under the original terms of the note, if the note was not
repaid by January 6, 1997, the Company was obligated to issue additional
warrants to Mr. Stealey to purchase 250,000 shares of Common Stock per 180 days
prorated over the time until repayment occurred. On March 20, 1997, in
connection with a loan to the Company by Petra, Mr. Stealey waived his right
under the note to accrue additional warrants after January 6, 1998. On February
4, 1998, in connection with the Company's Series B Preferred Stock financing,
Mr. Stealey converted the $1,000,000 principal outstanding under the July 10,
1996 note into 221,239 shares of Common Stock. The Company remains obligated to
pay Mr. Stealey approximately $234,729 in interest that accrued under this note
through February 4, 1998.
The Company has agreed to pay Mr. Stealey $371,404 of the remaining
$448,464 in accrued interest due to him as of March 31, 1998 in connection with
his loans and guaranties upon the consummation, and out of the proceeds, of
this offering.
The Company has borrowed approximately $870,000 from Laura M. Stealey, the
former wife of Mr. Stealey, under a $1,000,000 credit line established by Ms.
Stealey in favor of the Company, which is guaranteed by Mr. Stealey, pursuant
to a Letter Agreement dated October 31, 1996. In consideration of the credit
line, the Company granted to Ms. Stealey a warrant exercisable for 14,948
shares of Common Stock at a purchase price
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of $5.82 per share. On March 24, 1997, in connection with a loan to the Company
by Petra, Ms. Stealey waived her right to convert debt under the credit line
into shares of the Company's Common Stock. The Company has agreed to repay the
entire principal amount, plus the $117,175 in accrued interest thereon through
March 31, 1998, of this credit line upon the consummation, and out of the
proceeds, of this offering.
On February 4, 1998, Vertical Financial Holdings, Suriel Financial
Consulting and several other investors purchased an aggregate of 778,746 shares
of the Company's Series B Preferred Stock for $3,500,000. Mr. Suriel, a
director of the Company, is a Director of Vertical Financial Holdings and
founder and a principal of Suriel Financial Consulting. All of the Series B
Preferred Stock investors have signed a proxy agreement with Vertical Financial
Holdings granting Vertical Financial Holdings voting rights with respect to
their shares. In connection with the Recapitalization, the 778,746 shares of
Series B Preferred Stock will convert into 2,045,649 shares of Common Stock.
The Company and General Capital, an affiliate of Vertical Financial
Holdings, have also signed a Marketing Agreement dated February 4, 1998,
pursuant to which the Company is obligated to pay $400,000 to General Capital
for marketing services when the Company's shareholders' equity equals or
exceeds $5,000,000. The Company will satisfy such obligation upon the
consummation, and out of the proceeds, of this offering.
DESCRIPTION OF SECURITIES
Recapitalization
On May 26, 1998, the shareholders of the Company approved the
reincorporation of the Company, a Maryland corporation, in North Carolina by
adopting and approving an agreement and plan of merger pursuant to which the
Company merged with and into a wholly-owned subsidiary incorporated in North
Carolina to effect the reincorporation on July 1, 1998.
In addition, the shareholders of the Company have agreed to the
effectuation of the following Recapitalization of the Company on or prior to
the consummation of this offering:
(i) Oberlin and Petra have agreed to exercise their warrants (the
"Recapitalization Warrants") for the purchase of 208,946 and 307,823
shares of Class A Common Stock, respectively, for cash proceeds to the
Company of $10,335;
(ii) Messrs. Stealey, Pickens and Kaluza have exercised certain of
their stock options (the "Recapitalization Options") for the purchase of
268,750 shares of Class A Common Stock, 50,000 shares of Class B Common
Stock and 45,000 shares of Class B Common Stock, respectively, through
the forgiveness of $268,750 of accrued interest expense, the forgiveness
of $50,000 of accrued interest expense and a cash payment of $90,000,
respectively; and
(iii) all 3,931,215 shares of Class A Common Stock (voting) and
601,457 shares of Class B Common Stock (non-voting) of the Company,
including the shares issued in connection with (i) and (ii) above, will
be exchanged for 4,532,672 shares of Common Stock, all 82,634 shares of
Series A Convertible Preferred Stock will be converted into 82,634
shares of Common Stock, all 778,746 shares of Series B Convertible
Preferred Stock will be converted into 2,045,649 shares of Common Stock
and all 132,744 shares of Series C Convertible Preferred Stock will be
converted into 132,744 shares of Common Stock.
Once converted, all shares of Preferred Stock will be cancelled and will
return to the status of authorized but unissued shares of the Company's
Preferred Stock. Shares of authorized but unissued, or previously issued and
subsequently cancelled, Preferred Stock may be issued without shareholder
approval for any general corporate purpose, including acquisitions.
Common Stock
As of the date of this Prospectus, the Company has authorized 50,000,000
shares of Common Stock, $.10 par value per share. As of the date of this
Prospectus (giving effect to the Recapitalization), 6,793,699 shares of Common
Stock were issued and outstanding and held of record by 105 shareholders.
Holders of Common Stock are entitled to one vote for each share held on matters
which are submitted to a vote of shareholders and are not entitled to
cumulative voting in the election of directors. Subject to any preferential
rights of holders of Preferred Stock, holders of Common Stock are entitled to
receive dividends, if any, as declared from time to
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time by the Board of Directors out of assets legally available for such
purpose. On liquidation, holders of Common Stock are entitled to a pro rata
portion of all assets available for distribution after payment of creditors and
the liquidation preference of any outstanding shares of Preferred Stock.
Holders of Common Stock have no preemptive rights or other rights to subscribe
for additional shares. All outstanding shares of Common Stock are, and the
shares offered hereby will be, upon issuance, validly issued, fully paid and
non-assessable.
Preferred Stock
As of the date of this Prospectus, the Company has authorized 25,000,000
shares of Preferred Stock, $.10 par value per share, and (giving effect to the
Recapitalization) there are no shares of Preferred Stock outstanding. The
Company may issue shares of Preferred Stock in one or more series as may be
determined by the Company's Board of Directors, who may establish, from time to
time, the number of shares to be included in each series, may fix the
designation, powers, preferences and rights of the shares of each such series
and any qualifications, limitations or restrictions thereof, and may increase
or decrease the number of shares of any such series without any further vote or
action by the shareholders. Any Preferred Stock so issued by the Board of
Directors may rank senior to the Common Stock with respect to the payment of
dividends or upon liquidation, dissolution or winding up of the Company, or
both. In addition, any such shares of Preferred Stock may have class or series
voting rights. Under certain circumstances, the issuance of Preferred Stock or
the existence of the unissued Preferred Stock may tend to discourage or render
more difficult a merger or other change in control of the Company.
Warrants
As of the date of this Prospectus (giving effect to the Recapitalization)
the Company has outstanding warrants to purchase: (a) 73,845 shares of Common
Stock at an exercise price of $1.00, which expire on March 6, 2001; (b) 77,646
shares at exercise prices which vary in accordance with formulas set forth in
the applicable warrant agreements (ranging from $0.49 to $3.91 per share, as of
the date of this Prospectus and giving effect to the Recapitalization), each of
which expire on March 6, 2001; (c) 75,694 shares at an exercise price of $2.00
per share, which expire on May 20, 2003; (d) 100,695 shares at an exercise
price of $6.00 per share, which expire on July 10, 2003; (e) 22,058 shares at
an exercise price of $4.53 per share, which expire on July 15, 1999; (f) 14,949
shares at an exercise price of $5.82 per share, which expire on December 31,
2003; (g) 53,000 shares at an exercise price of $6.00 per share, which expire
on December 31, 2004; (h) 16,667 shares at an exercise price of $6.00 per
share, which expire on February 4, 2005; and (i) 15,000 shares at an exercise
price of $8.00 per share, which expire on March 20, 2003.
Certain Articles of Incorporation and Bylaws Provisions Having Potential
Anti-Takeover Effects
General
A number of provisions of the Company's Articles of Incorporation and
Bylaws address matters of corporate governance and the rights of shareholders.
The following summary of such provisions is not intended to be complete and is
qualified in all respects by the Company's Articles of Incorporation and
Bylaws. Certain of these provisions, as well as the ability of the Board of
Directors to issue shares of Preferred Stock and to set the voting rights,
preferences and other terms thereof, may delay or prevent takeover attempts not
first approved by the Board of Directors (including takeovers which certain
shareholders may deem to be in their best interests). These provisions also
could delay or frustrate the removal of incumbent directors or the assumption
of control by shareholders.
Classification of Board of Directors
The Board of Directors currently consists of five members. The Articles of
Incorporation provide that if the size of the Board increases to nine or more
members, the Board of Directors of the Company will be divided into three
classes as nearly equal in number as possible. The directors of each class will
serve a term of three years. As a result of a classification of the Board of
Directors, approximately one-third of the members of the Board of Directors
will be elected each year, and two annual meetings will be required for the
Company's shareholders to change a majority of the members constituting the
Board of Directors.
Nomination and Removal of Directors; Filling Vacancies
The Company's Bylaws provide that nominations to the Board of Directors
may only be made by the Board of Directors, a nominating committee of the Board
or by any shareholder entitled to vote in elections of directors
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who complies with certain notice procedures. In addition, the Articles of
Incorporation and Bylaws provide that a director may be removed by the
shareholders only upon the affirmative vote of the holders of two-thirds of the
voting power of all shares of capital stock entitled to vote generally in the
election of directors, and the Bylaws specify that vacancies on the Board of
Directors may be filled only by the Board of Directors. The purpose of these
provisions is to prevent a majority shareholder from circumventing the
classified board system by removing directors and filling the vacancies with
new individuals selected by that shareholder. Accordingly, these provisions may
have the effect of impeding efforts to gain control of the Board by anyone who
obtains a controlling interest in the Company's Common Stock.
Amendment of Articles of Incorporation
The Articles of Incorporation of the Company provide that amendments to
the Articles of Incorporation may be adopted only upon the affirmative vote of
the holders of at least two-thirds of the voting power of all shares of capital
stock of the Company entitled to vote thereon. However, if such amendment has
received the prior approval by an affirmative vote of a majority of
Disinterested Directors, as defined below, then the affirmative vote of the
holders of at least a majority of the voting power of all shares of capital
stock of the Company entitled to vote thereon, or such greater percentage
approval as required by North Carolina law, is sufficient to adopt such
amendment. A Disinterested Director is defined as any member of the Board of
Directors who is unaffiliated with, and not a nominee of, a Control Person, as
defined below, and was a member of the Board of Directors prior to the time a
Control Person became such, and any successor of a Disinterested Director who
is unaffiliated with, and not a nominee of, a Control Person, who is
recommended to succeed a Disinterested Director by a majority of Disinterested
Directors then on the Board of Directors. A Control Person is defined as any
corporation, person, group, or other entity, which together with its
affiliates, prior to a Business Combination, as defined below, beneficially
owns 10% or more of the shares of any class of equity or convertible securities
of the Company, and any affiliate of any such corporation, person, group, or
other entity; provided, however, any corporation, person, group or other entity
which, together with its affiliates, prior to July 2, 1998 beneficially owned
10% or more of the shares of any class of equity or convertible securities of
the Company, and any affiliate of any such party is not considered to be a
Control Person.
Amendment of Bylaws
Subject to certain restrictions described below, either the Board of
Directors or the shareholders of the Company may amend the Company's Bylaws.
The Board of Directors may amend the Bylaws and adopt new Bylaws except that:
(i) a bylaw adopted or amended by the shareholders may not be readopted,
amended, or repealed by the Board of Directors if neither the Articles of
Incorporation nor a bylaw adopted by the shareholders authorizes the Board of
Directors to adopt, amend, or repeal that particular bylaw or the Bylaws
generally; (ii) a bylaw that fixes a greater quorum or voting requirement for
the Board of Directors may not be adopted by the Board of Directors by a vote
of less than a majority of the directors then in office and may not itself be
amended by a quorum or vote of directors less than the quorum or vote therein
prescribed or prescribed by a bylaw adopted or amended by the shareholders; and
(iii) if a bylaw fixing a greater quorum or voting requirement for the Board of
Directors is originally adopted by the shareholders, it may be amended or
repealed only by the shareholders, unless the Bylaws permit amendment or repeal
by the Board of Directors. The shareholders of the Company generally may adopt,
amend, or repeal the Bylaws upon the affirmative vote of the holders of
two-thirds of the voting power of all shares of capital stock entitled to vote
thereon.
Supermajority Vote Requirement
The Articles of Incorporation of the Company provide that, unless
otherwise more restrictively required by applicable law, any Business
Combination, as defined below, must be approved by a majority of a quorum of
the Board of Directors and must receive the level of shareholder approval, if
any, as follows: (i) to the extent shareholder approval is otherwise required
by law, by an affirmative vote of the shareholders holding at least a majority
of the shares of capital stock of the Company entitled to vote thereon,
provided that such Business Combination has been approved by an affirmative
vote of at least two-thirds of the full Board of Directors before such Business
Combination is submitted for approval to the shareholders or (ii) by an
affirmative vote of the shareholders holding at least two-thirds of the shares
of capital stock of the Company entitled to vote thereon provided that such
Business Combination has been approved by an affirmative vote of at least a
majority of a quorum of the Board of Directors (but less than two-thirds of the
full Board of Directors). In addition, if the
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Business Combination is approved by the affirmative vote of the shareholders
holding at least two-thirds of the shares of Common Stock entitled to vote and
by a majority of a quorum of the Board of Directors but less than two-thirds of
the full Board of Directors, the Business Combination must grant to
shareholders not voting to approve the Business Combination certain "fair
price" rights.
The Company's Articles of Incorporation define a Business Combination as
(i) any merger or consolidation of the Company into any other corporation,
person, group, or other entity where the Company is not the surviving or
resulting entity; (ii) any merger or consolidation of the Company with or into
any Control Person or with any corporation, person, group or other entity where
the merger or consolidation is proposed by or on behalf of a Control Person;
(iii) any sale, lease, exchange, or other disposition of all or substantially
all of the assets of the Company; (iv) any sale, lease, exchange, or other
disposition of more than 10% of the total assets of the Company to a Control
Person; (v) the issuance of any securities of the Company to a Control Person;
(vi) the acquisition by the Company of any securities of a Control Person
unless such acquisition begins prior to the person becoming a Control Person or
is an attempt to prevent the Control Person from obtaining greater control of
the Company; (vii) the acquisition by the Company of all or substantially all
of the assets of any Control Person or any entity where the acquisition is
proposed by or on behalf of a Control Person; (viii) the adoption of any plan
or proposal for the liquidation or dissolution of the Company which is proposed
by or on behalf of a Control Person; (ix) any reclassification of securities or
recapitalization of the Company which has the effect of increasing the
proportionate share of the outstanding shares of any class of equity or
convertible securities of the Company which is beneficially owned or controlled
by a Control Person; (x) any of the above transactions which are between the
Company and any of its subsidiaries and which are proposed by or on behalf of
any Control Person; or (xi) any agreement, plan, contract, or other arrangement
providing for any of the above transactions.
The requirement of a supermajority vote of shareholders to approve certain
business transactions, as described above, may discourage a change in control
of the Company by allowing shareholders holding less than a majority of the
shares of Common Stock to prevent a transaction favored by shareholders holding
a majority of such shares. Also, in some circumstances, the Board of Directors
could cause a two-thirds vote to be required to approve a transaction thereby
enabling management to retain control over the affairs of the Company and their
positions with the Company.
Fair Price Provision
The "fair price" provision of the Company's Articles of Incorporation
applies to Business Combinations that have not received the approval of
two-thirds of the full Board of Directors and only to shareholders who vote
against such Business Combinations and who elect to sell their shares to the
Company for cash at their fair price. This "fair price" provision requires that
the consideration for such shares be paid in cash by the Company and that the
price per share be at least equal to the greater of the following:
(i) The highest price per share paid for the Company's Common Stock during
the four years immediately preceding the Business Combination vote by any
shareholder who beneficially owned five percent or more of the Company's
Common Stock and who votes in favor of the Business Combination;
(ii) The cash value of the highest price per share previously offered
pursuant to a tender offer to the shareholders of the Company within the
four years immediately preceding the Business Combination vote; or
(iii) The highest price per share, including commissions and fees, paid by
a Control Person in acquiring any of its holdings of the Company's Common
Stock.
The fair price provision is intended to prevent some of the potential
inequities of two-step takeover attempts by encouraging negotiations with the
Company. However, some shareholders may find the fair price provision
disadvantageous to the extent it discourages changes in control in which
shareholders might receive for at least some of their shares a substantial
premium above the market price at the time an acquisition transaction is made.
The Company is not aware of any pending or threatened effort to acquire
control of the Company or to change management. The Board of Directors does not
presently intend to propose any additional anti-takeover provisions.
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Constituencies
The Company's Articles of Incorporation expressly authorize the Board of
Directors of the Company, any committee of the Board of Directors, or any
individual director in determining what is in the best interest of the Company
and its shareholders, to consider, in addition to the long-term and short-term
interests of the shareholders, the social and economic effects of the matter to
be considered on the Company and its subsidiaries, their employees, clients,
creditors, and the communities in which the Company and its subsidiaries
operate or are located. When evaluating a business combination or a proposal by
another person to make a business combination or a tender offer or any other
proposal relating to a potential change in control of the Company, the Board of
Directors may consider such matters as (i) the business and financial condition
and earnings prospects of the acquiring person, and the possible effect of such
condition upon the Company and its subsidiaries and the communities in which
the Company and its subsidiaries operate, (ii) the competence, experience, and
integrity of the acquiring person and its management and (iii) the prospects
for successful conclusion of the business combination, offer or proposal. The
consideration of any of the above factors is completely discretionary with the
Company's Board of Directors. The constituency provision of the Company's
Articles of Incorporation may discourage or make more difficult certain
acquisition proposals or business combinations and therefore, may adversely
affect the ability of shareholders to benefit from certain transactions opposed
by the Company's Board of Directors.
Special Meetings of Shareholders
The Company's Bylaws provide that special meetings of shareholders may be
called only by the Board of Directors, the Chairman of the Board, the President
or holders of 20% or more of the voting power of the outstanding shares of the
Company. As a result, this provision would prevent shareholders owning less
than 20% of the voting power of the outstanding Common Stock from compelling
shareholder consideration of any proposal (such as a proposal for a Business
Combination) over the opposition of the Company's Board of Directors.
Shareholder Proposals
The Company's Bylaws provide that shareholders who desire to bring any
business before a meeting of shareholders must follow specified procedures,
including advance written notice to the Company. The shareholder proposal
provision may make it more difficult for shareholder proposals to be considered
at shareholder meetings.
Transfer Agent
The Company's transfer agent and registrar for its Common Stock is
Wachovia Bank and Trust Company, 301 North Church Street, 2nd Floor,
Winston-Salem, North Carolina 27102.
SHARES ELIGIBLE FOR FUTURE SALE
Upon consummation of this offering, the Company will have 9,393,699 shares
of Common Stock outstanding (9,783,699 shares if the Representatives'
over-allotment option is exercised in full), of which the 2,600,000 shares
offered hereby will be freely tradable without restriction or further
registration under the Securities Act, except for any shares purchased by
"affiliates" of the Company, as that term is defined in Rule 144 under the
Securities Act, which will be subject to the resale limitations imposed by Rule
144, as described below. The remaining 6,793,699 shares of Common Stock
outstanding will be "restricted securities" within the meaning of Rule 144.
Approximately 3,606,955 shares of the restricted securities will be eligible
for sale in the public market in accordance with Rule 144 or Rule 701 under the
Securities Act beginning 90 days after the date of this Prospectus; 2,323,504
of these shares are subject to the lock-up agreements described below (the
"Lock-Up Agreements"). The remaining 3,186,744 restricted securities will not
be eligible for resale under Rule 144 until after the expiration of a one-year
holding period (or for such shorter period as any amendments to Rule 144 shall
provide) from the date such restricted securities were acquired from the
Company or an affiliate, and may be resold in the public market only in
compliance with the registration requirements of the Securities Act or pursuant
to a valid exemption therefrom.
In general, under Rule 144 as currently in effect, a person (or persons
whose shares are required to be aggregated), including a person who may be
deemed an "affiliate" of the Company, who has beneficially owned restricted
securities for at least one year may sell a number of shares within any
three-month period which does not exceed the greater of (i) 1% of the then
outstanding shares of the Company's Common Stock (approximately
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93,936 shares after this offering) or (ii) the average weekly trading volume in
the Company's Common Stock in the four calendar weeks immediately preceding
such sale. Sales under Rule 144 also are subject to certain requirements as to
the manner of sale, notice and the availability of current public information
about the Company. A person who is not an affiliate of the issuer, has not been
an affiliate within three months prior to the sale and has owned the restricted
securities for at least two years is entitled to sell such shares under Rule
144(k) without regard to any of the limitations described above.
Beginning 90 days after the date of this Prospectus, certain shares issued
or issuable upon the exercise of options granted by the Company or acquired
pursuant to the 1995 Plans prior to the date of this Prospectus also will be
eligible for sale in the public market pursuant to Rule 701 under the
Securities Act. In general, Rule 701 permits resales of shares issued pursuant
to certain compensatory benefit plans and contracts commencing 90 days after
the issuer becomes subject to the reporting requirements of the Exchange Act in
reliance upon Rule 144, but without compliance with certain restrictions of
Rule 144, including the holding period requirements. The Company has granted
options under the 1995 Plans covering 1,695,545 shares of Common Stock which
have not been exercised and which become exercisable at various times in the
future; 994,124 shares of Common Stock issued upon the exercise of certain of
these options will be eligible for sale pursuant to Rule 701 provided that the
conditions of Rule 701 have been satisfied.
In addition to shares issuable pursuant to the exercise of outstanding
options, the Company has reserved additional shares for issuance under the
Plan, the Purchase Plan and outstanding warrants. When issued, these shares may
only be sold within the limitations of Rule 144 or pursuant to registration
under the Securities Act. The Company intends to file a registration statement
covering shares of Common Stock to be acquired pursuant to the exercise of
options granted under the Plan, the Purchase Plan and the 1995 Plans, however,
the Company has agreed not to file any registration statement for a period of
nine months after the date of this Prospectus without the prior written consent
of BlueStone. Once such a registration statement becomes effective, persons
acquiring shares pursuant to the exercise of options granted under the Plan,
the Purchase Plan and the 1995 Plans, including affiliates, will be able to
sell the shares in the public market without regard to the one-year holding
period of Rule 144.
The executive officers, directors and substantially all of the 1% or
greater shareholders of the Company have agreed, pursuant to the Lock-Up
Agreements, that they will not, without the prior written consent of BlueStone,
offer, sell, contract to sell or otherwise dispose of any shares of Common
Stock or any securities convertible into or exercisable or exchangeable for
Common Stock, for a period of nine months after the date of this Prospectus.
See "Underwriting."
Registration Rights
The Company has granted piggyback registration rights with respect to an
aggregate of 3,241,304 shares of Common Stock outstanding as of the closing of
this offering or purchasable upon the exercise of outstanding warrants to the
following investors: the former Series B Preferred Stock shareholders, Oberlin,
Petra, the former shareholders of ICI, High Point Capital, LLC, Ostrander,
Burch & Company, Inc. and Venture Lending (a division of Cupertino National
Bank and Trust) (collectively, the "Rights Holders"). In general, if the
Company proposes to register shares of Common Stock on a registration form
suitable for secondary offerings, the Company must at its cost and expense use
its best efforts to include in the registration statement certain shares of the
Rights Holders. However, in an underwritten offering, if a greater number of
shares is offered for participation than, in the opinion of the underwriters,
is compatible with the success of the offering, the number of shares shall be
reduced in accordance with the priorities established in the various agreements
between the Company and the Rights Holders. Securities to be offered by the
Company on its own behalf are entitled to first priority.
The Company also granted demand registration rights to (i) the former
Series B Preferred Stock shareholders, who, for up to five years following the
consummation of this offering, are entitled to a maximum of two demand
registrations (excluding registrations on Form S-3) beginning 180 days after
the effectiveness of this offering and a maximum of two demand registrations on
Form S-3 in any 12-month period, and (ii) Petra, which is entitled to two
demand registrations beginning 180 days after this offering. In the event that
either the former Series B Preferred Stock shareholders or Petra exercises
demand registration rights, the Company is obligated at its cost and expense to
use its best efforts to file a registration statement registering the shares of
Common Stock covered by such demand registration rights. All of the foregoing
registration rights holders have agreed to waive such
55
<PAGE>
rights, and the Company has agreed not to file any registration statement, for
a period of nine months after the date of this Prospectus without the prior
written consent of BlueStone.
In addition, the Company will provide the Representatives with a one-time
demand registration right and unlimited piggyback registration rights with
respect to the 260,000 shares of Common Stock underlying the Representatives'
Warrants. See "Underwriting."
UNDERWRITING
The underwriters named below (collectively, the "Underwriters"), for which
BlueStone Capital Partners, L.P. ("BlueStone") and Royce Investment Group, Inc.
are acting as representatives (the "Representatives"), have agreed severally,
not jointly, subject to the terms and conditions contained in the underwriting
agreement between the Company and the Underwriters (the "Underwriting
Agreement"), to purchase from the Company, and the Company has agreed to sell to
the several Underwriters, the 2,600,000 shares of Common Stock offered hereby.
The number of shares of Common Stock that each Underwriter has agreed to
purchase is set forth opposite its name below:
<TABLE>
<CAPTION>
Underwriter Number of Shares
- -------------------------------------------- -----------------
<S> <C>
BlueStone Capital Partners, L.P. ..........
Royce Investment Group, Inc. ..............
---------
Total .................................. 2,600,000
=========
</TABLE>
The Underwriters are committed on a "firm commitment" basis to purchase
and pay for all of the shares of Common Stock offered hereby (other than shares
offered pursuant to the over-allotment option) if any shares are purchased. The
shares of Common Stock are being offered by the Underwriters, subject to prior
sale, when, as and if delivered to and accepted by the Underwriters and subject
to approval of certain legal matters by counsel and to certain other
conditions.
Through the Representatives, the several Underwriters have advised the
Company that they propose to offer the shares of Common Stock to the public at
the public offering price set forth on the cover page of this Prospectus. The
Underwriters may allow to certain dealers who are members of the National
Association of Securities Dealers, Inc. ("NASD") concessions, not in excess of
$ per share, of which not in excess of $ per share may be reallowed to
other dealers who are members of the NASD.
The Company has granted the Representatives an option, exercisable for 45
days following the date of this Prospectus, to purchase up to 390,000
additional shares of Common Stock at the public offering price set forth on the
cover page of this Prospectus, less the underwriting discounts and commissions.
The Representatives may exercise this option in whole or, from time to time, in
part, solely for the purpose of covering over-allotments, if any, made in
connection with the sale of the shares of Common Stock offered hereby.
The Company has agreed to reimburse BlueStone for up to $350,000 of the
costs, fees and expenses customarily incurred by an underwriter during the
registration process, including legal fees and all costs associated with
marketing and selling the offering. The Company has also agreed to pay all
expenses in connection with qualifying the shares of Common Stock offered hereby
for sale under the laws of such states as the Representatives may designate,
including expenses of counsel retained for such purpose by the Representatives.
The Company has agreed to issue to the Representatives and their
designees, for an aggregate of $260, the Representatives' Warrants to purchase
up to 260,000 shares of Common Stock, at an exercise price of $ per share
(120% of the public offering price per share). The Representatives' Warrants
may not be transferred
56
<PAGE>
for one year following the date of this Prospectus, except to the officers and
partners of the Representatives or the Underwriters or members of the selling
group, and are exercisable at any time, and from time to time, during the
four-year period commencing one year following the date of this Prospectus (the
"Warrant Exercise Term"). During the Warrant Exercise Term, the holders of the
Representatives' Warrants are given, at nominal cost, the opportunity to profit
from a rise in the market price of the Common Stock. To the extent that the
Representatives' Warrants are exercised or exchanged, dilution to the interests
of the Company's shareholders will occur. Further, the terms upon which the
Company will be able to obtain additional equity capital may be adversely
affected since the holders of the Representatives' Warrants can be expected to
exercise them at a time when the Company would, in all likelihood, be able to
obtain any needed capital on terms more favorable to thfe Company than those
provided in the Representatives' Warrants. Any profit realized by the
Representatives on the sale of the Representatives' Warrants or the underlying
shares of Common Stock may be deemed additional underwriting compensation.
Subject to certain limitations and exclusions, the Company has agreed to
register, at the request of the holders of a majority of the Representatives'
Warrants and at the Company's expense, the Representatives' Warrants and the
shares of Common Stock underlying the Representatives' Warrants under the
Securities Act on one occasion during the Warrant Exercise Term and to include
such Representatives' Warrants and such underlying shares in any appropriate
registration statement that is filed by the Company during the seven years
following the date of this Prospectus.
All of the Company's officers, directors and certain shareholders
beneficially owning 1% or more of the Common Stock have agreed that, for the
nine-month period following the date of this Prospectus, they will not, without
the prior written consent of BlueStone, directly or indirectly, sell, offer for
sale, transfer, pledge or otherwise dispose of, any securities of the Company
or exercise any registration rights relating to any securities of the Company.
The Representatives have informed the Company that the Underwriters do not
intend to confirm sales in excess of 3% of the number of shares of Common Stock
offered hereby to discretionary accounts.
The Company has agreed to indemnify the Underwriters against certain civil
liabilities in connection with the Registration Statement of which this
Prospectus forms a part, including liabilities under the Securities Act.
Prior to this offering, there has been no public market for the Common
Stock. Consequently, the initial public offering price of the shares of Common
Stock has been determined by negotiation between the Company and the
Representatives and is not necessarily related to the Company's asset value,
net worth or other established criteria of value. Among the factors considered
in determining the offering price are the Company's financial condition and
prospects, management, market prices of similar securities of comparable
publicly-traded companies, certain financial and operating information of
companies engaged in activities similar to those of the Company and the general
condition of the securities market.
In connection with this offering, the Underwriters may purchase and sell
the Common Stock in the open market. These transactions may include
over-allotment and stabilizing transactions and purchases to cover syndicate
short positions created by the Underwriters in connection with the offering.
Stabilizing transactions consist of certain bids or purchases for the purpose
of preventing or retarding a decline in the market price of the Common Stock;
and syndicate short positions created by the Underwriters involve the sale by
the Underwriters of a greater number of securities than they are required to
purchase from the Company in the offering. The Underwriters also may impose a
penalty bid, whereby selling concessions allowed to syndicate members or other
broker-dealers in respect of the securities sold in the offering for their
account may be reclaimed by the syndicate Underwriters if such shares of Common
Stock are repurchased by the syndicate Underwriters in stabilizing or covering
transactions. These activities may stabilize, maintain or otherwise affect the
market price of the Common Stock, which may be higher than the price that might
otherwise prevail in the open market; and these activities, if commenced, may
be discontinued at any time. These transactions may be effected on Nasdaq, the
over-the-counter market or otherwise.
The Underwriters may also place bids or purchase shares to reduce a short
position created in connection with the offering. Short positions are created
by persons who sell shares which they do not own in anticipation of purchasing
shares at a lower price in the market to deliver in connection with the earlier
sale. Short positions tend to place downward pressure on the market price of a
stock.
57
<PAGE>
The Representatives and/or the Underwriters may impose a penalty bid by
reclaiming the selling concession to be paid to an Underwriter or selected
dealer when the securities sold by the Underwriter or selected dealer are
purchased to reduce a short position created in connection with the offering.
BlueStone was organized and registered as a broker-dealer with the
Commission and the NASD in March 1996. Although, since its organization,
BlueStone has engaged in the investment banking business and its principals
have had significant experience in the underwriting of securities in their
capacities with other broker-dealers, this offering will constitute one of the
first public offerings for which BlueStone has acted as lead manager.
LEGAL MATTERS
Certain legal matters in connection with this offering will be passed upon
for the Company by Smith, Anderson, Blount, Dorsett, Mitchell & Jernigan,
L.L.P., Raleigh, North Carolina. Certain legal matters in connection with this
offering will be passed upon for the Underwriters by Tenzer Greenblatt LLP, New
York, New York.
EXPERTS
The consolidated financial statements of the Company at December 31, 1996
and 1997, and for each of the three years in the period ended December 31, 1997
appearing in this Prospectus and the Registration Statement have been audited
by Ernst & Young LLP independent auditors, as set forth in their report thereon
appearing elsewhere herein and in the Registration Statement, and are included
in reliance upon such report given upon the authority of such firm as experts
in accounting and auditing.
ADDITIONAL INFORMATION
The Company has filed with the Commission a Registration Statement on Form
SB-2 under the Securities Act with respect to the shares of Common Stock
offered hereby. This Prospectus, which constitutes a part of the Registration
Statement, omits certain information contained in the Registration Statement,
and reference is made to the Registration Statement and the exhibits and
schedules thereto for further information with respect to the Company and the
shares of Common Stock offered hereby. Statements contained herein concerning
the provisions of any documents are not necessarily complete; and in each
instance reference is made to the copy of such document filed as an exhibit to
the Registration Statement. Each such statement is qualified in its entirety by
such reference. As of the date of this Prospectus, the Company will become
subject to the informational requirements of the Exchange Act and the rules and
regulations thereunder, and in accordance therewith, will file reports, proxy
and information statements, and other information with the Commission. The
Registration Statement, including exhibits and schedules filed therewith, and
the Company's reports, proxy and information statements and, other information
filed by the Company with the Commission, may be inspected without charge at
the Public Reference Room of the Commission at 450 Fifth Street, N.W., Room
1024, Washington, D.C. 20549, or at its Regional Offices located at 7 World
Trade Center, 13th Floor, New York, New York 10048 and 500 West Madison Street,
Suite 1400, Chicago, Illinois 60661-2511, and copies of all or any part of the
Registration Statement can be obtained from such offices at prescribed rates.
The Commission maintains an Internet web site at http://www.sec.gov that will
contain reports, proxy and information statements and other information
regarding the Company.
58
<PAGE>
INTERACTIVE MAGIC, INC.
CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 1995, 1996 and 1997
Contents
<TABLE>
<S> <C>
Report of Independent Auditors ........................... F-2
Consolidated Financial Statements
Consolidated Balance Sheets .............................. F-3
Consolidated Statements of Operations .................... F-4
Consolidated Statements of Stockholders' Deficit ......... F-5
Consolidated Statements of Cash Flows .................... F-6
Notes to Consolidated Financial Statements ............... F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT AUDITORS
THE BOARD OF DIRECTORS AND SHAREHOLDERS
INTERACTIVE MAGIC, INC.
We have audited the accompanying consolidated balance sheets of
Interactive Magic, Inc. (the "Company") as of December 31, 1996 and 1997, and
the related consolidated statements of operations, stockholders' deficit, and
cash flows for each of the three years in the period ended December 31, 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.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Interactive Magic, Inc. at December 31, 1996 and 1997, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended December 31, 1997 in conformity with generally accepted accounting
principles.
Ernst & Young LLP
Raleigh, North Carolina
May 6, 1998
F-2
<PAGE>
INTERACTIVE MAGIC, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
<TABLE>
<CAPTION>
Pro Forma
Balance
Sheet
December 31, (Note 3)
----------------------- March 31, March 31,
1996 1997 1998 1998
---------- ------------ ------------ ------------
(unaudited)
ASSETS
<S> <C> <C> <C> <C>
Current assets:
Cash and cash equivalents ................................................ $ 292 $ 384 $ 116 $ 216
Trade receivables, net of allowances of $2,700, $3,650 and $2,707,
respectively ........................................................... 1,168 2,920 4,618 4,618
Inventories .............................................................. 410 637 765 765
Advance royalties ........................................................ 815 1,989 1,622 1,622
Software development costs ............................................... 152 425 758 758
Prepaid expenses and other ............................................... 65 109 114 114
-------- --------- --------- ---------
Total current assets ...................................................... 2,902 6,464 7,993 8,093
Property and equipment, net ............................................... 1,229 1,196 1,158 1,158
Other noncurrent assets:
Advance royalties, less current portion .................................. 263 -- -- --
Other .................................................................... 170 87 60 60
-------- --------- --------- ---------
433 87 60 60
-------- --------- --------- ---------
Total assets .............................................................. $ 4,564 $ 7,747 $ 9,211 $ 9,311
======== ========= ========= =========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable and accrued expenses .................................... $ 1,576 $ 2,776 $ 2,942 $ 2,942
Royalties and commissions payable ........................................ 484 858 935 935
Lines of credit .......................................................... 3,514 3,983 2,557 2,557
Current portion of long-term debt ........................................ -- 745 725 725
Current portion of capital lease obligations ............................. 61 35 35 35
-------- --------- --------- ---------
Total current liabilities ................................................. 5,635 8,397 7,194 7,194
Noncurrent liabilities:
Accrued interest payable to related parties .............................. 334 982 1,089 770
Long-term debt, less current portion ..................................... 493 3,759 3,791 3,791
Capital lease obligations ................................................ 80 38 26 26
Notes payable to related parties ......................................... 2,970 3,470 870 870
-------- --------- --------- ---------
Total noncurrent liabilities .............................................. 3,877 8,249 5,776 5,457
Series C Redeemable Convertible Preferred Stock, $.10 par value;
132,744 shares authorized, issued and outstanding at March 31, 1998 ...... -- -- 600 --
Stockholders' deficit:
Series A Convertible Preferred Stock, $.10 par value; 82,634 shares
authorized, shares issued and outstanding at December 31, 1996 and
1997 and March 31, 1998 ................................................ 8 8 8 --
Series B Convertible Preferred Stock, $.10 par value; 778,746 shares
authorized, issued and outstanding at March 31, 1998 ................... -- -- 78 --
Class A Common Stock, $.10 par value; 10,000,000 shares authorized;
3,145,178, 3,145,696, and 3,145,696 shares issued and outstanding at
December 31, 1996 and 1997 and March 31, 1998, respectively ............ 314 314 314 --
Class B Common Stock, $.10 par value; 10,000,000 shares authorized;
6,750, 7,875 and 457,853 shares issued and outstanding at December
31, 1996 and 1997 and March 31, 1998, respectively ..................... 1 1 46 --
Common Stock, $.10 par value; 50,000,000 authorized, 6,793,699
shares issued and outstanding pro forma ................................ -- -- -- 679
Additional paid-in capital ............................................... 4,703 5,047 10,102 10,888
Cumulative currency translation adjustment ............................... (62) (59) (79) (79)
Accumulated deficit ...................................................... (9,912) (14,210) (14,828) (14,828)
-------- --------- --------- ---------
Total stockholders' deficit ............................................... (4,948) (8,899) (4,359) $ (3,340)
-------- --------- --------- =========
Total liabilities and stockholders' deficit ............................... $ 4,564 $ 7,747 $ 9,211 $ 9,311
======== ========= ========= =========
</TABLE>
See accompanying notes.
F-3
<PAGE>
INTERACTIVE MAGIC, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
<TABLE>
<CAPTION>
Year ended December 31, Three months ended March 31,
---------------------------------------- -------------------------------
1995 1996 1997 1997 1998
----------- ----------- ------------ --------------- -------------
(unaudited)
<S> <C> <C> <C> <C> <C>
Net revenues:
CD-ROM product sales ........................... $ 3,950 $ 4,852 $ 14,067 $ 3,399 $ 4,057
Online sales ................................... 6 733 1,615 357 358
Royalties and licenses ......................... 165 472 820 201 498
-------- -------- --------- --------- ----------
Total net revenues ............................... 4,121 6,057 16,502 3,957 4,913
Cost of revenues:
Cost of products sold .......................... 790 1,349 3,715 766 968
Royalties and amortized software costs ......... 879 1,044 2,634 649 909
-------- -------- --------- --------- ----------
Total cost of revenues ........................... 1,669 2,393 6,349 1,415 1,877
-------- -------- --------- --------- ----------
Gross profit ..................................... 2,452 3,664 10,153 2,542 3,036
Operating expenses:
Sales and marketing ............................ 2,335 5,008 6,760 1,642 1,667
Product development ............................ 1,518 3,788 3,878 859 1,103
General and administrative ..................... 828 1,451 1,941 598 449
-------- -------- --------- --------- ----------
Total operating expenses ......................... 4,681 10,247 12,579 3,099 3,219
-------- -------- --------- --------- ----------
Operating loss ................................... (2,229) (6,583) (2,426) (557) (183)
Other expense:
Interest expense -- third parties .............. 48 204 622 146 200
Interest expense -- related parties ............ 127 402 1,053 154 107
Other .......................................... -- -- 230 (1) --
-------- -------- --------- --------- ----------
Total other expense .............................. 175 606 1,905 299 307
-------- -------- --------- --------- ----------
Loss before income taxes ......................... (2,404) (7,189) (4,331) (856) (490)
Income tax (expense) benefit ..................... (47) (11) 33 31 (128)
-------- -------- --------- ---------- ----------
Net loss ......................................... $ (2,451) $ (7,200) $ (4,298) $ (825) $ (618)
======== ======== ========= ========== ==========
Pro forma net loss per share (Note 3) ............ $ (0.68) $ (0.09)
========= ==========
Number of shares used in computing pro
forma net loss per share (Note 3) .............. 6,343,080 6,619,708
</TABLE>
See accompanying notes.
F-4
<PAGE>
INTERACTIVE MAGIC, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
(In thousands, except share data)
<TABLE>
<CAPTION>
Series A Series B
Convertible Convertible
Preferred Stock Preferred Stock Class A Common Stock
----------------- ------------------- ---------------------
Shares Amount Shares Amount Shares Amount
-------- -------- ---------- -------- ------------ --------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1994 ............. -- $-- -- $ -- 60,000 $ 6
Issuance of common stock ................. -- -- -- -- 2,158,898 216
Currency translation adjustments ......... -- -- -- -- -- --
Net loss ................................. -- -- -- -- -- --
------ --- ------ ---- --------- -----
Balance at December 31, 1995 ............. -- -- -- -- 2,218,898 222
Issuance of common stock in lieu
of compensation ......................... -- -- -- -- 164,000 16
Issuance of common stock ................. -- -- -- -- 62,280 6
Exercise of stock options ................ -- -- -- -- -- --
Issuance of warrants ..................... -- -- -- -- -- --
Conversion of note payable into
preferred stock ......................... 82,634 8 -- -- -- --
Conversion of note payable into
common stock ............................ -- -- -- -- 700,000 70
Currency translation adjustments ......... -- -- -- -- -- --
Net loss ................................. -- -- -- -- -- --
------ --- ------ ---- --------- -----
Balance at December 31, 1996 ............. 82,634 8 -- -- 3,145,178 314
Issuance of common stock ................. -- -- -- -- 518 --
Issuance of warrants ..................... -- -- -- -- -- --
Exercise of stock options ................ -- -- -- -- -- --
Currency translation adjustments ......... -- -- -- -- -- --
Net loss ................................. -- -- -- -- -- --
------ --- ------ ---- --------- -----
Balance at December 31, 1997 ............. 82,634 8 -- -- 3,145,696 314
Exercise of stock options ................ -- -- -- -- -- --
Issuance of preferred stock .............. -- -- 778,746 78 -- --
Conversion of note payable into
common stock ............................ -- -- -- -- -- --
Currency translation adjustments ......... -- -- -- -- -- --
Net loss ................................. -- -- -- -- -- --
------ --- ------- ---- --------- -----
Balance at March 31, 1998
(Unaudited) ............................. 82,634 $ 8 778,746 $ 78 3,145,696 $ 314
====== === ======= ==== ========= =====
<CAPTION>
Class B Common
Stock Additional Cumulative
------------------- Paid-In Translation Accumulated
Shares Amount Capital Adjustment Deficit Total
---------- -------- ------------ ------------- ------------ --------------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1994 ............. -- $ -- $ (6) $ -- $ (261) $ (261)
Issuance of common stock ................. -- -- 2,275 -- -- 2,491
Currency translation adjustments ......... -- -- -- (2) -- (2)
Net loss ................................. -- -- -- -- (2,451) (2,451)
----- ---- ------- ------ -------- ---------
Balance at December 31, 1995 ............. -- -- $ 2,269 $ (2) $ (2,712) $ (223)
Issuance of common stock in lieu
of compensation ......................... -- -- 182 -- -- 198
Issuance of common stock ................. -- -- 999 -- -- 1,005
Exercise of stock options ................ 6,750 1 5 -- -- 6
Issuance of warrants ..................... -- -- 122 -- -- 122
Conversion of note payable into
preferred stock ......................... -- -- 496 -- -- 504
Conversion of note payable into
common stock ............................ -- -- 630 -- -- 700
Currency translation adjustments ......... -- -- -- (60) -- (60)
Net loss ................................. -- -- -- (7,200) (7,200)
----- ---- ------- ------ -------- --------
Balance at December 31, 1996 ............. 6,750 1 4,703 (62) (9,912) (4,948)
Issuance of common stock ................. -- -- 15 -- -- 15
Issuance of warrants ..................... -- -- 328 -- -- 328
Exercise of stock options ................ 1,125 -- 1 -- -- 1
Currency translation adjustments ......... -- -- -- 3 -- 3
Net loss ................................. -- -- -- -- (4,298) (4,298)
----- ---- ------- ------ -------- --------
Balance at December 31, 1997 ............. 7,875 1 5,047 (59) (14,210) (8,899)
Exercise of stock options ................ 7,500 1 8 -- -- 9
Issuance of preferred stock .............. -- -- 3,091 -- -- 3,169
Conversion of note payable into
common stock ............................ 442,478 44 1,956 -- -- 2,000
Currency translation adjustments ......... -- -- -- (20) -- (20)
Net loss ................................. -- -- -- -- (618) (618)
------- ---- ------- ------ -------- -------
Balance at March 31, 1998
(Unaudited) ............................. 457,853 $ 46 $10,102 $(79) $(14,828) $(4,359)
======= ==== ======= ====== ======== =======
</TABLE>
See accompanying notes.
F-5
<PAGE>
INTERACTIVE MAGIC, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Three months ended
Year ended December 31, March 31,
---------------------------------------- ---------------------
1995 1996 1997 1997 1998
-------------- ------------ ------------ ---------- ----------
(unaudited)
<S> <C> <C> <C> <C> <C>
Operating activities
Net loss ............................................... $(2,451) $ (7,200) $ (4,298) $ (825) $ (618)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization ......................... 94 230 422 81 89
Amortization of capitalized software
development costs ................................... 69 147 576 37 250
Issuance of common stock in lieu of
compensation ........................................ -- 198 -- -- --
Issuance of common stock for services ................. 20 12 15 15 --
Noncash interest expense .............................. -- 122 147 32 33
Write-off of investment ............................... -- -- 120 -- --
Changes in operating assets and liabilities:
Trade receivables ................................... (784) (334) (1,752) (1,209) (1,698)
Inventories ......................................... (269) (141) (227) (120) (128)
Advance royalties ................................... (266) (587) (911) 92 367
Prepaid expenses and other .......................... (79) (21) (87) (307) 22
Accounts payable and accrued expenses ............... 1,109 433 1,084 534 254
Royalties and commissions payable ................... 266 218 374 (10) 77
Accrued interest .................................... 86 282 764 170 18
------- -------- -------- -------- --------
Net cash used in operating activities .................. (2,205) (6,641) (3,773) (1,510) (1,334)
Investing activities
Purchase of property and equipment ..................... (683) (563) (382) (64) (51)
Purchase of investment ................................. -- (120) -- -- --
Software development costs ............................. (289) (79) (849) (255) (583)
------- -------- -------- -------- --------
Net cash used in investing activities .................. (972) (762) (1,231) (319) (634)
Financing activities
Proceeds from issuance of common stock ................. 2,401 999 -- -- 9
Proceeds from issuance of preferred stock .............. -- -- -- -- 3,169
Proceeds from long-term debt ........................... -- 993 4,192 3,000 --
Payments on long-term debt ............................. -- -- -- -- (20)
Proceeds from notes payable to related parties ......... 700 2,370 500 200 --
Net borrowings from (payments on)
lines-of-credit ........................................ 426 3,088 469 (1,510) (1,426)
Payments on capital lease obligations .................. (22) (47) (68) (14) (12)
------- -------- -------- -------- --------
Net cash provided by financing activities .............. 3,505 7,403 5,093 1,676 1,720
Effect of currency exchange rate changes on cash
and cash equivalents .................................. (2) (60) 3 16 (20)
------- -------- -------- -------- --------
Net increase (decrease) in cash and cash
equivalents ........................................... 326 (60) 92 (137) (268)
Cash and cash equivalents at beginning of period 26 352 292 292 384
------- -------- -------- -------- --------
Cash and cash equivalents at end of period ............. $ 352 $ 292 $ 384 $ 155 $ 116
======= ======== ======== ======== ========
Supplemental disclosure of cash flow
information
Cash paid for interest ................................. $ 87 $ 233 $ 760 $ 95 $ 276
------- -------- -------- -------- --------
Cash paid for income taxes ............................. $ -- $ 47 $ 8 $ -- $ --
======= ======== ======== ======== ========
Noncash investing and financing activities
Acquisition of equipment under capital leases .......... $ 155 $ 55 $ -- $ -- $ --
Issuance of common stock for receivable ................ $ 50 $ -- $ -- $ -- $ --
Issuance of common stock for equipment ................. $ 20 $ -- $ -- $ -- $ --
Conversion of notes payable into stock ................. $ -- $ 1,204 $ -- $ -- $ --
</TABLE>
See accompanying notes.
F-6
<PAGE>
INTERACTIVE MAGIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
1. DESCRIPTION OF BUSINESS
Interactive Magic, Inc. (the "Company") develops, publishes, and
distributes 3-D interactive, simulation and strategy entertainment software to
customers around the world via (1) retail distribution through international
and domestic software outlets and (2) proprietary, pay-for-play online service
on the Internet. The Company has agreements with various software licensors to
manufacture, market, sell and distribute software in the United States. Through
its wholly owned subsidiaries located in the United Kingdom and Germany, and
through its online service, the Company also distributes its products
internationally.
2. BUSINESS COMBINATION
On April 23, 1997, the Company acquired 100% of the outstanding capital
stock of Interactive Creations, Inc. ("ICI") in exchange for 655,696 shares of
the Company's Class A Common Stock (the "Merger"). Subsequent to the Merger,
ICI's name was changed to iMagic Online Corporation. The Merger constituted a
tax-free reorganization and was accounted for under the pooling of interests
method of accounting in accordance with Accounting Principles Board Opinion No.
16.
The results of operations for the separate companies and the combined
amounts presented in the consolidated financial statements follow (in
thousands):
<TABLE>
<CAPTION>
Three months
Year ended December 31,
--------------------------- ended March 31,
1995 1996 1997
------------ ------------ ----------------
(unaudited)
<S> <C> <C> <C>
Net Sales
Interactive Magic, Inc. ........... $ 4,115 $ 5,235 $3,602
iMagic Online Corporation ......... 6 822 355
-------- -------- ------
Combined .......................... $ 4,121 $ 6,057 $3,957
======== ======== ======
Net loss
Interactive Magic, Inc ............ $ (2,167) $ (6,236) $ (688)
iMagic Online Corporation ......... (284) (964) (137)
-------- -------- ------
Combined .......................... $ (2,451) $ (7,200) $ (825)
======== ======== ======
</TABLE>
The accompanying consolidated financial statements include the operations
of the combined entities for the years ended December 31, 1995, 1996 and 1997
and for the three months ended March 31, 1997 and 1998.
3. SIGNIFICANT ACCOUNTING POLICIES AND OTHER MATTERS
Consolidation
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries, iMagicOnline Corporation, Interactive Magic
Ltd. and Interactive Magic GmbH. All significant intercompany accounts and
transactions have been eliminated in consolidation.
March 31, 1997 and 1998 Interim Financial Information (Unaudited)
The consolidated statements of operations and cash flows for the
three-month periods ended March 31, 1997 and 1998 and the consolidated balance
sheet at March 31, 1998 are unaudited and reflect all adjustments (consisting
of normal recurring adjustments) which are, in the opinion of management,
necessary for a fair presentation of financial position, results of operations
and cash flows. All information related to the three-month periods ended March
31, 1997 and 1998 is unaudited.
F-7
<PAGE>
INTERACTIVE MAGIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
3. SIGNIFICANT ACCOUNTING POLICIES AND OTHER MATTERS -- (Continued)
Cash and Cash Equivalents
The Company includes amounts in demand deposit accounts in cash and cash
equivalents.
Inventories
Inventories consist of pre-packaged CD-ROM software packages and related
materials and are stated at the lower of cost or market. Costs are determined
using the first-in, first-out ("FIFO") cost flow assumption.
Inventories consist of the following (in thousands):
<TABLE>
<CAPTION>
December 31,
-------------------- March 31,
1996 1997 1998
--------- -------- ------------
(unaudited)
<S> <C> <C> <C>
Finished goods ...................... $ 417 $ 645 $ 774
Components .......................... 96 79 138
------ ----- ------
513 724 912
Inventory valuation reserve ......... (103) (87) (147)
------ ----- ------
$ 410 $ 637 $ 765
====== ===== ======
</TABLE>
Advance Royalties
Advance royalties represent prepayments made to independent software
developers under development agreements. Advance royalties are expensed as part
of royalties and amortized software costs at the contractual royalty rate based
on actual net product sales. Management continuously evaluates the future
realization of advance royalties, and charges to cost of revenues any amount
that management deems unlikely to be amortized at the contractual royalty rate
through product sales. Advance royalties are classified as current and
noncurrent assets based upon estimated product release dates of the related
software products.
Property and Equipment
Property and equipment are stated at cost. Depreciation for equipment,
furniture and fixtures and software is computed using the straight-line method
over the estimated useful lives of the assets, ranging from five to seven
years. Leasehold improvements are amortized on a straight-line basis over the
term of the estimated useful life of the asset or the remaining lease term,
whichever is less. Depreciation expense, including amortization of equipment
leased under capital leases, was $91,000, $215,000 and $415,000 for the years
ended December 31, 1995, 1996 and 1997, and $75,000 and $89,000 for the three
months ended March 31, 1997 and 1998, respectively.
Property and equipment consists of the following (in thousands):
<TABLE>
<CAPTION>
December 31,
--------------------- March 31,
1996 1997 1998
--------- --------- ------------
(unaudited)
<S> <C> <C> <C>
Equipment .............................................. $1,083 $1,287 $1,345
Furniture and fixtures ................................. 160 167 167
Software ............................................... 278 425 430
Leasehold improvements ................................. 33 54 54
------ ------ ------
1,554 1,933 1,996
Less accumulated depreciation and amortization ......... (325) (737) (838)
------ ------ ------
$1,229 $1,196 $1,158
====== ====== ======
</TABLE>
F-8
<PAGE>
INTERACTIVE MAGIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
3. SIGNIFICANT ACCOUNTING POLICIES AND OTHER MATTERS -- (Continued)
Capitalized Software Development Costs
Costs incurred in the development of software for sale to customers are
capitalized after a product's technological feasibility has been established.
Capitalization of such costs is discontinued when a product is available for
general release to customers. Capitalized software development costs are
capitalized at the lower of cost or net realizable value and amortized using
the greater of the revenue curve method or the straight-line method over the
estimated economic life of the related product. Amortization begins when a
product is ready for general release to customers. Amortization of capitalized
software development costs is included in royalties and amortized software
costs in the consolidated statement of operations and was $69,000, $147,000,
and $576,000 for the years ended December 31, 1995, 1996 and 1997, and $37,000
and $250,000 for the three months ended March 31, 1997 and 1998, respectively.
Information related to net capitalized software development costs is as
follows (in thousands):
<TABLE>
<CAPTION>
December 31,
--------------------- March 31,
1996 1997 1998
--------- --------- ------------
(unaudited)
<S> <C> <C> <C>
Balance at beginning of period ......... $ 220 $ 152 $ 425
Capitalized ............................ 79 849 583
Amortized .............................. (147) (576) (250)
------ ------ ------
Balance at end of period ............... $ 152 $ 425 $ 758
====== ====== ======
</TABLE>
Fair Value of Financial Instruments
The carrying value of cash and cash equivalents, trade receivables,
accounts payable and notes payable approximates the fair value.
Revenue Recognition
Revenue from CD-ROM product sales is recognized at the time of product
shipment. Revenue from online sales is recognized at the time the game is
played and is based upon actual usage by the customer on an hourly basis.
Revenue from royalties and licenses is recognized when earned under the terms
of the relevant agreements with OEMs, international distributors and other
third parties. With respect to license agreements that provide customers the
right to multiple copies in exchange for guaranteed amounts, net revenue is
recognized upon delivery of the product master or the first copy. Per copy
royalties on sales that exceed the guarantee are recognized as earned. The
Company accepts product returns and provides price protection on certain unsold
merchandise. Revenue is recorded net of an allowance for estimated future
returns, markdowns, price protection and warranty costs. Such reserves are
based upon management's evaluation of historical experience, current industry
trends and estimated costs.
The accounts receivable allowance consists primarily of reserves for
product returns, markdowns, price protection and warranty costs. The allowance
also includes a reserve for doubtful accounts, which management records based
on historical experience and current evaluation of potential collectibility
issues. Although the Company does not require collateral for unpaid balances,
credit losses have consistently been within management's expectations.
Product Development
Product development expenses (excluding capitalized software development
costs) are charged to operations in the period incurred and consist primarily
of payroll and payroll related costs.
F-9
<PAGE>
INTERACTIVE MAGIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
3. SIGNIFICANT ACCOUNTING POLICIES AND OTHER MATTERS -- (Continued)
Advertising
The Company expenses advertising costs as incurred. Advertising expense
was approximately $695,000, $1,661,000 and $2,529,000 for the years ended
December 31, 1995, 1996 and 1997, and $527,000 and $638,000 for the three
months ended March 31, 1997 and 1998, respectively.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Significant estimates include provisions for doubtful
accounts, sales returns and allowances, and estimates regarding the
recoverability of prepaid royalty advances and inventory. Actual results could
differ from those estimates.
Foreign Currency Translation
The Company follows the principles of the Financial Accounting Standards
Board ("FASB") Statement of Financial Accounting Standards ("SFAS") No. 52,
"Foreign Currency Translation," using the local currency of its operating
subsidiaries as the functional currency. Accordingly, all assets and
liabilities outside the United States are translated into U.S. dollars at the
rate of exchange in effect at the balance sheet date. Income and expense items
are translated at the weighted average exchange rate prevailing during the
period. Adjustments resulting from translation of financial statements are
reflected as a separate component of stockholders' equity.
Warrants
Stock purchase warrants issued in connection with debt instruments are
recorded at their estimated fair value and credited to additional paid-in
capital. The resulting debt discount is amortized to interest expense over the
term of the related debt.
Employee Stock Compensation
The Company has elected to continue to follow Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB No. 25") and
related interpretations in accounting for its employee stock options as
permitted by SFAS No. 123 and make the required pro forma disclosures required
by SFAS No. 123 (see Note 8). Under APB No. 25, because the exercise price of
the Company's employee stock options is not less than the estimated fair value
of the underlying stock on the date of grant, no compensation expense is
recognized.
Net Loss Per Share and Pro Forma Net Loss Per Share
The Company accounts for net loss per share in accordance with SFAS No.
128 "Earnings Per Share." In accordance with SFAS No. 128, net loss per share
is computed by dividing net loss by the weighted average number of common
shares outstanding during the period.
Pro forma net loss per share as presented in the consolidated statements
of operations has been computed as described above and also gives effect to the
conversion of the Series A and Series B Convertible Preferred Stock, and the
Series C Redeemable Convertible Preferred Stock and the exercise of options and
warrants that will occur in contemplation of completing the Company's planned
initial public offering (using the as-if converted method).
F-10
<PAGE>
INTERACTIVE MAGIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
3. SIGNIFICANT ACCOUNTING POLICIES AND OTHER MATTERS -- (Continued)
A reconciliation of shares used in the calculation of net loss per share
and pro forma net loss per share follows (in thousands, except per share data):
<TABLE>
<CAPTION>
Year ended December 31, Three months ended March 31,
--------------------------------------------- -----------------------------
1995 1996 1997 1997 1998
------------- ------------- ------------- ------------- -------------
(unaudited)
<S> <C> <C> <C> <C> <C>
Net loss ................................ $ (2,451) $ (7,200) $ (4,298) $ (825) $ (618)
========== ========== ========== ========== ==========
Weighted average shares of common
stock outstanding (shares used in
computing net loss per share) ......... 1,709,320 3,006,715 3,152,930 3,152,106 3,429,558
Net loss per share ...................... $ (1.43) $ (2.39) $ (1.36) $ (0.26) $ (0.18)
========== ========== ========== ========== ==========
Shares used in computing net loss per
share ................................. 3,152,930 3,429,558
Adjustment to reflect the effect of the
assumed conversion of the Series A
and Series B Convertible Preferred
Stock ................................. 2,128,283 2,128,283
Adjustment to reflect the effect of the
assumed conversion of the Series C
Redeemable Convertible Preferred
Stock ................................. 132,744 132,744
Adjustment to reflect the exercise of
certain options, assumed exercise of
certain warrants and assumed
issuance of shares of common stock
in connection with the
recapitalization ...................... 929,123 929,123
---------- ----------
Shares used in computing pro forma
net loss per share .................... 6,343,080 6,619,708
========== ==========
Pro forma net loss per share ............ $ (0.68) $ (0.09)
========== ==========
</TABLE>
Had the Company been in a net income position, diluted earnings per share
would have been presented and would have included the shares used in the
computation of pro forma net loss per share as well as additional potential
common shares related to outstanding options and warrants. The diluted earnings
per share computation is not included, as the inclusion of all potential common
shares is antidilutive.
Pro Forma Balance Sheet Information
The unaudited pro forma balance sheet information as of March 31, 1998,
reflects the conversion of the existing shares of convertible preferred stock,
redeemable convertible preferred stock, and Class A and Class B Common Stock
into equivalent shares of common stock, which conversion is contingent upon the
closing of the offering. In addition, the pro forma information reflects the
cash proceeds and payment of accrued interest used in connection with the
exercise of options and warrants, as well as the issuance of shares of common
stock, in contemplation of the Company's initial public offering.
The pro forma balance sheet information gives effect to the Company's
proposed Recapitalization and reflects the following transactions and pro forma
adjustments:
(A) Receipt of $90,000 in cash proceeds and issuance of 45,000 shares of
Class B Common Stock in connection with the exercise of incentive stock
options.
F-11
<PAGE>
INTERACTIVE MAGIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
3. SIGNIFICANT ACCOUNTING POLICIES AND OTHER MATTERS -- (Continued)
(B) Receipt of $10,335 in cash proceeds and issuance of 516,769 shares of
Class A Common Stock in connection with the exercise of warrants.
(C) Reduction of accrued interest payable to related parties and issuance of
268,750 shares of Class A Common Stock resulting from the exercise of
incentive stock options. Accrued interest of $268,750 was applied as
consideration to effect the exercise of the stock options.
(D) Reduction of accrued interest payable to related parties and issuance of
50,000 shares of Class B Common Stock resulting from the exercise of
incentive stock options. Accrued interest of $50,000 was applied as
consideration to effect the exercise of the stock options.
(E) Conversion of Series A Convertible Preferred Stock into 82,634 shares of
common stock.
(F) Conversion of Series B Convertible Preferred Stock into 2,045,649 shares
of common stock.
(G) Conversion of Series C Redeemable Convertible Preferred Stock into
132,744 shares of common stock.
(H) Exchange of Class A Common Stock to 3,931,215 shares of common stock.
(I) Exchange of Class B Common Stock to 601,457 shares of common stock,
which includes 48,604 shares issued subsequent to March 31, 1998 for
consideration already received.
Impact of Recently Issued Accounting Pronouncements
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income" and SFAS No. 131, "Disclosures about Segments of an Enterprise and
Related Information." In addition, the American Institute of Certified Public
Accountants issued Statement of Position (SOP) 97-2, "Software Revenue
Recognition", SOP 98-4, "Deferral of the Effective Date of a Provision of SOP
97-2, `Software Revenue Recognition'" and SOP 98-1, "Accounting for the Costs
of Computer Software Developed or Obtained for Internal Use." SFAS Nos. 130 and
131 and SOP 97-2 and SOP 98-4 are effective for fiscal years beginning after
December 15, 1997 and SOP 98-1 is effective for fiscal years beginning after
December 15, 1998. The Company does not believe that adoption of these
standards will have a material impact on the Company's financial position or
results of operations.
4. LINES OF CREDIT
The Company maintains a revolving line of credit arrangement with a bank
for up to $2,750,000. The principal balance outstanding at any point in time is
payable on demand with interest payable monthly at the current prime rate (8.5%
at December 31, 1997). The weighted-average interest rate on the line of credit
was 7.8% and 8.1% for the years ended December 31, 1996 and 1997, and 8.2% and
8.4% for the three months ended March 31, 1997 and 1998, respectively. The
balance outstanding as of December 31, 1996 and 1997 was $1,908,000 and
$2,439,000, respectively, and $2,461,000 as of March 31, 1998. Advances on the
line of credit are collateralized by a personal guarantee of the Company's
majority shareholder.
The Company also entered into a line of credit agreement with the same
bank to borrow up to $150,000. The line of credit is collateralized by the
Company's net property and equipment. The principal balance outstanding at any
point in time is payable on demand with interest payable monthly at the current
prime rate. The weighted-average interest rate on the line of credit was 7.8%
and 8.1% for the years ended December 31, 1996 and 1997, and 8.2% and 8.4% for
the three months ended March 31, 1997 and 1998, respectively. The balance
outstanding at December 31, 1996 and 1997 was $106,000 and $44,000,
respectively and $96,000 as of March 31, 1998.
During 1996, the Company also executed a line of credit agreement with
another bank, the terms of which stipulate that the Company may borrow up to
75% of its eligible domestic accounts receivable up to a maximum of $1,500,000.
The agreement entitles the bank to a perfected first lien security interest in
all of the Company's assets. Borrowings under this credit agreement were
$1,500,000 at December 31, 1996 and 1997. Interest is
F-12
<PAGE>
INTERACTIVE MAGIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
4. LINES OF CREDIT -- (Continued)
payable monthly at prime (8.5% at December 31, 1997) + 2.0%. The
weighted-average interest rate on the line of credit was 10.1% and 10.4% for
the years ended December 31, 1996 and 1997, and 10.5% and 10.6% for the three
months ended March 31, 1997 and 1998, respectively. Also, monthly fees of an
additional .5% are paid on outstanding advances under the line with a $15,000
minimum per quarter. The line of credit agreement expired and the related
outstanding borrowings were repaid in full in February 1998.
5. NOTES PAYABLE TO RELATED PARTIES
Notes payable to related parties consist of the following (in thousands):
<TABLE>
<CAPTION>
December 31,
------------------- March 31,
1996 1997 1998
-------- -------- ------------
(unaudited)
<S> <C> <C> <C>
Note payable to a stockholder, due on demand after January 1, 1999, interest
at 14% per annum ......................................................... $ 600 $ 600 $ --
Note payable to a stockholder, principal and interest due on demand after
January 1, 1999, stated interest at 15% per annum until November 17,
1996, 17% thereafter ..................................................... 1,000 1,000 --
Note payable to a stockholder, principal and interest due on demand after
January 1, 1999, stated interest at 15% per annum until January 6, 1997,
17% thereafter ........................................................... 1,000 1,000 --
Note payable to related party, principal and interest due January 1, 1999,
interest at 10% per annum ................................................ 370 870 870
------ ------ ----
$2,970 $3,470 $870
====== ====== ====
</TABLE>
On February 4, 1998, the $600,000 and the two $1 million notes payable to
shareholders were converted into 132,744 shares of Series C Redeemable
Convertible Preferred Stock and 442,478 shares of Class B Common Stock,
respectively. The Series C Redeemable Convertible Preferred Stock is
mandatorily redeemable in cash upon a public offering of the Company's common
stock or convertible into 132,744 shares of common stock at the election of the
holder. Unpaid accrued interest of $702,000 and $740,000 relating to these
notes was not converted and is included in accrued interest at December 31,
1997 and March 31, 1998, respectively.
F-13
<PAGE>
INTERACTIVE MAGIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
6. LONG-TERM DEBT
Long-term debt, other than to related parties, consists of the following
(in thousands):
<TABLE>
<CAPTION>
December 31,
------------------- March 31,
1996 1997 1998
------ ---------- ------------
(unaudited)
<S> <C> <C> <C>
Note payable due January 31, 1998, stated interest at prime plus 2% until an
additional round of equity investment is received by the Company at which
time the interest will be prime plus 4%, collateralized by property and
equipment (net of unamortized discount of $7,000 and $5,000 at December
31, 1996 and 1997, respectively) ............................................. $493 $ 495 $ 475
Subordinated note payable due March 24, 2002, stated interest at 13.5% per
annum, collateralized by property, equipment and inventory (net of
unamortized discount of $276,000 at December 31, 1997)........................ -- 2,724 2,747
Note payable due January 9, 1998, stated interest rate at prime (8.5% at
December 31, 1997) , collateralized by a personal guarantee of the
Company's majority shareholder. .............................................. -- 250 250
Junior subordinated note payable, due August 30, 2002, interest payable in
arrears every six months, at stated interest rate of 11% per annum for the
first twelve months, 12.0% per annum for next twelve months, and 12.5%
thereafter until maturity, collateralized by the assets of the Company (net of
unamortized discount of $165,000 at December 31, 1997)........................ -- 1,035 1,044
---- ------ ------
493 4,504 4,516
Current portion ................................................................ -- (745) (725)
---- ------ ------
Long-term debt, less current portion ........................................... $493 $3,759 $3,791
==== ====== ======
</TABLE>
The aggregate principal maturities at December 31, 1997 consist of
$745,000 due in 1998, with the remaining balance of long-term debt becoming due
in 2002.
The Company estimates that the fair value of notes payable approximates
the carrying value based upon its effective current borrowing rate for debt
with similar terms and remaining maturities. Disclosure about fair value of
financial instruments is based upon information available to management as of
December 31, 1996 and 1997 and March 31, 1998. Although management is not aware
of any factors that would significantly affect the fair value of amounts, such
amounts have not been comprehensively revalued for purposes of these financial
statements since that date.
7. LEASES
The Company rents its facilities and certain office equipment under
noncancellable operating leases through 2001. The monthly rent under certain
facility leases are periodically adjusted based on changes in the Consumer
Price Index.
F-14
<PAGE>
INTERACTIVE MAGIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
7. LEASES -- (Continued)
Property and equipment includes the following amounts for capital leases
(in thousands):
<TABLE>
<CAPTION>
December 31,
------------------- March 31,
1996 1997 1998
-------- -------- ------------
(unaudited)
<S> <C> <C> <C>
Leased equipment ...................... $ 157 $ 157 $ 157
Leased furniture and fixtures ......... 53 53 53
----- ----- -----
210 210 210
Less accumulated amortization ......... (44) (85) (95)
----- ----- -----
$ 166 $ 125 $ 115
===== ===== =====
</TABLE>
The following is a schedule of future minimum lease payments for capital
and operating leases for the years ending December 31 (in thousands):
<TABLE>
<CAPTION>
Capital Operating
Leases Leases
--------- ----------
<S> <C> <C>
1998 ................................................... $ 43 $309
1999 ................................................... 24 235
2000 ................................................... 19 204
2001 ................................................... -- 20
----- ----
Total future minimum lease payments .................... 86 $768
====
Less: amount representing interest ..................... (13)
-----
Present value of future minimum lease payments ......... 73
Less: current portion .................................. (35)
-----
$ 38
=====
</TABLE>
Total rent expense incurred was approximately $84,000, $261,000 and
$309,000 for the years ended December 31, 1995, 1996 and 1997, respectively and
$94,000 and $99,000 for the three months ended March 31, 1997 and 1998,
respectively.
8. STOCKHOLDERS' DEFICIT
Common Stock
The Company has two classes of common stock, Class A (voting) and Class B
(nonvoting). Common stockholder rights are subordinate to those of preferred
stockholders. Holders of the Class A Common Stock are entitled to one vote per
share of common stock held. Holders of Class B Common Stock do not receive any
voting privileges.
During 1995, 1996 and 1997, the Company issued 77,757, 2,418 and 1,037
shares of its Class A Common Stock for services rendered. During 1996, the
Company issued 164,000 shares of its Class A Common Stock in lieu of
compensation. These transactions were valued based on the estimated fair value
of the common stock at the time the related services were performed.
Convertible Preferred Stock
The Series A Convertible Preferred Stock ("Series A Preferred") is
automatically convertible into shares of Class A Common Stock upon the closing
of an underwritten public offering pursuant to an effective registration
statement under the Securities Act of 1933, as amended, covering the offer and
sale of Class A Common Stock of the Company to the public with an aggregate
gross offering price of not less than $10,000,000 and a per share price of not
less than $6.10. Each share of outstanding Series A Preferred is currently
convertible into one share
F-15
<PAGE>
INTERACTIVE MAGIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
8. STOCKHOLDERS' DEFICIT -- (Continued)
of Class A Common Stock, subject to adjustment as provided in the Amended
Articles of Incorporation of the Company. The Company has reserved 82,634
shares of common stock for issuance upon conversion.
The holders of the Series A Preferred Stock are entitled to vote on all
matters with votes equal to the number of shares of Class A Common Stock into
which the Preferred Stock is convertible. The Series A Preferred stockholders
are entitled to receive annual cumulative dividends of 8% only if, and when,
such dividends are declared by the Company's Board of Directors out of funds
legally available therefor. The approval of the majority of the then
outstanding shares of the Series A Preferred Stock is required in order to
declare dividends to the holders of common stock. As of December 31, 1997 and
March 31, 1998, no dividends had been declared with respect to the Series A
Preferred Stock.
The outstanding subordinated and junior subordinated notes payable
prohibit the declaration or payment of any dividends during the terms of the
notes without the written consent of the holders of such notes.
On February 4, 1998, the Company issued 778,746 shares of its Series B
Convertible Preferred Stock for an aggregate purchase price of $3,500,000. The
holders of the Series B Preferred stock are entitled to vote on all matters
with votes equal to the number of shares of common stock into which the Series
B Preferred Stock is convertible. The holders of Series B Preferred Stock are
entitled to convert their preferred shares into 2,045,649 shares of the
Company's common stock in the event the Company consummates an initial public
offering or enters into a sale agreement. In addition, the Company is required
to obtain the consent of the holders of the Series B Preferred Stock in the
event that it (i) contemplates issuance of convertible securities if the
cumulative number of shares issuable during the two years following an initial
public offering exceeds five percent of the outstanding shares of common stock
on a fully diluted basis, excluding the convertible securities and (ii) pays
any dividends other than required dividends on the Series A Preferred Stock.
The liquidation preference for the Series A, Series B and Series C
Preferred Stock is equal to the respective Series' issue price plus any accrued
and unpaid dividends.
Stock Options
Effective January 2, 1995, the Company adopted two employee incentive
stock option plans (the "1995 Plans"). One plan provided for the granting of
options to purchase Class A Common Stock which was voting stock, and one plan
provided for the granting of options to purchase Class B Common Stock which was
non-voting. The 1995 Plans are intended as incentives to induce key employees
of the Company to remain in the employ of the Company or of any subsidiary of
the Company and to encourage such employees to own stock in the Company. This
purpose is carried out by granting options to purchase shares of Common Stock.
The Company may grant incentive stock options ("ISOs") within the meaning of
Section 422 of the Internal Revenue Code of 1986, as amended (the "Code") to
eligible participants under the 1995 Plans. The exercise price of an ISO may
not be less than 100% of the fair market value of the underlying shares at the
time the ISO is granted.
The 1995 Plans are administered by the Board of Directors. The Board has
the authority to administer the 1995 Plans and determine, among other things,
the interpretation of any provisions of the 1995 Plans, the eligible employees
who are to be granted stock options, the number of shares which may be issued
and the option exercise price.
The Company's incentive stock options vest over time with 20% vesting
during the second year after the date of grant with an additional 5% vesting
each calendar quarter thereafter. Incentive stock options generally may only be
exercised if the participant has been employed by the Company continuously for
at least one year as of the last day of the first 12-month period following the
date of option grant. The option is only exercisable if the participant is
employed by the Company and for limited periods of time after the participant's
termination of employment. If the participant ceases to be employed on account
of termination by the Company for cause or resignation (other than retirement
as defined in the option agreement), the right to exercise any unexercised
portion of the option terminates. If the participant is terminated by the
Company without cause, the participant
F-16
<PAGE>
INTERACTIVE MAGIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
8. STOCKHOLDERS' DEFICIT -- (Continued)
shall be entitled to purchase, within three months, option shares equal to an
additional 25% of the participant's option shares that were not exercisable as
of the termination date. The option becomes immediately and fully vested and
exercisable in the event of a change in control as defined in the option
agreement.
The performance incentive stock options ("PSOs") are exercisable during
the period commencing from March 31, 1997 and ending March 31, 2005.
Performance options vest upon the earlier of the Company's achievement of
certain performance standards or seven years from the date of grant. The number
and exercise price of the options are fixed at the date of grant. Options are
exercisable only in the event the participant is employed by the Company and
for limited periods of time after the participant's termination of employment.
If the participant ceases to be an employee on account of resignation (other
than retirement as defined in the option agreement) or termination for cause,
the right to exercise any unexercised portion of the option shall terminate.
The option becomes immediately and fully vested and exercisable as of a change
in control date.
As the exercise price of the options was not less than the estimated fair
value of the stock on the date of grant, no compensation expense was recorded
related to these options.
The following table summarizes the ISO and PSO activity under the
Company's 1995 Plans:
<TABLE>
<CAPTION>
Class A Class B
Voting Non-Voting Weighted-Average
Shares Shares Exercise
Available for Available for Options Price Per
Grant Grant Outstanding Share Exercisable
--------------- --------------- ------------- ----------------- ------------
<S> <C> <C> <C> <C> <C>
Options authorized for grant ......... 750,000 1,500,000 -- $ -- --
Options granted ...................... (500,000) (1,010,000) 1,510,000 1.00 --
-------- ---------- --------- ----- --
Balances at December 31, 1995 .......... 250,000 490,000 1,510,000 1.00 148,750
Options authorized for grant ......... -- 625,000 -- -- --
Options granted ...................... (85,076) (318,294) 403,370 3.83 --
Options exercised .................... -- -- (6,750) 1.00 --
Options canceled ..................... -- 43,250 (43,250) 1.00 --
-------- ---------- --------- ----- -------
Balances at December 31, 1996 .......... 164,924 839,956 1,863,370 1.78 54,644
Options authorized for grant ......... 250,000 357,500 -- -- --
Options granted ...................... (111,360) (218,956) 330,316 5.63 --
Options exercised .................... -- -- (1,125) 1.00 --
Options canceled ..................... 127,933 71,580 (199,513) 4.90 --
-------- ---------- --------- ----- -------
Balances at December 31, 1997 .......... 431,497 1,050,080 1,993,048 2.14 1,007,328
Options granted ...................... -- (11,250) 11,250 6.00 --
Options exercised .................... -- -- (7,500) 0.60 --
Options canceled ..................... -- 120,188 (120,188) 1.86 --
-------- ---------- --------- ----- ---------
Balances at March 31, 1998
(Unaudited) ......................... 431,497 1,159,018 1,876,610 $ 1.99 1,435,665
======== ========== ========= ====== =========
</TABLE>
The Company has adopted the disclosure-only provisions of SFAS 123. The
fair value for each ISO and PSO option was estimated at the date of grant using
a Black-Scholes option pricing model with the following weighted average
assumptions:
F-17
<PAGE>
INTERACTIVE MAGIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
8. STOCKHOLDERS' DEFICIT -- (Continued)
<TABLE>
<CAPTION>
Three months
Year ended ended
December 31, March 31,
------------------------ ----------------
1995 1996 1997 1997 1998
------ ------ ------ ------ -------
(unaudited)
<S> <C> <C> <C> <C> <C>
Expected dividend yield ....................... 0% 0% 0% 0% 0%
Risk-free interest rate ....................... 6% 6% 6% 6% 6%
Expected volatility ........................... 59% 59% 59% 59% 59%
Expected life (in years from vesting) ......... 5.4 3.4 1.9 2.2 4.9
</TABLE>
For purposes of pro forma disclosures, the estimated fair values of the
stock options are amortized to expense over the vesting period. The grant date
Black-Scholes weighted-average value was $0.32, $0.54 and $0.95 per share for
1995, 1996 and 1997 and $1.04 and $1.69 per share for the three-month periods
ended March 31, 1997 and 1998, respectively. As of December 31, 1997, 422,970
Class A options and 584,358 Class B options were exercisable with a
weighted-average remaining contractual life of seven years.
The following table shows pro forma net loss and net loss per share as if
the fair value accounting method prescribed by SFAS 123 had been used to
account for stock based compensation (in thousands, except per share data):
<TABLE>
<CAPTION>
Three months ended March
Year ended December 31, 31,
------------------------------------------ -----------------------
1995 1996 1997 1997 1998
------------ ------------ ------------ ---------- ----------
(unaudited)
<S> <C> <C> <C> <C> <C>
Net loss as reported .............................. $ (2,451) $ (7,200) $ (4,298) $ (825) $ (618)
Pro forma compensation expense .................... (119) (198) (484) (104) (62)
-------- -------- -------- ------- -------
Pro forma net loss (for SFAS 123 disclosure
purposes) ....................................... $ (2,570) $ (7,398) $ (4,782) $ (929) $ (680)
======== ======== ======== ======= =======
Net loss per share:
Historical (as disclosed in Note 3) ............. $ (1.43) $ (2.39) $ (1.36) $ (0.26) $ (0.19)
Pro forma (for SFAS 123 disclosure purposes)..... $ (1.50) $ (2.46) $ (1.52) $ (0.29) $ (0.21)
</TABLE>
Stock Warrants
Warrants issued in connection with notes payable are recorded at their
estimated fair value and credited to additional paid in capital. The resulting
debt discount is amortized to interest expense over the term of the related
debt. Warrants issued to members of the Board of Directors are recorded at
their estimated fair value and the related general and administrative expense
is charged when the warrants are issued. The fair value of warrants issued to
the placement agent in connection with the issuance of preferred stock in
February 1998 was recorded as a stock issuance cost.
F-18
<PAGE>
INTERACTIVE MAGIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
8. STOCKHOLDERS' DEFICIT -- (Continued)
The following table summarizes all warrants issued to purchase the
Company's Class A and Class B Common Stock:
<TABLE>
<CAPTION>
Shares of
Stock
Purchasable
Under Exercise Date of
Description Warrant Price Expiration
- ----------------------------------------------------------------- ------------ ------------------- -----------
<S> <C> <C> <C>
Issued to shareholders in connection with notes payable or as
consideration for providing loan collateral .................... 60,000 $ 1.00 3/06/01
------
Outstanding at December 31, 1995 ................................ 60,000
Expiration of warrants at date of note conversion ............... (16,155)
Issued to shareholders in connection with notes payable or as
consideration for providing loan collateral .................... 117,608 30,000 @ $1.00 3/06/01
31,250 @ 2.00 5/20/03
50,000 @ 6.00 7/10/03
6,358 @ 5.82 12/31/03
Issued to lenders in connection with notes payable .............. 99,704 77,646 $ * 3/06/01
-------
22,058 @ 4.53 7/15/99
Outstanding at December 31, 1996 ................................ 261,157
Issued to lenders in connection with notes payable .............. 345,501 249,886 @ $0.02 3/24/08
95,615 @ 0.02 8/30/03
Issued to shareholders in connection with notes payable ......... 102,896 44,444 @ $2.00 5/20/03
49,861 @ 6.00 7/10/03
8,591 @ 5.82 12/31/03
Issued to members of Board of Directors ......................... 40,500 $ 6.00 12/31/04
-------
Outstanding at December 31, 1997 ................................ 750,054
Issued to placement agent in connection with private placement
of preferred stock ............................................. 16,667 $ 6.00 2/04/05
Additional warrants issued to lender in connection with
March 24, 1997 note payable .................................... 57,937 $ 0.02 3/24/08
Issued to shareholder in connection with notes payable .......... 834 $ 6.00 7/10/03
Issued to a member of Board of Directors ........................ 12,500 $ 6.00 12/31/04
-------
Outstanding at March 31, 1998 (unaudited) ....................... 837,992
=======
</TABLE>
- ------------
* Exercise price is calculated as defined in the warrant agreement.
In connection with the note payable maturing on August 30, 2002, the
Company granted to the lender and warrant holder an option (the "Put Option")
to sell to the Company its warrant shares. The Put Option becomes effective
beginning on September 29, 2002. As defined in the loan and security agreement,
the price of the Put Option (the "Put Price") is calculated as the higher of
the following: (i) the product of five times the Company's per share earnings
before interest, taxes, depreciation and amortization for the most recent
twelve-month period before exercise of the Put Option less the debt per share
of the Company's outstanding common stock on a fully diluted basis for the same
twelve month period, plus cash per share of the Company's outstanding common
stock on a fully diluted basis all multiplied by the number of Put Shares or
(ii) the Company's book value per share at the end of the most recently
completed month before exercise of the Put Option multiplied by the number of
Put Shares. Based upon the calculated Put Price, the Company determined the Put
Option had negligible value at December 31, 1997 and March 31, 1998.
In connection with the conversion of a note payable, the Company has an
additional commitment to issue 48,604 shares of its Class B common stock to the
former holder of the note. As of December 31, 1997 and March 31, 1998, the
Company had not yet issued the aforementioned shares.
F-19
<PAGE>
INTERACTIVE MAGIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
8. STOCKHOLDERS' DEFICIT -- (Continued)
Common Stock Reserved for Future Issuance
The Company has reserved authorized shares of Common Stock for future
issuance as follows:
<TABLE>
<CAPTION>
December 31, 1997,
------------------------
Class A Class B
--------- ------------
<S> <C> <C>
Series A Convertible Preferred Stock ..................... 82,634 --
Outstanding incentive stock options ...................... 514,938 870,610
Outstanding performance based stock options .............. 250,000 357,500
Possible future issuance under stock option plan ......... 431,497 1,050,080
Stock purchase warrants .................................. 750,054 --
</TABLE>
9. INCOME TAXES
At March 31, 1998, the Company has a cumulative domestic federal net
operating loss carryforward available to offset future taxable income of
approximately $11 million which begins to expire in the year 2011. State tax
losses of approximately $11 million will begin to expire in 2001. The Company
also has $78,000 of research credits to carry forward for use against future
domestic federal income taxes. U.S. tax laws impose limitations on the use of
net operating losses and credits following certain changes in ownership. If
such a change occurs, the limitations could reduce the amount of these benefits
that would be available to offset future taxable income each year, starting
with the year of ownership change.
From the Company's inception, June 16, 1994, through October 1995, the
Company operated under the provisions of Subchapter S of the Internal Revenue
Code, and consequently was not subject to federal income tax. On October 31,
1995, the Company terminated its Subchapter S election and now operates under
the provisions of Subchapter C of the Internal Revenue Code. The Company
currently reports on a calendar year end for tax purposes.
Deferred income taxes reflect the net tax effect of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components
of the Company's deferred tax assets and liabilities consisted of the following
at (in thousands):
<TABLE>
<CAPTION>
December 31,
--------------------- March 31,
1996 1997 1998
--------- --------- ------------
(unaudited)
<S> <C> <C> <C>
Deferred tax assets:
Net operating loss carryforwards ..................... $2,455 $3,669 $4,304
Sales and accounts receivable reserves ............... 828 1,048 578
Accrued salaries ..................................... -- 10 10
Other reserves ....................................... 42 191 190
Accrued interest to related party .................... 131 397 408
Research and development credit carryforward ......... 78 78 78
------ ------ ------
Total deferred tax assets ............................. 3,534 5,393 5,568
Deferred tax liabilities:
Depreciation ......................................... 13 17 17
Accounting method change ............................. 49 72 65
------ ------ ------
Total deferred tax liabilities ........................ 62 89 82
Less:
Valuation allowance .................................. 3,472 5,304 5,486
------ ------ ------
Total net deferred taxes .............................. $ -- $ -- $ --
====== ====== ======
</TABLE>
F-20
<PAGE>
INTERACTIVE MAGIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
9. INCOME TAXES -- (Continued)
For financial reporting purposes, income before income taxes includes the
following
components (in
thousands):
<TABLE>
<CAPTION>
December 31, December 31, March 31,
1996 1997 1998
-------------- -------------- ------------
(unaudited)
<S> <C> <C> <C>
Pretax Income:
United States ......... $ (6,529) $ (4,873) $ (916)
Foreign ............... (660) 542 426
-------- -------- ------
$ (7,189) $ (4,331) $ (490)
======== ======== ======
</TABLE>
Significant components of the provision for income taxes attributable to
continuing operations are as follows:
<TABLE>
<CAPTION>
December 31,
-------------------- March 31,
1996 1997 1998
------ ----------- ------------
(unaudited)
<S> <C> <C> <C>
Current:
Federal ............... $ -- $(41) $ --
Foreign ............... 8 15 128
State ................. 3 (7) --
---- ------ ----
Total current ......... $ 11 $(33) $128
==== ====== ====
</TABLE>
The Company has recorded a valuation allowance for the full amount of its
deferred income tax assets as of December 31, 1996 and 1997 and March 31, 1998,
based on management's evaluation of the criteria set forth in SFAS No. 109.
10. RETIREMENT PLAN
The Company has a qualified 401(k) Retirement Plan. The Plan covers
substantially all of the Company's full-time employees. Effective November 20,
1996, the Plan requires six months of full-time service for an employee to be
eligible to participate. Participants may contribute up to 15% of their
compensation to the Plan, subject to the yearly maximums established by the
Internal Revenue Service. Employer matching contributions are at the discretion
of the Company's Board of Directors. There were no discretionary employer
contributions made during the years ended December 31, 1995, 1996 and 1997 and
for the three-month periods ended March 31, 1997 and 1998.
11. SIGNIFICANT CUSTOMERS
Revenues from significant customers, those representing 10% or more of net
revenues for the respective periods, are summarized as follows:
<TABLE>
<CAPTION>
Three months
Year ended December 31, ended March 31,
------------------------ ---------------
1995 1996 1997 1997 1998
------ ------ ------ ------ -----
(unaudited)
<S> <C> <C> <C> <C> <C>
Customer 1 ......... -- -- -- -- 16%
Customer 2 ......... 12% 11% -- -- 15%
Customer 3 ......... -- 27% 19% 25% 12%
Customer 4 ......... -- -- 10% -- 10%
Customer 5 ......... -- -- -- 11% --
Customer 6 ......... 36% -- -- -- --
Customer 7 ......... 11% -- -- -- --
</TABLE>
F-21
<PAGE>
INTERACTIVE MAGIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
11. SIGNIFICANT CUSTOMERS -- (Continued)
Additionally, two customers comprised 43% of accounts receivable at
December 31, 1996, three customers comprised 40% of accounts receivable at
December 31, 1997, and three customers comprised 35% of accounts receivable at
March 31, 1998.
12. OPERATIONS
In addition to domestic sales, the Company sells its products through its
subsidiaries to international customers. These sales amounted to 13%, 23% and
37% of net revenues during the years ended December 31, 1995, 1996 and 1997 and
37% and 56% of net revenues during the three months ended March 31, 1997 and
1998, respectively.
The following table presents the Company's operations by geographic
location (in thousands):
<TABLE>
<CAPTION>
Year ended December 31, Three months ended March 31,
------------------------------------------ ----------------------------
1995 1996 1997 1997 1998
------------ ------------ ------------ ------------ ------------
(unaudited)
<S> <C> <C> <C> <C> <C>
Identifiable assets:
United States ............... $ 2,410 $ 3,725 $ 5,082 $ 5,527 $ 8,123
Europe ...................... 686 839 2,665 645 1,088
-------- -------- -------- -------- --------
$ 3,096 $ 4,564 $ 7,747 $ 6,172 $ 9,211
======== ======== ======== ======== ========
Net revenue:
United States ............... $ 3,458 $ 4,978 $ 11,090 $ 2,108 $ 3,037
Europe ...................... 663 1,079 5,412 1,849 1,876
-------- -------- -------- -------- --------
$ 4,121 $ 6,057 $ 16,502 $ 3,957 $ 4,913
======== ======== ======== ======== ========
Income (loss) from operations:
United States ............... $ (2,387) $ (5,919) $ (2,971) $ (1,526) $ (1,118)
Europe ...................... 158 (664) 545 969 935
-------- -------- -------- -------- --------
$ (2,229) $ (6,583) $ (2,426) $ (557) $ (183)
======== ======== ======== ======== ========
</TABLE>
13. SUBSEQUENT EVENTS
On April 30, 1998, the Company closed on a $5 million line of credit
bearing an interest rate of the bank's prime (8.5% on May 1, 1998) plus 2%.
Borrowings on the line of credit are limited to the lesser of $5 million or 65%
of the Company's outstanding eligible domestic receivables. Borrowings on the
line of credit are collateralized by the Company's accounts receivable,
inventory, and intellectual property, and proceeds will be used to extinguish
certain existing debt and provide additional working capital. The line of
credit expires on April 30, 1999. On May 1, 1998, borrowings on the line were
$1.3 million.
Management believes the financing transactions entered into subsequent to
December 31, 1997 will allow the Company to meet its short-term cash needs in
1998. However, should cash constraints arise, management plans to obtain
additional debt or equity financing or, if such financing is not available on
acceptable terms, reduce expected increases in operating expenses.
On July 1, 1998 the Company effected a one-for-two reverse stock split of
the Company's capital stock in connection with the Company's reincorporation in
North Carolina. All references in the financial statements with regard to
number of shares of each class of stock have been restated to reflect the
reverse stock split for all periods presented.
The Company's 1998 Stock Plan (the "Plan") was adopted by the Board of
Directors and approved by the shareholders of the Company in May 1998. The
Company anticipates that no future grants will be made under the 1995 Plans
after the effective date of the Plan. A total of 800,000 shares of Common Stock
have been reserved for issuance under the Plan. The Plan provides for grants to
employees of the Company of ISOs. In addition,
F-22
<PAGE>
INTERACTIVE MAGIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
13. SUBSEQUENT EVENTS -- (Continued)
the Plan provides for grants of nonqualified stock options and stock purchase
rights to employees, directors and consultants of the Company. The Plan is
administered by the Board of Directors or by a Committee appointed by the
Board. The administrator determines the terms of options and stock purchase
rights granted, including the exercise price and the number of shares subject
to the option or stock purchase right. The exercise price of incentive stock
options granted under the Plan must be at least equal to the fair market value
of the Company's Common Stock on the date of grant. The maximum term of options
granted under the Plan is 10 years.
The Company's 1998 Employee Stock Purchase Plan (the "Purchase Plan") was
adopted by the Company's Board of Directors and approved by the Company's
shareholders in May 1998. The Purchase Plan is intended to qualify under
Section 423 of the Code. The Company has reserved 500,000 shares of Common
Stock for issuance under the Purchase Plan. Under the Purchase Plan, an
eligible employee may purchase shares of Common Stock from the Company through
payroll deductions of up to 10% of his or her base compensation, not to exceed
$25,000 per year, at a price per share equal to 85% of the fair market value of
a share of the Company's Common Stock on the last day of the offering period.
The maximum number of shares that an employee may purchase in any offering
period is 2,500 shares. Any employee who is customarily employed for at least
20 hours per week and more than five months per calendar year and who is
employed on or before the commencement date of an offering period is eligible
to participate in the Purchase Plan.
14. RECAPITALIZATION (UNAUDITED)
The Company anticipates that the following recapitalization through the
exchange of securities will be deemed to be effective as of the closing date of
the Company's initial public offering, with the exception of the exercise of
options and warrants which may occur at an earlier date, in contemplation of
the offering.
Incentive Stock Options: Options were exercised to purchase 268,750 shares
of Class A Common Stock and 95,000 shares of Class B Common Stock in
exchange for cash and forgiveness of accrued interest.
Stock Warrants: Warrants were exercised to purchase 516,769 shares of Class
A Common Stock in exchange for cash.
Class A Common Stock: Exchanged for an aggregate of 3,931,215 shares of
common stock
Class B Common Stock: Exchanged for an aggregate of 601,457 shares of
common stock, which includes 48,604 shares issued after March 31, 1998
Series A Convertible Preferred Stock: Converted into an aggregate of 82,634
shares of common stock
Series B Convertible Preferred Stock: Converted into an aggregate of
2,045,649 shares of common stock
Series C Redeemable Convertible Preferred Stock: Converted into an
aggregate of 132,744 shares of common stock
Upon consummation of the offering, the Company will have authorized
capital of 50,000,000 shares of $.10 par value common stock and 25,000,000
shares of $.10 par value preferred stock.
F-23
<PAGE>
(inside back cover of Prospectus)
[INTERACTIVE MAGIC logo]
WARBIRDS "Online Game of the Year 1996" - PC Games Magazine
"Online Game of the Year 1997" - PC Games Magazine
"Finalist - Best Flight Simulation Game" (1997) - Computer
Gaming World
"Finalist - Best Online Game" (1997) - Computer Game
Developers Association
SEVEN KINGDOMS "Strategy Game of the Year" (1997) - Power Play (Germany)
"Editor's Choice" (1998) - PC Gamer
"A-List" (1998) - PC Games
iF22 Nominated as "Best Simulation at Electronic
Entertainment Expo" (1997) - Game Pen
WAR INC. "A-List" - PC Games
HIND "Editor's Choice" (1996) - PC Gamer
"Finalist - Best Flight Simulation Game"(1997) - Computer
Gaming World
"Simulation of the Year" (1996) - PC Today Magazine
APACHE "Best Simulation of 1995" - PC Gamer
"Best Simulation of 1995" - Strategy Plus
"Editor's Choice" (1995) - PC Gamer
CAPITALISM "Best Simulation Game - Finalist" (1996) - PC Gamer
"Editor's Choice" (1995) - PC Gamer
"Special Achievement in Tutorial Design" (1996) - PC Gamer
[Award logos from PC Games, PC Gamer, Computer Gaming World]
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
No dealer, sales representative, or other person has been authorized to give
any information or to make any representation in connection with this offering
not contained in this Prospectus, and if given or made, such information or
representation must not be relied upon as having been authorized by the Company
or any Underwriter. This Prospectus does not constitute an offer to sell or a
solicitation of an offer to buy any securities other than the securities
offered by this Prospectus, or an offer to sell or a solicitation of an offer
to buy any securities by anyone in any jurisdiction in which such offer or
solicitation is not authorized or would be unlawful. Neither the delivery of
this Prospectus nor any sale made hereunder shall, under any circumstances,
create any implication that information herein is correct as of any time
subsequent to the date hereof.
-----------------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
---------
<S> <C>
Prospectus Summary ............................ 3
Risk Factors .................................. 7
Use of Proceeds ............................... 17
Dividend Policy ............................... 18
Dilution ...................................... 18
Capitalization ................................ 20
Selected Consolidated Financial Data .......... 21
Management's Discussion and Analysis of
Financial Condition and Results of
Operations ................................. 23
Business ...................................... 30
Management .................................... 41
Principal Shareholders ........................ 47
Certain Transactions .......................... 48
Description of Securities ..................... 50
Shares Eligible for Future Sale ............... 54
Underwriting .................................. 56
Legal Matters ................................. 58
Experts ....................................... 58
Additional Information ........................ 58
Index to Financial Statements ................. F-1
</TABLE>
Until , 1998, (25 days after the date of this Prospectus) all dealers
effecting transactions in the Common Stock, whether or not participating in
this distribution, may be required to deliver a Prospectus. This is in addition
to the obligation of dealers to deliver a Prospectus when acting as
underwriters and with respect to their unsold allotments or subscriptions.
2,600,000 Shares
[LOGO]
Common Stock
------------------------------------
PROSPECTUS
------------------------------------
BlueStone Capital Partners, L.P.
Royce Investment Group, Inc.
, 1998
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 24. Indemnification of Directors and Officers
Sections 55-8-50 through 55-8-58 of the North Carolina Business
Corporation Act permit a corporation to indemnify its directors, officers,
employees or agents under either or both a statutory or non-statutory scheme of
indemnification. Under the statutory scheme, a corporation may, with certain
exceptions, indemnify a director, officer, employee or agent of the corporation
who was, is, or is threatened to be made, a party to any threatened, pending or
completed legal action, suit or proceeding, whether civil, criminal,
administrative, or investigative, because of the fact that such person was a
director, officer, agent or employee of the corporation, or is or was serving
at the request of such corporation as a director, officer, employee or agent of
another corporation or enterprise. This indemnity may include the obligation to
pay any judgment, settlement, penalty, fine (including an excise tax assessed
with respect to an employee benefit plan) and reasonable expenses incurred in
connection with a proceeding (including counsel fees), but no such
indemnification may be granted unless such director, officer, agent or employee
(i) conducted himself in good faith, (ii) reasonably believed (1) that any
action taken in his official capacity with the corporation was in the best
interest of the corporation or (2) that in all other cases his conduct at least
was not opposed to the corporation's best interest, and (iii) in the case of
any criminal proceeding, had no reasonable cause to believe his conduct was
unlawful. Whether a director has met the requisite standard of conduct for the
type of indemnification set forth above is determined by the board of
directors, a committee of directors, special legal counsel or the shareholders
in accordance with Section 55-8-55. A corporation may not indemnify a director
under the statutory scheme in connection with a proceeding by or in the right
of the corporation in which the director was adjudged liable to the corporation
or in connection with a proceeding in which a director was adjudged liable on
the basis of having received an improper personal benefit.
In addition to, and separate and apart from the indemnification described
above under the statutory scheme, Section 55-8-57 of the North Carolina
Business Corporation Act permits a corporation to indemnify or agree to
indemnify any of its directors, officers, employees or agents against liability
and expenses (including attorney's fees) in any proceeding (including
proceedings brought by or on behalf of the corporation) arising out of their
status as such or their activities in such capacities, except for any
liabilities or expenses incurred on account of activities that were, at the
time taken, known or believed by the person to be clearly in conflict with the
best interests of the corporation. The Company's Bylaws provide for
indemnification to the fullest extent permitted under the North Carolina
Business Corporation Act, provided, however, that the Company will indemnify
any person seeking indemnification in connection with a proceeding initiated by
such person only if such proceeding was authorized by the Board of Directors of
the Company. Accordingly, the Company may indemnify its directors, officers and
employees in accordance with either the statutory or the non-statutory
standard.
Sections 55-8-52 and 55-8-56 of the North Carolina Business Corporation
Act require a corporation, unless its articles of incorporation provide
otherwise, to indemnify a director or officer who has been wholly successful,
on the merits or otherwise, in the defense of any proceeding to which such
director or officer was a party. Unless prohibited by the articles of
incorporation, a director or officer also may make application and obtain
court-ordered indemnification if the court determines that such director or
officer is fairly and reasonably entitled to such indemnification as provided
in Sections 55-8-54 and 55-8-56.
Finally, Section 55-8-57 of the North Carolina Business Corporation Act
provides that a corporation may purchase and maintain insurance on behalf of an
individual who is or was a director, officer, employee or agent of the
corporation against certain liabilities incurred by such persons, whether or
not the corporation is otherwise authorized by the North Carolina Business
Corporation Act to indemnify such party. It is anticipated that the Company's
directors and officers will be covered under directors' and officers' insurance
policies maintained by the Company prior to this offering.
As permitted by North Carolina law, Article IX of the Company's Articles
of Incorporation limits the personal liability of directors for monetary
damages for breaches of duty as a director, provided that such limitation will
not apply to (i) acts or omissions that the director at the time of the breach
knew or believed were clearly in conflict with the best interests of the
Company, (ii) any liability for unlawful distributions under Section 55-8-33,
(iii) any transaction from which the director derived an improper personal
benefit, or (iv) acts or omissions occurring prior to the date the provision
became effective.
II-1
<PAGE>
The form of the Underwriting Agreement filed as Exhibit 1.01 hereto also
contains certain provisions pursuant to which certain officers, directors and
controlling persons of the Company may be entitled to be indemnified by the
underwriters named therein.
Item 25. Other Expenses of Issuance and Distribution.
The estimated expenses of the Company payable in connection with the
issuance and distribution of the Common Stock being registered hereby,
excluding underwriting discounts and commissions, are as follows:
<TABLE>
<S> <C>
SEC Registration Fee ................................... $ 9,499
NASD Filing Fee ........................................ 3,720
NASDAQ Fee ............................................. 75,625
Printing and Engraving Expenses ........................ 75,000*
Legal Fees and Expenses ................................ 220,000*
Accounting Fees and Expenses ........................... 115,000*
Blue Sky Expenses ...................................... 10,000*
Transfer Agent and Registrar Fees and Expenses ......... 5,000*
Insurance Premium ...................................... 75,000*
Miscellaneous Expenses ................................. 11,156*
Underwriters' Expenses ................................. 300,000*
---------
Total .................................................. $ 900,000
=========
</TABLE>
- ------------
* To be provided by amendment.
Item 26. Recent Sales of Unregistered Securities
In the three years preceding the filing of this Registration Statement,
the Company issued the following securities, which were not registered pursuant
to the Securities Act:
From May 1, 1995 to May 21, 1998, the Company issued an aggregate of
2,026,795 incentive and performance incentive stock options to purchase Common
Stock pursuant to the 1995 Plans to officers and employees of the Company, as
described in the Prospectus, at a weighted average exercise price of $2.30 per
share. (1)
On June 25, 1995, the Company sold 66,000 shares of Common Stock for an
aggregate purchase price of $66,000 to three employees. (2)
On August 31, 1995, the Company issued a warrant currently exercisable for
30,000 shares of Common Stock to J.W. Stealey in consideration of a personal
guarantee and pledge of collateral made by Mr. Stealey in favor of a creditor
of the Company. (2)
On August 31, 1995, the Company issued a warrant currently exercisable for
13,845 shares of Common Stock to Robert L. Pickens in consideration of a
$600,000 loan made by Mr. Pickens to the Company. (2)
On January 2, 1996, the Company issued 144,000 shares of Common Stock to
J. W. Stealey in consideration of the deferral of Mr. Stealey's 1995 salary in
the amount of $144,000. (2)
On March 6, 1996, the Company issued a warrant currently exercisable for
25,882 shares of Common Stock to Venture Lending (a division of Cupertino
National Bank and Trust) in consideration of a $500,000 loan made by Venture
Lending. (2)
On March 6, 1996, the Company issued two warrants, each of which is
currently exercisable for 25,882 shares of Common Stock, to High Point Capital,
LLC in consideration of a $500,000 loan made by High Point Capital, LLC. (2)
On March 29, 1996, the Company issued a warrant exercisable for 10,000
shares of Common Stock in connection with a $500,000 loan made by Southeast
Interactive Technology Fund I, L.L.C. (2)
On March 31, 1996, the Company issued 700,000 shares of Common Stock to
J.W. Stealey in consideration for the conversion of outstanding indebtedness in
the principal amount of $700,000 owed by the Company to
II-2
<PAGE>
Mr. Stealey. The Company also issued a warrant to purchase 30,000 shares of
Common Stock to Mr. Stealey in consideration of such conversion. (2)
Between April 23, 1996 and June 18, 1996, the Company sold 6,750 shares of
Common Stock for an aggregate purchase price of $6,750 to three former
employees who exercised incentive stock options upon departing the Company. (3)
On May 1, 1996, the Company granted William J. Kaluza 20,000 shares of
Common Stock upon his acceptance of employment with the Company. (1)
On May 20, 1996, the Company issued a warrant currently exercisable for
75,694 shares of Common Stock to J.W. Stealey in consideration of a $1,000,000
loan made by Mr. Stealey to the Company. (2)
On July 10, 1996, the Company issued a warrant currently exercisable for
100,695 shares of Common Stock to J.W. Stealey in consideration of a $1,000,000
loan made by Mr. Stealey to the Company. (2)
On July 15, 1996, the Company issued 82,634 shares of Series A Convertible
Preferred Stock to Southeast Interactive Technology Fund I upon conversion of
indebtedness owed to Southeast Interactive Technology Fund I, in the principal
amount of $500,000 plus accrued interest. (2)
On July 15, 1996, the Company issued a warrant currently exercisable for
22,058 shares of Common Stock to Southeast Interactive Technology Fund I,
L.L.C. in exchange for the March 29, 1996 warrant issued to Southeast
Interactive Technology Fund I, L.L.C. by the Company. (2)
On December 31, 1996, the Company issued a warrant to purchase 6,358
shares of Common Stock to Laura M. Stealey in consideration of amounts
outstanding under the $1,000,000 credit line established by Ms. Stealey in
favor of the Company. (2)
On February 11, 1997, the Company issued warrants to purchase 13,500
shares of Common Stock to each of J. Nicholas England, David H. Kestel and W.
Joseph McClelland. (2)
On March 24, 1997, the Company issued a warrant that will be exercisable
for 307,823 shares of Common Stock upon the consummation of this offering to
Petra in consideration of a $3,000,000 loan made by Petra. (2)
On April 23, 1997, in connection with the Company's acquisition of
Interactive Creations Incorporated, the Company issued an aggregate of 655,696
shares of Common Stock to former shareholders of Interactive Creations
Incorporated and options exercisable for 98,218 shares of Common Stock. (1)(2)
On April 23, 1997, the Company issued warrants to purchase 15,000 shares
of Common Stock to Oppenheimer & Co., Inc. (2)
On September 29, 1997, the Company issued a warrant that will be
exercisable for 208,946 shares of Common Stock upon the consummation of this
offering to Oberlin in consideration of a $1,200,000 loan made by Oberlin. (2)
Between December 1, 1997 and January 30, 1998, the Company sold 8,625
shares of Common Stock pursuant to the exercise of employee stock options for
$10,125. (3)
On December 31, 1997, the Company issued a warrant to purchase 8,591
shares of Common Stock to Laura M. Stealey in consideration of amounts
outstanding under the $1,000,000 credit line established by Ms. Stealey in
favor of the Company. (2)
On February 4, 1998, the Company issued warrants to purchase 16,667 shares
of Common Stock to Marion Bass, Inc. (2)
On February 4, 1998, the Company issued 778,746 shares of Series B
Preferred Stock to several investors for $3,500,000, which shares of Series B
Preferred Stock will be converted into 2,045,649 shares of Common Stock upon
the closing of this offering. (2)
On February 4, 1998, the Company issued 132,744 shares of Series C
Preferred Stock to Robert L. Pickens upon the conversion of $600,000 of the
Company's debt held by Mr. Pickens, which shares will be converted into 132,744
shares of Common Stock upon the closing of this Offering. (2)
II-3
<PAGE>
On February 4, 1998, the Company issued 442,478 shares of Common Stock to
J. W. Stealey upon the conversion of $2,000,000 of the Company's debt held by
Mr. Stealey. (2)
On February 4, 1998, the Company issued warrants to purchase 12,500 shares
of Common Stock to Avi Suriel. (2)
On March 12, 1998, the Company issued options to purchase 12,500 shares of
Common Stock to Jeff Stealey, an employee of the Company. (1)
On April 30, 1998, the Company issued 45,000 shares of Common Stock to
William Kaluza upon the exercise of outstanding options held by Mr. Kaluza. (3)
On May 12, 1998, the Company issued 48,604 shares of Common Stock to
Southeast Interactive Technology Fund I, L.L.C. pursuant to certain
anti-dilution rights contained in an agreement between the Company and
Southeast Interactive Technology Fund I, L.L.C. (2)
On May 21, 1998, the Company issued 268,750 shares of Common Stock to J.W.
Stealey upon the exercise of outstanding options held by Mr. Stealey. (2)
On May 21, 1998, the Company issued 50,000 shares of Common Stock to
Robert L. Pickens upon the exercise of outstanding options held by Mr. Pickens.
(2)
No underwriter was engaged in connection with the foregoing sales of
securities.
- ------------
(1) In the view of the Company, the options granted pursuant to the 1995 Plans
and the options exchanged in the ICI transaction were issued but not sold
and, therefore, registration thereof was not required.
(2) Sales of Common Stock and the issuance of warrants were made in reliance
upon Section 4(2) of the Securities Act or Regulation D promulgated
thereunder as transactions not involving any public offering. Each of the
purchasers were sophisticated investors.
(3) Sales of Common Stock were made in reliance upon Rule 701 promulgated under
the Securities Act as transactions not involving a public offering.
Item 27. Exhibits
The following documents (unless indicated) are filed herewith and made a
part of this Registration Statement.
<TABLE>
<CAPTION>
Exhibit
Number Description of Exhibit
- ---------- ------------------------------------------------------------------------------------------
<S> <C>
1.01 -Form of Underwriting Agreement
2.01* -Plan and Agreement of Merger by and between I-Magic Mergeco, Inc. and Interactive
Magic, Inc.
3.01 -Articles of Incorporation
3.02* -Bylaws
3.03* -Articles of Merger of Interactive Magic, Inc.
4.01 -Specimen Common Stock Certificate
4.02 -Articles of Incorporation (see Exhibit 3.01)
4.03* -Bylaws (see Exhibit 3.02)
4.04 -Form of Representatives' Warrant Agreement, including Form of Warrant Certificate
5.01 -Opinion of Smith, Anderson, Blount, Dorsett, Mitchell & Jernigan, L.L.P.
10.01* -Stock Purchase Agreement, dated February 4, 1998, by and between the Company and
Vertical Financial Holdings
10.02* -Investor's Rights Agreement, dated February 4, 1998, by and between the Company and
Vertical Financial Holdings
10.03* -Marketing Agreement, dated February 4, 1998, between the Company and General Capital
10.04* -Merger Agreement, dated as of March 24, 1997, as amended April 2, 1997, by and among
the Company, Interactive Creations Acquisition Corp., certain shareholders of Interactive
Creations Incorporated and Interactive Creations Incorporated
</TABLE>
II-4
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Description of Exhibit
- ----------- ------------------------------------------------------------------------------------------
<S> <C>
10.05* -Form of Shareholder Agreement between the Company and each shareholder of Interactive
Creations Incorporated
10.06* -Form of Stock Purchase Warrant issued to each of J. W. Stealey, Robert L. Pickens, Laura
Stealey, David H. Kestel, J. Nicholas England, W. Joseph McClelland, Avi Suriel, Marion
Bass and Oppenheimer
10.07* -Corporate Airplane Agreement, dated January 3, 1995, between J.W. Stealey and the
Company
10.08* -Loan and Security Agreement, dated March 24, 1997, as amended April 1, 1997 (See
Exhibit 10.10 below), by and between the Company and Petra Capital LLC
10.09* -Stock Purchase Warrant, dated March 24, 1997, as amended April 1, 1997 (See Exhibit
10.10 below), and January 31, 1998, as amended, issued by the Company to Petra Capital
LLC
10.10* - First Amendment to Loan and Security Agreement and Stock Purchase Warrant dated April
1, 1997 by and between the Company and Petra Capital LLC
10.11* -Promissory Note, dated August 25, 1997, issued by the Company to Branch Banking &
Trust Company
10.12* -Guaranty Agreement, dated August 25, 1997, between J. W. Stealey and Branch Banking &
Trust Company
10.13* -Loan and Security Agreement, dated September 29, 1997, among the Company, iMagic
Online Corporation and Oberlin Capital, L.P.
10.14* -Loan and Security Agreement, dated April 30, 1997, between Greyrock Business Credit, a
Division of NationsCredit Commercial Corporation, and the Company
10.15* -Lease Agreement, dated December 4, 1995, as amended February 7, 1996, by and between
Southport Business Park Limited Partnership and the Company
10.16* -Employment Agreement, dated January 3, 1995, between the Company and J.W. Stealey, as
amended
10.17* -Employment Agreement, dated January 3, 1995, between the Company and Robert L.
Pickens, as amended
10.18* -Employment Agreement, dated March 25, 1996, between the Company and William J.
Kaluza
10.19* -Employment Agreement, dated January 3, 1995, between the Company and Joseph
Rutledge, and form of amendment thereto
10.20* -Employment Agreement, dated February 1, 1995, between the Company and Raymond
Rutledge, and form of amendment thereto
10.21* -Form of Class A Incentive Stock Option Plan
10.22* -Form of Class B Incentive Stock Option Plan
10.23* -Form of ICI Stock Option Plan
10.24* -Form of 1998 Stock Plan
10.25* -Form of 1998 Employee Stock Purchase Plan
10.26* -Letter Agreement, dated as of May 27, 1998, by and among the Company and the holders
of the Company's outstanding Series B Preferred Stock
21.01* -List of subsidiaries
23.01 -Consent of Ernst & Young LLP
23.02 -Consent of Smith, Anderson, Blount, Dorsett, Mitchell & Jernigan, L.L.P. (included in
Exhibit 5.01 hereto.
24.01* -Powers of Attorney
27.01* -Financial Data Schedule
</TABLE>
- ------------
* Previously filed
II-5
<PAGE>
Item 28. Undertakings
1. The small business issuer hereby undertakes to provide to the Underwriters
at the closing specified in the Underwriting Agreement certificates in such
denominations and registered in such names as required by the Underwriters to
permit prompt delivery to each purchaser.
2. Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
small business issuer pursuant to the foregoing provisions, or otherwise, the
small business issuer has been advised that in the opinion of the Securities
and Exchange Commission such indemnification is against public policy as
expressed in the Act and is, therefore, unenforceable.
In the event that a claim for indemnification against such liabilities (other
than the payment by the small business issuer of the expenses incurred or paid
by a director, officer or controlling person of the small business issuer in
the successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the small business issuer will, unless in the opinion of its
counsel the matter has been settled by controlling precedent, submit to a court
of appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in the Act and will be governed by the final
adjudication of such issue.
3. The small business issuer hereby undertakes that: (a) for purposes of
determining any liability under the Securities Act, the information omitted
from the form of prospectus filed as part of this Registration Statement in
reliance upon Rule 430A and contained in a form of prospectus filed by the
small business issuer pursuant to Rule 424(b)(1) or (4) or 497(h) under the
Securities Act shall be deemed to be part of this Registration Statement as of
the time it is declared effective; and (b) for the purpose of determining any
liability under the Securities Act, each post-effective amendment that contains
a form of prospectus shall be deemed to be a new registration statement
relating to the securities offered therein, and the offering of such securities
at that time shall be deemed to be the initial bona fide offering thereof.
II-6
<PAGE>
SIGNATURES
In accordance with the requirements of the Securities Act of 1933, the
Registrant certifies that it has reasonable grounds to believe that it meets
all of the requirements for filing on Form SB-2 and authorized this Amendment
No. 2 to the Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the Town of Morrisville, State of
North Carolina on July 16, 1998.
INTERACTIVE MAGIC, INC.
By: /s/ J.W. STEALEY
---- ------------------------------
J. W. Stealey
Chairman of the Board of Directors
and Chief Executive Officer
In accordance with the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities indicated on July 16, 1998.
<TABLE>
<CAPTION>
Signature Title
- -------------------------------------- ---------------------------------------------
<S> <C>
/s/ J.W. STEALEY Chairman of the Board of Directors
- -------------------------------------
J.W. Stealey and Chief Executive Officer
/s/ WILLIAM H. MARKS Chief Financial Officer
- -------------------------------------
William H. Marks (Principal Financial and Accounting Officer)
/s/ *
- -------------------------------------
J. Nicholas England Director
/s/ *
- -------------------------------------
David H. Kestel Director
/s/ *
- -------------------------------------
W. Joseph McClelland Director
/s/ *
- -------------------------------------
Avi Suriel Director
</TABLE>
*By: /s/ J.W. STEALEY
----------------------------------
J. W. Stealey as Attorney-in-Fact
II-7
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
Number Description of Exhibit
- ---------- ------------------------------------------------------------------------------------------
<S> <C>
1.01 -Form of Underwriting Agreement
2.01* -Plan and Agreement of Merger by and between I-Magic Mergeco, Inc. and Interactive
Magic, Inc.
3.01 -Articles of Incorporation
3.02* -Bylaws
3.03* -Articles of Merger of Interactive Magic, Inc.
4.01 -Specimen Common Stock Certificate
4.02 -Articles of Incorporation (see Exhibit 3.01)
4.03* -Bylaws (see Exhibit 3.02)
4.04 -Form of Representatives' Warrant Agreement, including Form of Warrant Certificate
5.01 -Opinion of Smith, Anderson, Blount, Dorsett, Mitchell & Jernigan, L.L.P.
10.01* -Stock Purchase Agreement, dated February 4, 1998, by and between the Company and
Vertical Financial Holdings
10.02* -Investor's Rights Agreement, dated February 4, 1998, by and between the Company and
Vertical Financial Holdings
10.03* -Marketing Agreement, dated February 4, 1998, between the Company and General Capital
10.04* -Merger Agreement, dated as of March 24, 1997, as amended April 2, 1997, by and among
the Company, Interactive Creations Acquisition Corp., certain shareholders of Interactive
Creations Incorporated and Interactive Creations Incorporated
10.05* -Form of Shareholder Agreement between the Company and each shareholder of Interactive
Creations Incorporated
10.06* -Form of Stock Purchase Warrant issued to each of J. W. Stealey, Robert L. Pickens, Laura
Stealey, David H. Kestel, J. Nicholas England, W. Joseph McClelland, Avi Suriel, Marion
Bass and Oppenheimer
10.07* -Corporate Airplane Agreement, dated January 3, 1995, between J.W. Stealey and the
Company
10.08* -Loan and Security Agreement, dated March 24, 1997, as amended April 1, 1997 (See
Exhibit 10.10 below), by and between the Company and Petra Capital LLC
10.09* -Stock Purchase Warrant, dated March 24, 1997, as amended April 1, 1997 (See Exhibit
10.10 below), and January 31, 1998, as amended, issued by the Company to Petra Capital
LLC
10.10* -First Amendment to Loan and Security Agreement and Stock Purchase Warrant dated April
1, 1997 by and between the Company and Petra Capital LLC
10.11* -Promissory Note, dated August 25, 1997, issued by the Company to Branch Banking &
Trust Company
10.12* -Guaranty Agreement, dated August 25, 1997, between J. W. Stealey and Branch Banking &
Trust Company
10.13* -Loan and Security Agreement, dated September 29, 1997, among the Company, iMagic
Online Corporation and Oberlin Capital, L.P.
10.14* -Loan and Security Agreement, dated April 30, 1997, between Greyrock Business Credit, a
Division of NationsCredit Commercial Corporation, and the Company
10.15* -Lease Agreement, dated December 4, 1995, as amended February 7, 1996, by and between
Southport Business Park Limited Partnership and the Company
10.16* -Employment Agreement, dated January 3, 1995, between the Company and J.W. Stealey, as
amended
10.17* -Employment Agreement, dated January 3, 1995, between the Company and Robert L.
Pickens, as amended
10.18* -Employment Agreement, dated March 25, 1996, between the Company and William J.
Kaluza
10.19* -Employment Agreement, dated January 3, 1995, between the Company and Joseph
Rutledge, and form of amendment thereto
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Description of Exhibit
- ----------- ---------------------------------------------------------------------------------------
<S> <C>
10.20* -Employment Agreement, dated February 1, 1995, between the Company and Raymond
Rutledge, and form of amendment thereto
10.21* -Form of Class A Incentive Stock Option Plan
10.22* -Form of Class B Incentive Stock Option Plan
10.23* -Form of ICI Stock Option Plan
10.24* -Form of 1998 Stock Plan
10.25* -Form of 1998 Employee Stock Purchase Plan
10.26* -Letter Agreement, dated as of May 27, 1998, by and among the Company and the holders
of the Company's outstanding Series B Preferred Stock
21.01* -List of subsidiaries
23.01 -Consent of Ernst & Young LLP
23.02 -Consent of Smith, Anderson, Blount, Dorsett, Mitchell & Jernigan, L.L.P. (included in
Exhibit 5.01 hereto.
24.01* -Powers of Attorney
27.01* -Financial Data Schedule
</TABLE>
- ------------
* Previously filed
INTERACTIVE MAGIC, INC.
2,600,000 Shares of Common Stock
(Par Value $.10 per share)
UNDERWRITING AGREEMENT
New York, New York
July __, 1998
Blue Stone Capital Partners, L.P.
Royce Investment Group, Inc.
as Representatives of the
Several Underwriters named
in Schedule A hereto
c/o BlueStone Capital Partners, L.P.
575 Fifth Avenue
New York, New York 10017
Dear Sirs:
Interactive Magic, Inc., a North Carolina corporation (the "Company"),
proposes to issue and sell to the underwriters (the "Underwriters") named in
Schedule A to this Underwriting Agreement (the "Agreement"), for whom BlueStone
Capital Partners, L.P. ("BlueStone") and Royce Investment Group, Inc. are acting
as representatives (hereinafter sometimes referred to together as the
"Representatives"), two million six hundred thousand (2,600,000) shares of
common stock, par value $.10 per share (the "Offered Shares"), which Offered
Shares are presently authorized but unissued shares of the common stock, par
value $.10 per share (individually a "Common Share" and collectively the "Common
Shares"), of the Company. In addition, the Representatives, in order to cover
over-allotments in the sale of the Offered Shares, may purchase from the
Company, for their own accounts, up to an aggregate of three hundred ninety
thousand (390,000) Common Shares (the "Optional Shares"; the Offered Shares and
the Optional Shares are hereinafter sometimes collectively referred to as the
"Shares"). The Shares are described in the Registration Statement, as defined
below. The Company also proposes to issue and sell to the Representatives for
their own accounts and/or the accounts of their designees, warrants to purchase
an aggregate of two hundred sixty thousand (260,000) Common Shares (the "Warrant
Shares") at an exercise price of $_____ per Warrant Share (the "Representatives'
Warrants"), which sale will be consummated in accordance with the
<PAGE>
terms and conditions of the form of Representatives' Warrant Agreement filed as
an exhibit to the Registration Statement.
The Representatives hereby warrant to the Company that they have been
authorized by each of the Underwriters to enter into this Underwriting Agreement
on their behalf and to act for them in the manner herein provided. The Company
hereby confirms its respective agreements with the Representatives and each of
the Underwriters, on whose behalf the Representatives are signing this
Agreement, as follows:
1. Purchase and Sale of Offered Shares. On the basis of the
representations and warranties herein contained, but subject to the terms and
conditions herein set forth, the Company hereby agrees to sell the Offered
Shares to the Underwriters, severally, and each Underwriter agrees severally and
not jointly, to purchase from the Company, at a purchase price of $______ per
share, the number of Offered Shares set forth opposite the name of such
Underwriter in Schedule A attached hereto, plus any additional Offered Shares
which such Underwriter may become obligated to purchase pursuant to the
provisions of Section 10 hereof. The Underwriters plan to offer the Offered
Shares to the public at a public offering price of $_____ per share.
2. Payment and Delivery.
(a) Payment for the Offered Shares will be made to the Company by
wire transfer of same day funds against delivery of the Offered Shares to the
Representatives. Such payment and delivery will be made at 10:00 A.M. New York
City time, on the third business day following the Effective Date (as
hereinafter defined) (the fourth business day following the Effective Date in
the event that trading of the Offered Shares commences on the day following the
Effective Date), the date and time of such payment and delivery being herein
called the "Closing Date." The certificates representing the Offered Shares to
be delivered will be in such denominations and registered in such names as the
Representatives may request not less than two full business days prior to the
Closing Date, and will be made available to the Representatives for inspection,
checking and packaging at the offices of Wachovia Bank & Trust Company, the
Company's transfer agent, at 301 North Church Street, 2nd Floor, Winston Salem,
North Carolina, not less than one full business day prior to the Closing Date.
(b) On the Closing Date, the Company will sell the
Representatives' Warrants to the Representatives or to their designees (limited
to officers and partners of the Representatives and Underwriters). The
Representatives' Warrants will be in the form of, and in accordance with, the
provisions of the
-2-
<PAGE>
Representatives' Warrant Agreement attached as an exhibit to the Registration
Statement, with such changes as the Representatives and the Company shall
approve. The aggregate purchase price for the Representatives' Warrants is $260.
The Representatives' Warrants will be restricted from sale, transfer, assignment
or hypothecation for a period of one year from the Effective Date, except to
officers or partners of the Representatives and Underwriters and members of the
selling group and/or their officers or partners. Payment for the
Representatives' Warrants will be made to the Company by check or checks payable
to its order on the Closing Date against delivery of the certificates
representing the Representatives' Warrants. The certificates representing the
Representatives' Warrants will be in such denominations and such names as the
Representatives may request prior to the Closing Date.
3. Option to Purchase Optional Shares.
(a) For the purposes of covering any overallotments in connection
with the distribution and sale of the Offered Shares as contemplated by the
Prospectus as defined below, the Representatives are hereby granted an option to
purchase for their own accounts, and not as representatives of the Underwriters,
all or any part of the Optional Shares from the Company. The purchase price to
be paid for the Optional Shares will be the same price per Optional Share as the
price per Offered Share set forth in Section 1 hereof. The option granted hereby
may be exercised by the Representatives as to all or any part of the Optional
Shares at any time within 45 days after the Effective Date. The Representatives
will not be under any obligation to purchase any Optional Shares prior to the
exercise of such option.
(b) The option granted hereby may be exercised by the
Representatives by giving oral notice to the Company, which must be confirmed by
a letter, telex or telegraph setting forth the number of Optional Shares to be
purchased, the date and time for delivery of and payment for the Optional Shares
to be purchased and stating that the Optional Shares referred to therein are to
be used for the purpose of covering over-allotments in connection with the
distribution and sale of the Offered Shares. If such confirmed notice is given
prior to the Closing Date, the date set forth therein for such delivery and
payment will not be earlier than either two full business days thereafter or the
Closing Date, whichever occurs later. If such confirmed notice is given on or
after the Closing Date, the date set forth therein for such delivery and payment
will not be earlier than two (2) full business days thereafter. In either event,
the date so set forth will not be more than 15 full business days after the date
of such confirmed notice. The date and time set forth in such confirmed notice
is herein called the "Option Closing Date." Upon exercise of such option, the
Company will become obligated to convey to the
-3-
<PAGE>
Representatives, and, subject to the terms and conditions set forth in Section
3(d) hereof, the Representatives will become obligated to purchase, the number
of Optional Shares specified in such confirmed notice.
(c) Payment for any Optional Shares purchased will be made to the
Company by wire transfer against delivery of the Optional Shares purchased to
the Representatives. The certificates representing the Optional Shares to be
delivered will be in such denominations and registered in such names as the
Representatives request not less than two full business days prior to the Option
Closing Date, and will be made available to the Representatives for inspection,
checking and packaging at the aforesaid office of the Company's transfer agent
or correspondent not less than one full business day prior to the Option Closing
Date.
(d) The obligation of the Representatives to purchase and pay for
any of the Optional Shares is subject to the accuracy and completeness (as of
the date hereof and as of the Option Closing Date) of and compliance in all
material respects with the representations and warranties of the Company herein,
to the accuracy and completeness of the statements of the Company or its
officers made in any certificate or other document to be delivered by the
Company pursuant to this Agreement, to the performance in all material respects
by the Company of its obligations hereunder, to the satisfaction by the Company
of the conditions, as of the date hereof and as of the Option Closing Date, set
forth in Section 3(b) hereof, and to the delivery to the Representatives of
opinions, certificates and letters dated the Option Closing Date substantially
similar in scope to those specified in Sections 5 and 6(b), (c), (d) and (e)
hereof, but with each reference to "Offered Shares" and "Closing Date" to be,
respectively, to the Optional Shares and the Option Closing Date.
4. Representations and Warranties of the Company. The Company
represents and warrants to, and agrees with, the several Underwriters that:
(a) The Company is a corporation duly organized and validly
existing under the laws of the State of North Carolina, with full power and
authority, corporate and other, to own or lease, as the case may be, and operate
its properties and to conduct its business as described in the Registration
Statement and to execute, deliver and perform this Agreement and the
Representatives' Warrant Agreement and to consummate the transactions
contemplated hereby and thereby. The Company is duly qualified to do business as
a foreign corporation in all jurisdictions wherein such qualification is
necessary except where failure so to qualify would not have a material adverse
effect on the financial condition, results of operations, business or properties
-4-
<PAGE>
of the Company. Other than iMagicOnline Corporation ("iMagic"), a corporation
duly organized and validly existing under the laws of the State of North
Carolina and a wholly-owned subsidiary of the Company, Interactive Magic Ltd.
("IML"), a corporation duly organized and validly existing under the laws of the
United Kingdom and a wholly-owned subsidiary of the Company, and Interactive
Magic Gmbh ("IM Gmbh"), a corporation duly organized and validly existing under
the laws of Germany and a wholly-owned subsidiary of IML (collectively, the
"Subsidiaries"), the Company has no subsidiaries and the Company has no equity
interest in any entities other than the Subsidiaries and a 15% interest in
Charybdis Enterprises, Inc.
("CEI").
(b) Each of the Subsidiaries has full power and authority,
corporate and other, necessary to own or lease, as the case may be, and operate
its properties and to conduct its business as described in the Registration
Statement. Each of the Subsidiaries is also duly qualified to do business as a
foreign corporation in all jurisdictions wherein such qualification is
necessary, except where failure to so qualify would not have a material adverse
effect on the financial condition, results of operations, business or properties
of the Company and the Subsidiaries taken as a whole. Except as set forth in the
Prospectus, the Company owns all of the issued and outstanding shares of capital
stock of iMagic and IML and its 15% equity interest in CEI and IML owns all of
the issued and outstanding capital stock of IM Gmbh, free and clear of any
security interests, liens, encumbrances, claims and charges, and all of such
shares have been duly authorized and validly issued and are fully paid and
non-assessable. There are no options or warrants for the purchase of, or other
rights to purchase, or outstanding securities convertible into or exchangeable
for, any capital stock or other securities of any Subsidiary.
(c) This Agreement has been duly executed and delivered by the
Company and constitutes the valid and binding obligation of the Company, and the
Representatives' Warrant Agreement, when executed and delivered by the Company
on the Closing Date, will be the valid and binding obligation of the Company,
enforceable against the Company in accordance with their respective terms,
except (i) as such enforceability may be limited by bankruptcy, insolvency,
fraudulent conveyance, reorganization or similar laws affecting creditors'
rights generally, (ii) as enforceability of any indemnification provision may be
limited under the federal and state securities laws and (iii) that the remedy of
specific performance and injunctive and other forms of equitable relief may be
subject to the discretion of the court before which any proceeding therefor may
be brought. The execution, delivery and performance of this Agreement and the
Representatives' Warrant Agreement by the Company, the consummation
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<PAGE>
by the Company of the transactions herein and therein contemplated and the
compliance by the Company with the terms of this Agreement and the
Representatives' Warrant Agreement have been duly authorized by all necessary
corporate action and do not and will not, with or without the giving of notice
or the lapse of time, or both, (i) result in any violation of the Company's or
of any Subsidiary's Articles of Incorporation, Memorandum or Articles of
Association or By-Laws (or similar charter documents); (ii) result in a breach
of or conflict with any of the terms or provisions of, or constitute a default
under, or result in the modification or termination of, or result in the
creation or imposition of any lien, security interest, charge or encumbrance
upon any of the properties or assets of the Company or any Subsidiary pursuant
to any indenture, mortgage, note, contract, commitment or other agreement or
instrument to which the Company or any Subsidiary is a party or by which the
Company or any Subsidiary or any of their respective properties or assets is or
may be bound or affected, in any case, that is material to the Company and the
Subsidiaries, taken as a whole; (iii) violate any existing applicable law, rule,
regulation, judgment, order or decree of any governmental agency or court,
domestic or foreign, having jurisdiction over the Company or any Subsidiary or
any of their respective properties or business which would materially adversely
affect the Company and the Subsidiaries, taken as a whole; or (iv) have any
effect on any permit, certification, registration, approval, consent, order,
license, franchise or other authorization (collectively, the "Permits")
necessary for the Company or any Subsidiary to own or lease and operate their
respective properties or conduct their respective businesses or the ability of
the Company to make use thereof, which would materially adversely affect the
Company and the Subsidiaries, taken as a whole.
(d) No Permits of any court or governmental agency or body, other
than under the Securities Act of 1933, as amended (the "Act"), the Regulations
(as hereinafter defined) and applicable state securities laws or "Blue Sky"
laws, are required (i) for the valid authorization, issuance, sale and delivery
of the Shares to the Underwriters, and (ii) the consummation by the Company of
the transactions contemplated by this Agreement and the Representatives' Warrant
Agreement.
(e) The conditions for use of a registration statement on Form
SB-2 set forth in the General Instructions to Form SB-2 have been satisfied with
respect to the Company, the transactions contemplated herein and in the
Registration Statement. The Company has prepared in conformity in all material
respects with the requirements of the Act and the rules and regulations (the
"Regulations") of the Securities and Exchange Commission (the "Commission") and
filed with the Commission a registration statement (File No. 333-53755) on Form
SB-2 and has filed one or
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<PAGE>
more amendments thereto, covering the registration of the Shares under the Act,
including the related preliminary prospectus or preliminary prospectuses (each
thereof being herein called a "Preliminary Prospectus") and a proposed final
prospectus. Each Preliminary Prospectus was endorsed with the legend required by
Item 501(a)(5) of Regulation S-B of the Regulations and, if applicable, Rule
430A of the Regulations. Such registration statement including any documents
incorporated by reference therein and all financial schedules and exhibits
thereto, as amended at the time it becomes effective, and the final prospectus
included therein are herein, respectively, called the "Registration Statement"
and the "Prospectus," except that, (i) if the prospectus filed by the Company
pursuant to Rule 424(b) of the Regulations differs from the Prospectus, the term
"Prospectus" shall mean the prospectus filed pursuant to Rule 424(b), and (ii)
if the Registration Statement is amended or such Prospectus is supplemented
after the date the Registration Statement is declared effective by the
Commission (the "Effective Date") and prior to the Option Closing Date, the
terms "Registration Statement" and "Prospectus" shall include the Registration
Statement as amended or supplemented.
(f) Neither the Commission nor, to the best of the Company's
knowledge, any state regulatory authority has issued any order preventing or
suspending the use of any Preliminary Prospectus or has instituted or, to the
best of the Company's knowledge, threatened to institute any proceedings with
respect to such an order.
(g) The Registration Statement when it becomes effective, the
Prospectus (and any amendment or supplement thereto) when it is filed with the
Commission pursuant to Rule 424(b), and both documents as of the Closing Date
and the Option Closing Date referred to below, will contain all statements which
are required to be stated therein in accordance with the Act and the Regulations
and will in all material respects conform to the requirements of the Act and the
Regulations, and neither the Registration Statement nor the Prospectus, nor any
amendment or supplement thereto, on such dates, will contain any untrue
statement of a material fact or omit to state any material fact required to be
stated therein or necessary to make the statements therein, in light of the
circumstances under which they were made, not misleading, except that this
representation and warranty does not apply to statements or omissions made in
reliance upon and in conformity with information furnished in writing to the
Company in connection with the Registration Statement or Prospectus or any
amendment or supplement thereto by the Representatives, or by any Underwriter
through the Representatives, expressly for use therein.
-7-
<PAGE>
(h) The Company had at the date or dates indicated in the
Prospectus a duly authorized and outstanding capitalization as set forth in the
Registration Statement and the Prospectus. The Company will have on the Closing
Date the adjusted stock capitalization set forth therein. Except as set forth in
the Registration Statement or the Prospectus, on the Effective Date and on the
Closing Date, there will be no options to purchase, warrants or other rights to
subscribe for, or any securities or obligations convertible into, or any
contracts or commitments to issue or sell shares of the Company's capital stock
or any such warrants, convertible securities or obligations which are material
in the aggregate or represent more than an aggregate total of 15,000 shares of
Common Stock. Except as set forth in the Prospectus, no other securities of the
Company have any rights, "demand," "piggyback" or otherwise, to have such
securities registered under the Act.
(i) The descriptions in the Registration Statement and the
Prospectus of contracts and other documents described therein are accurate and
present fairly the information required to be disclosed, and there are no
contracts or other documents required to be described in the Registration
Statement or Prospectus or to be filed as exhibits to the Registration Statement
under the Act or the Regulations which have not been so described or filed as
required.
(j) Ernst & Young LLP, the accountants who have certified certain
of the consolidated financial statements filed and to be filed with the
Commission as part of the Registration Statement and the Prospectus, have
informed the Company that they are independent public accountants within the
meaning of the Act and Regulations. The consolidated financial statements and
schedules and the notes thereto filed as part of the Registration Statement and
included in the Prospectus are complete, correct and present fairly the
financial position of the Company as of the dates thereof, and the results of
operations and changes in financial position of the Company for the periods
indicated therein, all in conformity with generally accepted accounting
principles applied on a consistent basis throughout the periods involved except
as otherwise stated in the Registration Statement and the Prospectus. The
selected financial data set forth in the Registration Statement and the
Prospectus present fairly the information shown therein and have been compiled
on a basis consistent with that of the audited and unaudited financial
statements included in the Registration Statement and the Prospectus.
(k) The Company and each Subsidiary has each filed with the
appropriate federal, state and local governmental agencies, and all appropriate
foreign countries and political
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<PAGE>
subdivisions thereof, all tax returns, including franchise tax returns, which
are required to be filed or has duly obtained extensions of time for the filing
thereof, other than those tax returns the failure of which to file would not
have a material adverse effect on the Company and the Subsidiaries, taken as a
whole and has paid all taxes shown on such returns and all assessments received
by it to the extent that the same have become due other than those taxes the
failure of which to pay would not have a material adverse effect on the Company
and the Subsidiaries, taken as a whole; and the provisions for income taxes
payable, if any, shown on the consolidated financial statements filed with or as
part of the Registration Statement are sufficient for all accrued and unpaid
foreign and domestic taxes, whether or not disputed, and for all periods to and
including the dates of such consolidated financial statements. Except as
disclosed in writing to the Representatives, neither the Company nor any
Subsidiary has executed or filed with any taxing authority, foreign or domestic,
any agreement extending the period for assessment or collection of any income
taxes and is not a party to any pending action or proceeding by any foreign or
domestic governmental agency for assessment or collection of taxes; and no
claims for assessment or collection of taxes have been asserted against the
Company or any Subsidiary, that would be material to the Company and the
Subsidiaries, taken as a whole.
(l) The outstanding Common Shares and outstanding options and
warrants to purchase Common Shares have been duly authorized and validly issued.
The outstanding Common Shares are fully paid and nonassessable. The outstanding
options and warrants to purchase Common Shares constitute the valid and binding
obligations of the Company, enforceable in accordance with their terms. None of
the outstanding Common Shares or options or warrants to purchase Common Shares
has been issued in violation of the preemptive rights of any shareholder of the
Company. None of the holders of the outstanding Common Shares is subject to
personal liability solely by reason of being such a holder. The offers and sales
of the outstanding Common Shares and outstanding options and warrants to
purchase Common Shares were at all relevant times either registered under the
Act and the applicable state securities or Blue Sky laws or exempt from such
registration requirements. The authorized Common Shares and outstanding options
and warrants to purchase Common Shares conform in all material respects to the
descriptions thereof contained in the Registration Statement and Prospectus.
(m) No securities of the Company have been sold by the Company
within the three years prior to the date hereof, except as disclosed in the
Registration Statement.
-9-
<PAGE>
(n) The issuance and sale of the Shares and the Warrant Shares
have been duly authorized and, when the Shares and the Warrant Shares have been
issued and duly delivered against payment therefor as contemplated by this
Agreement and the Representatives' Warrant Agreement, respectively, the Shares
and the Warrant Shares will be validly issued, fully paid and nonassessable, and
the holders thereof will not be subject to personal liability solely by reason
of being such holders. Neither the Shares nor the Warrant Shares will be subject
to preemptive rights of any shareholder of the Company.
(o) The issuance and sale of the Representatives' Warrants have
been duly authorized and, when issued, paid for and delivered as contemplated by
the Representatives' Warrant Agreement, the Representatives' Warrants will
constitute valid and binding obligations of the Company, enforceable as to the
Company in accordance with their terms. The Representatives' Warrants will not
be subject to preemptive rights of any shareholder of the Company. The Warrant
Shares have been duly reserved for issuance upon exercise of the
Representatives' Warrants in accordance with the provisions of the
Representatives' Warrant Agreement. The Representatives' Warrants conform to the
description thereof contained in the Registration Statement and Prospectus.
(p) Neither the Company nor any Subsidiary is in violation of, or
in default under, (i) any term or provision of its Articles of Incorporation,
Memorandum or Articles of Association or By-Laws (or similar charter documents);
(ii) any material term or provision or any financial covenants of any indenture,
mortgage, contract, commitment or other agreement or instrument to which it is a
party or by which it or any of its property or business is or may be bound or
affected; or (iii) any existing applicable law, rule, regulation, judgment,
order or decree of any governmental agency or court, domestic or foreign, having
jurisdiction over the Company, any Subsidiary or any of their respective
properties or business, except for such violations or defaults under clauses
(i), (ii) or (iii) above which, individually or in the aggregate would not have
a material adverse effect on the Company and its Subsidiaries, taken as a whole.
The Company and each Subsidiary owns, possesses or has obtained all governmental
and other (including those obtainable from third parties) Permits necessary to
own or lease, as the case may be, and to operate its properties, whether
tangible or intangible, and to conduct the business and operations of the
Company as presently conducted, and all such Permits are outstanding and in good
standing, and there are no proceedings pending or to the best of the Company's
knowledge, threatened (nor, to the best of the Company's knowledge, is there any
basis therefor) which seek to cancel, terminate or limit such Permits, except in
each case as would not, individually or in the
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<PAGE>
aggregate, have a material adverse effect on the Company and the
Subsidiaries, taken as a whole.
(q) Except as set forth in the Prospectus, there are no claims,
actions, suits, proceedings, arbitrations, investigations or inquiries before
any governmental agency, court or tribunal, domestic or foreign, or before any
private arbitration tribunal, pending, or, to the best of the Company's
knowledge, threatened against the Company or any Subsidiary or involving the
Company's or any Subsidiary's properties or business which, if determined
adversely to the Company or any Subsidiary would, individually or in the
aggregate, result in any material adverse change in the financial position,
shareholders' equity, results of operations, properties, business, management or
affairs or business prospects of the Company or which question the validity of
the capital stock of the Company or this Agreement or of any action taken or to
be taken by the Company pursuant to, or in connection with, this Agreement; nor,
to the best of the Company's knowledge, is there any basis for any such claim,
action, suit, proceeding, arbitration, investigation or inquiry. There are no
outstanding orders, judgments or decrees of any court, governmental agency or
other tribunal naming the Company or any Subsidiary and enjoining the Company or
any Subsidiary from taking, or requiring the Company or any Subsidiary to take,
any action, or to which the Company or any Subsidiary or the Company's or any
Subsidiary's properties or business is bound or subject.
(r) Neither the Company nor any of its affiliates has incurred any
liability for any finder's fees or similar payments in connection with the
transactions herein contemplated.
(s) The Company and each of the Subsidiaries each owns or
possesses adequate and enforceable rights to use all patents, patent
applications, trademarks, service marks, copyrights, trade secrets, confidential
information, processes and formulations used or proposed to be used in the
conduct of its business as described in the Prospectus (collectively the
"Intangibles"); to the best of the Company's knowledge, neither the Company nor
any Subsidiary has infringed or is infringing upon the rights of others in any
material respect with respect to the Intangibles; and neither the Company nor
any Subsidiary has received any notice of conflict with the asserted rights of
others with respect to the Intangibles which could, singly or in the aggregate,
materially adversely affect its business as presently conducted or the
prospects, financial condition or results of operations of the Company and the
Subsidiaries, taken as a whole, and the Company knows of no basis therefor; and,
to the best of the Company's knowledge, no others have infringed upon the
Intangibles of the Company or any Subsidiary.
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<PAGE>
(t) Except as otherwise may be disclosed in the Registration
Statement and the Prospectus, since the respective dates as of which information
is given in the Registration Statement and the Prospectus and the Company's
latest consolidated financial statements, neither the Company nor any Subsidiary
has incurred any material liability or obligation, direct or contingent, or
entered into any material transaction, whether or not incurred in the ordinary
course of business, or sustained any material loss or interference with its
business from fire, storm, explosion, flood or other casualty, whether or not
covered by insurance, or from any labor dispute or court or governmental action,
order or decree; and since the respective dates as of which information is given
in the Registration Statement and the Prospectus, there have not been, and prior
to the Closing Date referred to below there will not be, any material changes in
the capital stock or any material increases in the long-term debt of the Company
or any Subsidiary or any material adverse change in or affecting the general
affairs, management, financial condition, shareholders' equity, results of
operations or prospects of the Company or any Subsidiary, other than as set
forth or contemplated in the Prospectus.
(u) Neither the Company nor any Subsidiary owns any real property.
The Company and each Subsidiary each has good title to all personal property
(tangible and intangible) owned by it, free and clear of all security interests,
charges, mortgages, liens, encumbrances and defects, except such as are
described in the Registration Statement and Prospectus or such as do not
materially affect or interfere with the operations of the Company or any
Subsidiary. The leases, licenses or other contracts or instruments under which
the Company and the Subsidiaries lease, hold or are entitled to use any
property, real or personal, are valid, subsisting and enforceable only with such
exceptions as are not material and do not interfere with the use of such
property made, or proposed to be made, by the Company or any Subsidiary, and all
rentals, royalties or other payments, if any, accruing thereunder which became
due prior to the date of this Agreement have been duly paid, and neither the
Company nor any Subsidiary, nor, to the best of the Company's knowledge, any
other party is in default thereunder and, to the best of the Company's
knowledge, no event has occurred which, with the passage of time or the giving
of notice, or both, would constitute a default thereunder. Neither the Company
nor any Subsidiary has received notice of any violation of any applicable law,
ordinance, regulation, order or requirement relating to its owned or leased
properties that would have a material adverse effect on the Company. The Company
and each Subsidiary has adequately insured its properties against loss or damage
by fire or other casualty and maintains, in adequate amounts, such other
insurance as is usually maintained by companies
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<PAGE>
engaged in the same or similar businesses located in its geographic
area.
(v) Each contract or other instrument (however characterized or
described) to which the Company or a Subsidiary is a party or by which their
respective properties or businesses are or may be bound or affected and to which
reference is made in the Prospectus has been duly and validly executed, is in
full force and effect in all material respects and is enforceable against the
Company and, to the best of the Company's knowledge, the other parties thereto
in accordance with its terms, and none of such contracts or instruments has been
assigned by the Company or any Subsidiary, and neither the Company nor any
Subsidiary, nor, to the best of the Company's knowledge, any other party is in
default thereunder and, to the best of the Company's knowledge, no event has
occurred which, with the lapse of time or the giving of notice, or both, would
constitute a default thereunder which could materially adversely affect the
Company and the Subsidiaries taken as a whole.
To the best of the Company's knowledge, none of the material
provisions of such contracts or instruments violates any existing applicable
law, rule, regulation, judgment, order or decree of any governmental agency or
court having jurisdiction over the Company or any Subsidiary or any of their
respective assets or businesses.
(w) The employment, consulting, confidentiality and
non-competition agreements between the Company and its officers, employees and
consultants and between the Subsidiaries and their respective officers,
employees and consultants, described in the Registration Statement, are binding
and enforceable obligations upon the respective parties thereto in accordance
with their respective terms, except as such enforceability may be limited by
applicable bankruptcy, insolvency, moratorium or other similar laws or
arrangements affecting creditors' rights generally and subject to principles of
equity.
(x) Except as set forth in the Prospectus, the Company has no
employee benefit plans (including, without limitation, profit sharing and
welfare benefit plans) or deferred compensation arrangements that are subject to
the provisions of the Employee Retirement Income Security Act of 1974, as
amended.
(y) To the best of the Company's knowledge, no labor disputes
exist between the Company and its employees or any Subsidiary and its employees
or is imminent which could materially adversely affect the Company or any
Subsidiary.
(z) Neither the Company nor any Subsidiary has, directly or
indirectly, at any time (i) made any contributions to
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any candidate for political office, or failed to disclose fully any such
contribution in violation of law or (ii) made any payment to any state, federal
or foreign governmental officer or official, or other person charged with
similar public or quasi-public duties, other than, in each case, payments or
contributions required or allowed by applicable law. The Company's internal
accounting controls and procedures are sufficient to cause the Company to comply
in all material respects with the Foreign Corrupt Practices Act of 1977, as
amended.
(aa) The Shares have been approved for listing on the Nasdaq
National Market ("Nasdaq").
(ab) The Company has provided to Tenzer Greenblatt LLP, counsel to
the several Underwriters ("Underwriters' Counsel"), all material agreements,
certificates, correspondence and other items, documents and information
requested by such counsel's Corporate Review Memorandum dated April 14, 1998.
Any certificate signed by an officer of the Company or by an
officer of a Subsidiary and delivered to the Representatives or to Underwriters'
Counsel shall be deemed to be a representation and warranty by the Company to
the Underwriters as to the matters covered thereby.
5. Certain Covenants of the Company. The Company covenants with the
several Underwriters as follows:
(a) The Company will not at any time, whether before the Effective
Date or thereafter during such period as the Prospectus is required by law to be
delivered in connection with the sales of the Shares by the Representatives or a
dealer, file or publish any amendment or supplement to the Registration
Statement or Prospectus of which the Representatives have not been previously
advised and furnished a copy, or to which the Representatives shall object in
writing.
(b) The Company will use its best efforts to cause the
Registration Statement to become effective and will advise the Representatives
promptly, and, if requested by the Representatives, confirm such advice in
writing, (i) when the Registration Statement, or any post-effective amendment to
the Registration Statement or any supplemented Prospectus is filed with the
Commission; (ii) of the receipt of any comments from the Commission; (iii) of
any request of the Commission for amendment or supplementation of the
Registration Statement or Prospectus or for additional information; and (iv) of
the issuance by the Commission of any stop order suspending the effectiveness of
the Registration Statement or of any order preventing or suspending the use of
any Preliminary Prospectus, or of the suspension of the qualification of the
Shares
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<PAGE>
for offering or sale in any jurisdiction, or of the initiation of any
proceedings for any of such purposes. The Company will use its best efforts to
prevent the issuance of any such stop order or of any order preventing or
suspending such use and to obtain as soon as possible the lifting thereof, if
any such order is issued.
(c) The Company will deliver to each Underwriter, without charge,
from time to time until the Effective Date, as many copies of each Preliminary
Prospectus as each Underwriter may reasonably request, and the Company hereby
consents to the use of such copies for purposes permitted by the Act. The
Company will deliver to each Underwriter, without charge, as soon as the
Registration Statement becomes effective, and thereafter from time to time as
requested, such number of copies of the Prospectus (as supplemented, if the
Company makes any supplements to the Prospectus) as each Underwriter may
reasonably request. The Company has furnished or will furnish to each of the
Representatives a signed copy of the Registration Statement as originally filed
and of all amendments thereto, whether filed before or after the Registration
Statement becomes effective, a copy of all exhibits filed therewith and a signed
copy of all consents and certificates of experts.
(d) The Company will comply with the Act, the Regulations, the
Securities Exchange Act of 1934, as amended (the "Exchange Act"), and the rules
and regulations thereunder so as to permit the continuance of sales of and
dealings in the Offered Shares and in any Optional Shares which may be issued
and sold. If, at any time when a prospectus relating to the Shares is required
to be delivered under the Act, any event occurs as a result of which the
Registration Statement and Prospectus as then amended or supplemented would
include an untrue statement of a material fact or omit to state a material fact
necessary to make the statements therein, in light of the circumstances under
which they were made, not misleading, or if it shall be necessary to amend or
supplement the Registration Statement and Prospectus to comply with the Act or
the regulations thereunder, the Company will promptly file with the Commission,
subject to Section 5(a) hereof, an amendment or supplement which will correct
such statement or omission or which will effect such compliance.
(e) The Company will furnish such proper information as may be
required and otherwise cooperate in qualifying the Shares for offering and sale
under the securities or Blue Sky laws relating to the offering in such
jurisdictions as the Representatives may reasonably designate, provided that no
such qualification will be required in any jurisdiction where, solely as a
result thereof, the Company would be subject to service of general process or to
taxation or qualification as a foreign corporation doing business in such
jurisdiction.
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<PAGE>
(f) The Company will make generally available to its security
holders, in the manner specified in Rule 158(b) under the Act, and deliver to
the Representatives and Underwriters' Counsel as soon as practicable and in any
event not later than 45 days after the end of its fiscal quarter in which the
first anniversary date of the effective date of the Registration Statement
occurs, earning statements meeting the requirements of Rule 158(a) under the Act
covering a period of at least 12 consecutive months beginning after the
effective date of the Registration Statement.
(g) For a period of three years from the Effective Date, the
Company will deliver to the Representatives, on a timely basis (i) a copy of
each report or document, including, without limitation, reports on Forms 8-K,
10-C, 10-K (or 10-KSB) and 10-Q (or 10-QSB) and exhibits thereto, filed or
furnished to the Commission, any securities exchange or the National Association
of Securities Dealers, Inc. (the "NASD") on the date each such report or
document is so filed or furnished; (ii) as soon as practicable, copies of any
reports or communications (financial or other) of the Company mailed to its
security holders; (iii) as soon as practicable, a copy of any Schedule 13D, 13G,
14D-1 or 13E-3 received or prepared by the Company from time to time; (iv) to
the extent publicly available, quarterly statements setting forth such
information regarding the Company's results of operations and financial position
(including balance sheet, profit and loss statements and data regarding backlog)
as is regularly prepared by management of the Company; and (v) such additional
publicly available information concerning the business and financial condition
of the Company as the Representatives may from time to time reasonably request
and which can be prepared or obtained by the Company without unreasonable effort
or expense. The Company will furnish to its shareholders annual reports
containing audited financial statements and such other periodic reports as it
may determine to be appropriate or as may be required by law.
(h) Neither the Company nor any person that controls, is
controlled by or is under common control with the Company will take any action
designed to or which might be reasonably expected to cause or result in the
stabilization or manipulation of the price of the Common Shares.
(i) If the transactions contemplated by this Agreement are
consummated, BlueStone shall retain the $40,000 previously paid to it, and the
Company will pay or cause to be paid the following: all costs and expenses
incident to the performance of the obligations of the Company under this
Agreement, including, but not limited to, the fees and expenses of accountants
and counsel for the Company; the preparation, printing, mailing and filing of
the Registration Statement (including financial
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statements and exhibits), Preliminary Prospectuses and the Prospectus, and any
amendments or supplements thereto; the printing and mailing of the Selected
Dealer Agreement; the issuance and delivery of the Shares to the
Representatives; all taxes, if any, on the issuance of the Shares; the fees,
expenses and other costs of listing the Shares on Nasdaq and of qualifying the
Shares for sale under the "Blue Sky" or securities laws of those states in which
the Shares are to be offered or sold, including the fees and disbursements of
Underwriters' Counsel incurred in connection therewith, and the cost of printing
and mailing the "Blue Sky Survey"; the filing fees incident to securing any
required review by the NASD; the cost of furnishing to the several Underwriters
copies of the Registration Statement, Preliminary Prospectuses and the
Prospectus as herein provided; the costs of placing "tombstone advertisements"
in any publications which may be selected by the Representatives; and all other
costs and expenses incident to the performance of the Company's obligations
hereunder which are not otherwise specifically provided for in this Section
5(i).
In addition, at the Closing Date, the Representatives will deduct
from the payment for the Offered Shares an amount equal to the Representatives'
costs, fees and expenses incurred during the registration process (less the sum
of $40,000 previously paid to BlueStone), including all reasonable out-of-pocket
accountable expenses relating to the transactions contemplated hereby, which
amount will include the fees and expenses of Underwriters' Counsel (other than
those payable by the Company in connection with "Blue Sky" qualifications
referred to in the preceding paragraph) and all of the costs associated with the
marketing and selling of the Offered Shares.
(j) If the transactions contemplated by this Agreement or related
hereto are not consummated because the Company decides not to proceed with the
offering for any reason or if the Representatives decide not to proceed with the
offering because of a breach by the Company of its representations, warranties
or covenants in this Agreement or as a result of material adverse changes in the
affairs of the Company, the Company will reimburse the Representatives for all
of their accountable expenses reasonably incurred in connection with the
offering. If the Representatives decide not to proceed with the offering for any
other reason, the Company will reimburse the Representatives (and the
Representatives will be entitled to retain), for their accountable expenses, up
to the $40,000 previously paid to BlueStone. In no event, however, will the
Representatives, in the event the offering is terminated, be entitled to retain
or receive more than an amount equal to their actual accountable out-of-pocket
expenses.
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(k) The Company intends to apply the net proceeds from the sale of
the Shares for the purposes set forth in the Prospectus.
(l) During the period of nine (9) months following the date
hereof, neither the Company nor any of its officers, directors or
securityholders who have executed lock-up letter agreements with BlueStone
("Affiliated Shareholders") will offer for sale, sell, transfer, pledge or
otherwise dispose of, directly or indirectly, any securities of the Company, in
any manner whatsoever, whether pursuant to Rule 144 of the Regulations or
otherwise, except that the Company may issue Common Shares upon the exercise of
options or warrants outstanding as of the Effective Date or pursuant to the
Company's Employee Stock Purchase Plan, and no holder of registration rights
relating to securities of the Company will execute any such registration rights,
in either case, without the prior written consent of BlueStone. The Company will
deliver to the Representatives the undertakings as of the date hereof of its
officers, directors and Affiliated Shareholders to this effect.
(m) The Company will not file any registration statement relating
to the offer or sale of any of the Company's securities, including any
registration statement on Form S-8, during the nine (9) months following the
date hereof without BlueStone's prior written consent.
(n) The Company maintains and will continue to maintain a system
of internal accounting controls sufficient to provide reasonable assurances
that: (i) transactions are executed in accordance with management's general or
specific authorization; (ii) transactions are recorded as necessary in order to
permit preparation of financial statements in accordance with generally accepted
accounting principles and to maintain accountability for assets; (iii) access to
assets is permitted only in accordance with management's general or specific
authorization; and (iv) the recorded accountability for assets is compared with
existing assets at reasonable intervals and appropriate action is taken with
respect to any differences.
(o) The Company will use its best efforts to maintain the listing
of the Shares on Nasdaq or another exchange that is mutually agreed upon by the
Company and the Representatives for at least five (5) years from the Effective
Date.
(p) The Company will, concurrently with the Effective Date,
register the class of equity securities of which the Shares are a part under
Section 12(g) of the Exchange Act and the Company will use its best efforts to
maintain the registration for a minimum of five (5) years after the Effective
Date.
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(q) The Company shall retain Wachovia Bank and Trust Company as
its transfer agent for the Common Shares (or such other transfer agent which is
reasonably acceptable to BlueStone), for a period of three (3) years following
the Effective Date. In addition, for a period of three (3) years following the
Effective Date, the Company, at its own expense, shall cause its transfer agent
to provide BlueStone, if so requested in writing, with copies of the Company's
daily transfer sheets and when requested by BlueStone, a current list of the
Company's security holders, including a list of the beneficial owners of
securities held by a depository trust company and other nominees.
(r) The Company hereby agrees, at its sole cost and expense, to
supply and deliver to Underwriters' Counsel, within a reasonable period from the
date hereof, four bound volumes, including the Registration Statement, as
amended or supplemented, all exhibits to the Registration Statement, the
Prospectus and all other underwriting documents.
(s) For a period of three (3) years following the Effective Date,
the Company shall continue to retain Ernst & Young LLP (or such other nationally
recognized accounting firm as is acceptable to BlueStone) as the Company's
independent public accountants.
(t) For a period of three (3) years following the Effective Date,
the Company, at its expense, shall cause its independent certified public
accountants, as described in Section 5(v) above, to read and comment on (but not
audit) the Company's financial statements for each of the first three fiscal
quarters prior to the announcement of quarterly financial information, the
filing of the Company's 10-Q (or 10-QSB) quarterly report and the mailing of
quarterly financial information to shareholders.
(u) For a period of twenty-five (25) days following the Effective
Date, the Company will not issue press releases or engage in any other publicity
without BlueStone's prior written consent, other than normal and customary
releases issued in the ordinary course of the Company's business or those
releases required by law.
(v) For a period of eighteen (18) months following the Effective
Date, the Company will not offer or sell any of its securities, other than the
issuance of Common Shares upon exercise of options and warrants outstanding on
the Effective Date or pursuant to the Company's Employee Stock Purchase Plan at
a discount from the then current market price without the prior written consent
of BlueStone, which consent shall not be unreasonably withheld.
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6. Conditions of the Underwriters' Obligation to Purchase Shares from
the Company. The obligation of the several Underwriters to purchase and pay for
the Offered Shares which they have agreed to purchase from the Company is
subject (as of the date hereof and the Closing Date) to the accuracy of, and the
Company's compliance in all material respects with, the representations and
warranties of the Company herein, to the accuracy of the statements of the
Company and its officers made pursuant hereto, to the performance in all
material respects by the Company or its Subsidiaries of their respective
obligations hereunder, and to the following additional conditions:
(a) The Registration Statement will have become effective not
later than 11:00 A.M., New York City time, on the day following the date of this
Agreement, or at such later time or on such later date as the Representatives
may agree to in writing; prior to the Closing Date, no stop order suspending the
effectiveness of the Registration Statement will have been issued and no
proceedings for that purpose will have been initiated or will be pending or, to
the best of the Representatives' or the Company's knowledge, will be
contemplated by the Commission; and any request on the part of the Commission
for additional information will have been complied with to the satisfaction of
Underwriters' Counsel.
(b) At the time that this Agreement is executed and at the Closing
Date, there will have been delivered to the Representatives a signed opinion of
Smith, Anderson, Blount, Dorsett, Mitchell & Jernigan, L.L.P., counsel for the
Company ("Company Counsel"), dated as of the date hereof or the Closing Date, as
the case may be (and any other opinions of counsel referred to in such opinion
of Company Counsel or relied upon by Company Counsel in rendering their
opinion), in the form attached to this Agreement as Schedule B.
(c) At the Closing Date, there will have been delivered to the
Representatives a signed opinion of Underwriters' Counsel, dated as of the
Closing Date, to the effect that the opinions delivered pursuant to Section 6(b)
hereof appear on their face to be appropriately responsive to the requirements
of this Agreement, except to the extent waived by the Representatives,
specifying the same, and with respect to such other related matters as the
Representatives may require.
(d) At the Closing Date (i) the Registration Statement and the
Prospectus and any amendments or supplements thereto will contain all material
statements which are required to be stated therein in accordance with the Act
and the Regulations and will conform in all material respects to the
requirements of the Act and the Regulations, and neither the Registration
Statement nor the Prospectus nor any amendment or supplement thereto will
contain
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<PAGE>
any untrue statement of a material fact or omit to state any material fact
required to be stated therein or necessary to make the statements therein, in
light of the circumstances under which they were made, not misleading; (ii)
since the respective dates as of which information is given in the Registration
Statement and the Prospectus, there will not have been any material adverse
change in the financial condition, results of operations or general affairs of
the Company from that set forth or contemplated in the Registration Statement
and the Prospectus, except changes which the Registration Statement and the
Prospectus indicate might occur after the Effective Date; (iii) since the
respective dates as of which information is given in the Registration Statement
and the Prospectus, there shall have been no material transaction, contract or
agreement entered into by the Company, other than in the ordinary course of
business, which would be required to be set forth in the Registration Statement
and the Prospectus, other than as set forth therein; and (iv) no action, suit or
proceeding at law or in equity will be pending or, to the best of the Company's
knowledge, threatened against the Company which is required to be set forth in
the Registration Statement and the Prospectus, other than as set forth therein,
and no proceedings will be pending or, to the best of the Company's knowledge,
threatened against the Company before or by any federal, state or other
commission, board or administrative agency wherein an unfavorable decision,
ruling or finding would materially adversely affect the business, property,
financial condition or results of operations of the Company and the
Subsidiaries, taken as a whole, other than as set forth in the Registration
Statement and the Prospectus. At the Closing Date, there will be delivered to
the Representatives a certificate signed by the Chairman of the Board or the
President or a Vice President of the Company, dated the Closing Date, evidencing
compliance with the provisions of this Section 6(d) and stating that the
representations and warranties of the Company set forth in Section 4 hereof were
accurate and complete in all material respects when made on the date hereof and
are accurate and complete in all material respects on the Closing Date as if
then made; that the Company has performed all covenants in all material respects
and complied with all conditions required by this Agreement to be performed or
complied with by the Company prior to or as of the Closing Date; and that, as of
the Closing Date, no stop order suspending the effectiveness of the Registration
Statement has been issued and no proceedings for that purpose have been
initiated or, to the best of his knowledge, are contemplated or threatened. In
addition, the Representatives will have received such other and further
certificates of officers of the Company as the Representatives or Underwriters'
Counsel may reasonably request.
(e) At the time that this Agreement is executed and at the Closing
Date, the Representatives will have received a signed letter from Ernst & Young
LLP, dated the date such letter is
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to be received by the Representatives and addressed to them, confirming that it
is a firm of independent public accountants within the meaning of the Act and
Regulations and stating that: (i) insofar as reported on by it, in its opinion,
the consolidated financial statements of the Company included in the Prospectus
comply as to form in all material respects with the applicable accounting
requirements of the Act and the applicable Regulations; (ii) on the basis of
procedures and inquiries (not constituting an examination in accordance with
generally accepted auditing standards) consisting of a reading of the unaudited
interim financial statements of the Company, if any, appearing in the
Registration Statement and the Prospectus and the latest available unaudited
interim financial statements of the Company, if more recent than that appearing
in the Registration Statement and Prospectus, inquiries of officers of the
Company responsible for financial and accounting matters as to the transactions
and events subsequent to the date of the latest audited financial statements of
the Company, and a reading of the minutes of meetings of the shareholders, the
Board of Directors of the Company and any committees of the Board of Directors,
as set forth in the minute books of the Company, nothing has come to its
attention which, in its judgment, would indicate that (A) during the period from
the date of the latest financial statements of the Company appearing in the
Registration Statement and Prospectus to a specified date not more than three
business days prior to the date of such letter, there have been any material
decreases in net current assets or net assets as compared with amounts shown in
such financial statements or material decreases in net sales or decreases in
total or per share net income compared with the corresponding period in the
preceding year or any material change in the capitalization or long-term debt of
the Company, except in all cases as set forth in or contemplated by the
Registration Statement and the Prospectus, and (B) the unaudited interim
financial statements of the Company, if any, appearing in the Registration
Statement and the Prospectus, do not comply as to form in all material respects
with the applicable accounting requirements of the Act and the Regulations or
are not fairly presented in conformity with generally accepted accounting
principles and practices on a basis substantially consistent with the audited
financial statements included in the Registration Statement or the Prospectus;
and (iii) it has compared specific dollar amounts, numbers of shares, numerical
data, percentages of revenues and earnings, and other financial information
pertaining to the Company set forth in the Prospectus (with respect to all
dollar amounts, numbers of shares, percentages and other financial information
contained in the Prospectus, to the extent that such amounts, numbers,
percentages and information may be derived from the general accounting records
of the Company, and excluding any questions requiring an interpretation by legal
counsel) with the results obtained from the application of specified readings,
inquiries and other appropriate procedures
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<PAGE>
(which procedures do not constitute an examination in accordance with generally
accepted auditing standards) set forth in the letter, and found them to be in
agreement.
(f) There shall have been duly tendered to the Representatives
certificates representing the Offered Shares to be sold on the Closing Date.
(g) The NASD shall have indicated that it has no objection to the
underwriting arrangements pertaining to the sale of the Offered Shares by the
Underwriters or the sale of the Shares by the Representatives.
(h) No action shall have been taken by the Commission or the NASD
the effect of which would make it improper, at any time prior to the Closing
Date or the Option Closing Date, as the case may be, for any member firm of the
NASD to execute transactions (as principal or as agent) in the Shares, and no
proceedings for the purpose of taking such action shall have been instituted or
shall be pending, or, to the best of the Representatives' or the Company's
knowledge, shall be contemplated by the Commission or the NASD. The Company
represents at the date hereof, and shall represent as of the Closing Date or
Option Closing Date, as the case may be, that it has no knowledge that any such
action is in fact contemplated by the Commission or the NASD.
(i) The Common Shares have been approved for listing on Nasdaq.
(j) All proceedings taken at or prior to the Closing Date or the
Option Closing Date, as the case may be, in connection with the authorization,
issuance and sale of the Shares shall be reasonably satisfactory in form and
substance to the Representatives and to Underwriters' Counsel, and such counsel
shall have been furnished with all such documents, certificates and opinions as
they may reasonably request for the purpose of enabling them to pass upon the
matters referred to in Section 6(c) hereof and in order to evidence the accuracy
and completeness of any of the representations, warranties or statements of the
Company, the performance of any covenants of the Company, or the compliance by
the Company with any of the conditions herein contained.
(k) As of the date hereof, the Company will have delivered to the
Underwriters the written undertakings of its officers, directors and security
holders and/or registration rights holders, as the case may be, to the effect of
the matters set forth in Section 5(l).
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If any of the conditions specified in this Section 6 have not been
fulfilled, this Agreement may be terminated by the Representatives on written
notice to the Company.
7. Indemnification.
(a) The Company agrees to indemnify and hold harmless each
Underwriter, including specifically each person that may be substituted for an
Underwriter as provided in Section 10 hereof, each officer, director, partner,
employee and agent of any Underwriter, and each person, if any, who controls any
of the Underwriters within the meaning of Section 15 of the Act or Section 20(a)
of the Exchange Act, from and against any and all losses, claims, damages,
expenses or liabilities, joint or several (and actions in respect thereof), to
which they or any of them may become subject under the Act or under any other
statute or at common law or otherwise, and, except as hereinafter provided, will
reimburse each of the Underwriters and each such person, if any, for any legal
or other expenses reasonably incurred by them or any of them in connection with
investigating or defending any actions, whether or not resulting in any
liability, insofar as such losses, claims, damages, expenses, liabilities or
actions arise out of or are based upon any untrue statement or alleged untrue
statement of a material fact contained (i) in the Registration Statement, in any
Preliminary Prospectus or in the Prospectus (or the Registration Statement or
Prospectus as from time to time amended or supplemented) or (ii) in any
application or other document executed by the Company, or based upon written
information furnished by or on behalf of the Company, filed in any jurisdiction
in order to qualify the Shares under the securities laws thereof (hereinafter
"application"), or arise out of or are based upon the omission or alleged
omission to state therein a material fact required to be stated therein or
necessary in order to make the statements therein not misleading, in light of
the circumstances under which they were made, unless such untrue statement or
omission was made in such Registration Statement, Preliminary Prospectus,
Prospectus or application in reliance upon and in conformity with information
furnished in writing to the Company in connection therewith by the Underwriter
or any such person through the Underwriter expressly for use therein; provided,
however, that the indemnity agreement contained in this Section 7(a) with
respect to any Preliminary Prospectus will not inure to the benefit of the
Underwriter (or to the benefit of any other person that may be indemnified
pursuant to this Section 7(a)) if (A) the person asserting any such losses,
claims, damages, expenses or liabilities purchased the Shares which are the
subject thereof from such Underwriter or other indemnified person; (B) such
Underwriter or other indemnified person failed to send or give a copy of the
Prospectus to such person at or prior to the written confirmation of the sale of
such Shares to such person; and (C) the Prospectus did not contain any untrue
statement or
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alleged untrue statement or omission or alleged omission giving rise to such
cause, claim, damage, expense or liability.
(b) Each Underwriter (including specifically each person that may
be substituted for an Underwriter as provided in Section 11 hereof) agrees to
indemnify and hold harmless the Company, each of its directors, each of its
officers who have signed the Registration Statement, each employee, each agent
and each person, if any, who controls the Company within the meaning of Section
15 of the Act or Section 20(a) of the Exchange Act, from and against any and all
losses, claims, damages, expenses or liabilities, joint or several (and actions
in respect thereof), to which they or any of them may become subject under the
Act or under any other statute or at common law or otherwise, and, except as
hereinafter provided, will reimburse the Company and each such director,
officer, employee, agent or controlling person for any legal or other expenses
reasonably incurred by them or any of them in connection with investigating or
defending any actions, whether or not resulting in any liability, insofar as
such losses, claims, damages, expenses, liabilities or actions arise out of or
are based upon any untrue statement or alleged untrue statement of a material
fact contained (i) in the Registration Statement, in any Preliminary Prospectus
or in the Prospectus (or the Registration Statement or Prospectus as from time
to time amended or supplemented) or (ii) in any application (including any
application for registration of the Shares under state securities or Blue Sky
laws), or arise out of or are based upon the omission or alleged omission to
state therein a material fact required to be stated therein or necessary in
order to make the statements therein not misleading, in light of the
circumstances under which they were made, but only insofar as any such statement
or omission was made in reliance upon and in conformity with information
furnished in writing to the Company in connection therewith by such Underwriter,
or by the Representatives on behalf of such Underwriter, expressly for use
therein.
(c) Promptly after receipt of notice of the commencement of any
action in respect of which indemnity may be sought against any indemnifying
party under this Section 7, the indemnified party will notify the indemnifying
party in writing of the commencement thereof, and the indemnifying party will,
subject to the provisions hereinafter stated, assume the defense of such action
(including the employment of counsel satisfactory to the indemnified party and
the payment of expenses) insofar as such action relates to an alleged liability
in respect of which indemnity may be sought against the indemnifying party.
After notice from the indemnifying party of its election to assume the defense
of such claim or action, the indemnifying party shall no longer be liable to the
indemnified party under this Section 7 for any legal or other expenses
subsequently incurred by the indemnified party in connection with the defense
thereof; provided,
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however, that if, in the reasonable judgment of the indemnified party or
parties, it is advisable for the indemnified party or parties to be represented
by separate counsel, the indemnified party or parties shall have the right to
employ a single counsel to represent the indemnified parties who may be subject
to liability arising out of any claim in respect of which indemnity may be
sought by the indemnified parties thereof against the indemnifying party, but
the fees and expenses of such counsel shall be at the expense of such
indemnified party unless (i) the indemnifying party and the indemnified party
shall have mutually agreed to the retention of such counsel or (ii) the named
parties to any such proceeding (including any impleaded parties) include both
the indemnifying party and the indemnified party and representation of both
parties by the same counsel would be inappropriate due to actual or potential
differing interests between them. It is understood that the indemnifying party
shall not, in respect of the legal expenses of any indemnified party in
connection with any proceeding or related proceedings in the same jurisdiction,
be liable for the fees and expenses of more than one separate firm (in addition
to any local counsel) for all such indemnified parties and that all such fees
and expenses shall be reimbursed as they are incurred. Any party against whom
indemnification may be sought under this Section 7 shall not be liable to
indemnify any person that might otherwise be indemnified pursuant hereto for any
settlement of any action effected without such indemnifying party's consent.
8. Contribution. To provide for just and equitable contribution, if (i)
an indemnified party makes a claim for indemnification pursuant to Section 8
hereof (subject to the limitations thereof) and it is finally determined, by a
judgment, order or decree not subject to further appeal, that such claim for
indemnification may not be enforced, even though this Agreement expressly
provides for indemnification in such case; or (ii) any indemnified or
indemnifying party seeks contribution under the Act, the Exchange Act, or
otherwise, then the Company (including, for this purpose, any contribution made
by or on behalf of any director of the Company, any officer of the Company who
signed the Registration Statement, any employee, any agent and any controlling
person of the Company) as one entity and the Underwriters (including, for this
purpose, any contribution by or on behalf of each person, if any, who controls
any Underwriter within the meaning of Section 15 of the Act or Section 20(a) of
the Exchange Act and each officer, director, partner, employee and agent of any
of the Underwriters) as a second entity, shall contribute to the losses,
liabilities, claims, damages and expenses whatsoever to which any of them may be
subject, so that the Underwriters are responsible for the proportion thereof
equal to the percentage which the underwriting discount per Share set forth on
the cover page of the Prospectus represents of the initial public offering
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<PAGE>
price per Share set forth on the cover page of the Prospectus and the Company is
responsible for the remaining portion; provided, however, that if applicable law
does not permit such allocation, then, if applicable law permits, other relevant
equitable considerations such as the relative fault of the Company and the
Underwriters in connection with the facts which resulted in such losses,
liabilities, claims, damages and expenses shall also be considered. The relative
fault, in the case of an untrue statement, alleged untrue statement, omission or
alleged omission, shall be determined by, among other things, whether such
statement, alleged statement, omission or alleged omission relates to
information supplied by the Company or by the Underwriters, and the parties'
relative intent, knowledge, access to information and opportunity to correct or
prevent such statement, alleged statement, omission or alleged omission. The
Company, on one hand, and the Underwriters, on the other hand, agree that it
would be unjust and inequitable if the respective obligations of the Company and
the Underwriters for contribution were determined by pro rata or per capita
allocation of the aggregate losses, liabilities, claims, damages and expenses or
by any other method of allocation that does not reflect the equitable
considerations referred to in this Section 8. No person guilty of a fraudulent
misrepresentation (within the meaning of Section 11(f) of the Act) will be
entitled to contribution from any person who is not guilty of such fraudulent
misrepresentation. For purposes of this Section 8, each person, if any, who
controls any of the Underwriters within the meaning of Section 15 of the Act or
Section 20(a) of the Exchange Act and each officer, director, partner, employee
and agent of any of the Underwriters will have the same rights to contribution
as the Underwriters, and each person, if any, who controls the Company within
the meaning of Section 15 of the Act or Section 20(a) of the Exchange Act, each
officer of the Company who has signed the Registration Statement and each
director, employee and agent of the Company will have the same rights to
contribution as the Company, subject in each case to the provisions of this
Section 8. Anything in this Section 8 to the contrary notwithstanding, no party
will be liable for contribution with respect to the settlement of any claim or
action effected without its written consent. This Section 8 is intended to
supersede, to the extent permitted by law, any right to contribution under the
Act or the Exchange Act or otherwise available.
9. Survival of Indemnities, Contribution, Warranties and
Representations. The respective indemnity and contribution agreements of the
Company and the Underwriters contained in Sections 7 and 8 hereof, and the
representations and warranties of the Company in contained Section 4 of this
Agreement shall remain operative and in full force and effect, regardless of any
termination or cancellation of this Agreement or any investigation made by or on
behalf of the Underwriters, the Company or any of its
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directors and officers or any controlling person referred to in said Sections,
and shall survive the delivery of, and payment for, the Shares.
10. Substitution of Underwriters.
(a) If one or more Underwriters should default in its or their
obligation to purchase and pay for any Offered Shares hereunder and if the
aggregate number of such Offered Shares which all Underwriters so defaulting
have agreed to purchase does not exceed 10% of the total number of the Offered
Shares, the non-defaulting Underwriters will be obligated severally to purchase
and pay for (in addition to the number of Offered Shares set forth opposite
their names in Schedule A attached hereto) the full number of Offered Shares
agreed to be purchased by all defaulting Underwriters, and not so purchased, in
proportion to their respective commitments hereunder. In such event the
Representatives, for the accounts of the several nondefaulting Underwriters, may
take up and pay for all or any part of such additional Offered Shares to be
purchased by each such Underwriter under this Section 10(a), and may postpone
the Closing Date to a time not exceeding three full business days after the
Closing Date determined as provided in Section 2 hereof.
(b) If one or more Underwriters should default in its or their
obligation to purchase and pay for any Offered Shares hereunder and if the
aggregate number of such Offered Shares which all Underwriters so defaulting
have agreed to purchase exceeds 10% of the total number of Offered Shares, or if
one or more Underwriters for any reason permitted hereunder should cancel its or
their obligation to purchase and pay for Offered Shares hereunder, the
non-cancelling and non-defaulting Underwriters (hereinafter called the
"remaining Underwriters") will have the right to purchase such Offered Shares in
such proportion as may be agreed among them at the Closing Date determined as
provided in Section 2 hereof. If the remaining Underwriters do not purchase and
pay for such Offered Shares at such Closing Date, the Closing Date will be
postponed for 24 hours and the remaining Underwriters will have the right to
purchase such Offered Shares, or to substitute another person or persons to
purchase the same, or both, at such postponed Closing Date. If purchasers have
not been found for such Offered Shares by such postponed Closing Date, the
Closing Date will be postponed for a further 24 hours, and the Company will have
the right to substitute another person or persons, reasonably satisfactory to
the Representatives to purchase such Offered Shares at such second postponed
Closing Date. If it shall be arranged for the remaining Underwriters or
substituted underwriters to take up the Firm Shares of the defaulting
Underwriter or Underwriters as provided in this Section, (A) the Company shall
have the right to postpone the time of delivery for a period of not more than
three
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<PAGE>
(3) full Business Days, in order to effect whatever changes may thereby be made
necessary in the Registration Statement or the Prospectus or in any other
documents or arrangements, and the Company agrees promptly to file any
amendments to the Registration Statement or supplements to the Prospectus which
may thereby be made necessary. If the Company has not found such purchasers for
such Offered Shares by such second postponed Closing Date, then this Agreement
will automatically terminate, and neither the Company nor the remaining
Underwriters will be under any obligation under this Agreement (except that the
Company and the Underwriters will remain liable to the extent provided in
Sections 7 and 8 hereof and the Company will also remain liable to the extent
provided in Section 5(j) hereof). As used in this Agreement, the term
"Underwriter" includes any person substituted for an Underwriter under this
Section 10(b). Nothing in Section 11 hereof will relieve a defaulting
Underwriter from the liability for its default and nothing in this Section 10(b)
will obligate any Underwriter to purchase or find purchasers for any Offered
Shares in excess of those agreed to be purchased by such Underwriter under the
terms of Section 2 hereof.
11. Termination of Agreement.
(a) The Company, by written or telegraphic notice to the
Representatives, or the Representatives, by written or telegraphic notice to the
Company, may terminate this Agreement prior to the earlier of (i) 11:00 A.M.,
New York City time, on the first full business day after the Effective Date; or
(ii) the time when the Underwriters, after the Registration Statement becomes
effective, release the Offered Shares for public offering. The time when the
Underwriters "release the Offered Shares for public offering" for the purposes
of this Section 11 means the time when the Underwriters release for publication
the first newspaper advertisement, which is subsequently published, relating to
the Offered Shares, or the time when the Underwriters release for delivery to
members of a selling group copies of the Prospectus and an offering letter or an
offering telegram relating to the Offered Shares, whichever will first occur.
(b) This Agreement, including without limitation, the obligation
to purchase the Shares and the obligation to purchase the Optional Shares after
exercise of the option referred to in Section 3 hereof, is subject to
termination by the Underwriters, by written notice given to the Company prior to
delivery of and payment for all the Offered Shares or the Optional Shares, as
the case may be, if, prior to such time, any of the following shall have
occurred: (i) the Company withdraws the Registration Statement from the
Commission or the Company does not or cannot expeditiously proceed with the
public offering; (ii) the representations and warranties in Section 4 hereof are
not
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<PAGE>
materially correct or cannot be materially complied with and, in BlueStone's
judgment, the effect of such is so adverse as to make it impracticable for
BlueStone to market the Shares on the terms contemplated in the Prospectus;
(iii) trading in securities generally on the New York Stock Exchange or the
American Stock Exchange will have been suspended; (iv) limited or minimum prices
will have been established on either such Exchange; (v) a banking moratorium
will have been declared either by federal or New York State authorities; (vi)
any other restrictions on transactions in securities materially affecting the
free market for securities or the payment for such securities, including the
Offered Shares or the Optional Shares, will be established by either of such
Exchanges, by the Commission, by any other federal or state agency, by action of
the Congress or by Executive Order; (vii) trading in any securities of the
Company shall have been suspended or halted by any national securities exchange,
the NASD or the Commission; (viii) a materially adverse change in the condition
(financial or otherwise), prospects or obligations of the Company that is not
reflected in the Registration Statement or the Prospectus and which, in
BlueStone's judgement, is so adverse as to make it impracticable for BlueStone
to market the Shares on the terms contemplated in the Prospectus; (ix) the
Company will have sustained a material loss, whether or not insured, by reason
of fire, flood, accident or other calamity that is not reflected in the
Registration Statement or the Prospectus and which, in BlueStone's judgement, is
so adverse as to make it impracticable for BlueStone to market the Shares on the
terms contemplated in the Prospectus; (x) any action has been taken by the
government of the United States or any department or agency thereof which, in
the judgment of the Representatives, has had a material adverse effect upon the
market or potential market for securities in general; or (xi) the market for
securities in general or political, financial or economic conditions will have
so materially adversely changed that, in the judgment of the Representatives, it
will be impracticable to offer for sale, or to enforce contracts made by the
Underwriters for the resale of, the Offered Shares or the Optional Shares, as
the case may be.
(c) If this Agreement is terminated pursuant to Section 6 hereof
or this Section 11 or if the purchases provided for herein are not consummated
because any condition of the Underwriters' obligations hereunder is not
satisfied or because of any refusal, inability or failure on the part of the
Company to comply with any of the terms or to fulfill any of the conditions of
this Agreement, or if for any reason the Company shall be unable to or does not
perform all of its obligations under this Agreement, the Company will not be
liable to any of the Underwriters for damages on account of loss of anticipated
profits arising out of the transactions covered by this Agreement, but the
Company will remain liable to the extent provided in Sections 5(j), 7, 8 and 9
of this Agreement.
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<PAGE>
12. Information Furnished by the Underwriters to the Company. It is
hereby acknowledged and agreed by the parties hereto that for the purposes of
this Agreement, including, without limitation, Sections 4(f), 7(a), 7(b) and 8
hereof, the only information given by the Underwriters to the Company for use in
the Prospectus are the statements set forth in the last sentence of the last
paragraph on the cover page, the statement appearing in the last paragraph on
page 2 with respect to stabilizing the market price of Shares, information in
the paragraph under the caption "Risk Factors - Limited Underwriting Experience"
on page 16, information in the third paragraph under the "Underwriting" caption
on page 56 with respect to concessions and reallowances, the table on page 56
regarding the offering syndicate, and the information in the second and fourth
full paragraphs on page 57 with respect to discretionary accounts and the
determination of the public offering price, the fifth, sixth and seventh full
paragraphs on page 57 with respect to stabilizing the market price of the
Shares, and the first paragraph on page 58 with respect to BlueStone, as such
information appears in any Preliminary Prospectus and in the Prospectus.
13. Notices and Governing Law. All communications hereunder will be in
writing and, except as otherwise provided, will be delivered at, or mailed by
certified mail, return receipt requested, or telecopied to, the following
addresses: if to BlueStone, the Representatives, or the Underwriters, to
BlueStone Capital Partners, L.P., 575 Fifth Avenue, New York, New York 10017,
Facsimile No. (212) 297-5695, with a copy to Tenzer Greenblatt LLP, Attention:
Robert J. Mittman, Esq., 405 Lexington Avenue, New York, New York 10174,
Facsimile No. (212) 885-5001; if to the Company, to Interactive Magic, Inc., 215
Southport Drive, Suite 1000, Morrisville, North Carolina 27560, Attention: J.W.
Stealey, Chairman and Chief Executive Officer, Facsimile No. (919) 462-3081 with
a copy to Smith, Anderson, Blount, Dorsett, Mitchell & Jernigan, L.L.P.,
Attention: Gerald F. Roach, Esq., 2500 First Union Capitol Center, Raleigh,
North Carolina 27601, Facsimile No.
(919) 821-6800.
This Agreement shall be deemed to have been made and delivered in New
York City and shall be governed as to validity, interpretation, construction,
effect and in all other respects by the internal laws of the State of New York.
The Company (1) agrees that any legal suit, action or proceeding arising out of
or relating to this Agreement shall be instituted exclusively in New York State
Supreme Court, County of New York, or in the United States District Court for
the Southern District of New York, (2) waives any objection which the Company
may have now or hereafter to the venue of any such suit, action or proceeding,
and (3) irrevocably consents to the jurisdiction of the New York State Supreme
Court, County of New York, and the United States District Court for the Southern
District of New York in any such suit, action or proceeding. The Company further
agrees to accept and acknowledge service of any and all process which may be
served in
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<PAGE>
any such suit, action or proceeding in the New York State Supreme Court, County
of New York, or in the United States District Court for the Southern District of
New York and agrees that service of process upon the Company mailed by certified
mail to the Company's address (Attention: President) shall be deemed in every
respect effective service of process upon the Company in any such suit, action
or proceeding.
14. Parties in Interest. This Agreement is made solely for the benefit
of the several Underwriters, the Company and, to the extent expressed, any
person controlling the Company or the Underwriters, each officer, director,
partner, employee and agent of the Underwriters, the directors of the Company,
its officers who have signed the Registration Statement, its employees and
agents and their respective executors, administrators, successors and assigns,
and, no other person will acquire or have any right under or by virtue of this
Agreement. The term "successors and assigns" will not include any purchaser of
the Shares from any of the Underwriters, as such purchaser.
If the foregoing is in accordance with your understanding of our
agreement, kindly sign and return to us the enclosed duplicates hereof,
whereupon it will become a binding agreement between the Company and the
Underwriters in accordance with its terms.
Very truly yours,
INTERACTIVE MAGIC, INC.
By:_____________________________
J.W. Stealey,
Chairman and Chief
Executive Officer
Confirmed and accepted in New York, N.Y., as of the date first above written:
BLUESTONE CAPITAL PARTNERS, L.P.
By: BlueStone Capital Management, Inc.,
General Partner
By:__________________________________
Kerry J. Dukes,
President
ROYCE INVESTMENT GROUP, INC.
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<PAGE>
By:__________________________________
Name:
Title:
Acting on behalf of themselves as the Representatives of the several
Underwriters named in Schedule A hereto.
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<PAGE>
SCHEDULE A
TO THE UNDERWRITING AGREEMENT
Underwriter Number of Shares
BlueStone Capital Partners, L.P.......
Royce Investment Group, Inc.. . . . . . . . .
Total........................
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ARTICLES OF INCORPORATION
OF
I-MAGIC MERGECO, INC.
The undersigned, being of the age of 18 or more, does hereby make and
acknowledge these Articles of Incorporation for the purpose of forming a
business corporation under and by virtue of the laws of the State of North
Carolina:
ARTICLE I
The name of the Corporation is I-MAGIC MERGECO, INC.
ARTICLE II
The period of duration of the Corporation is perpetual.
ARTICLE III
The purpose for which the Corporation is organized is to engage in any
lawful act or activity for which corporations may be organized under Chapter 55
of the General Statutes of North Carolina.
ARTICLE IV
Section 4.1. Authorized Capital. The total number of shares of capital
stock of all classes that the Corporation shall have the authority to issue is
Seventy-Five Million (75,000,000) shares. The authorized capital stock is
divided into Twenty-Five Million (25,000,000) shares of preferred stock, having
$.10 par value (the "Preferred Stock"), and Fifty Million (50,000,000) shares of
common stock, having $.l0 par value (the "Common Stock").
Section 4.2. Preferred Stock.
(a) The shares of Preferred Stock of the Corporation may be issued from
time to time in one or more series, the shares of each series to have such
voting powers, full or limited, or no voting powers, and such designations,
preferences and rights (or qualifications, limitations or restrictions thereof)
as are stated in the resolution or resolutions providing for the issue of such
series adopted by the Board of Directors as provided in Section 4.2(b).
(b) Authority is granted to the Board of Directors of the Corporation,
subject to the provisions of this Article IV and to the limitations prescribed
by the North Carolina Business Corporation Act, to authorize the issuance of one
or more series of Preferred Stock and with respect to each such series to fix by
resolution or resolutions the voting powers, full or limited, if any, of the
shares of such series and the designations, preferences and rights (or
qualifications, limitations or restrictions thereof).
Section 4.3. Common Stock. Thirty Million (30,000,000) of the authorized
shares of the Common Stock are hereby designated Class A Common Stock (Voting)
(the "Class A Common"), and Twenty Million (20,000,000) of the authorized shares
of the Common Stock are
<PAGE>
hereby designated Class B Common Stock (Nonvoting) (the "Class B Common").
Immediately upon the closing of an initial public offering of the Corporation's
securities and a firm commitment underwriting pursuant to a registration
statement on Form S-1 or SB-2 (or any equivalent successor form) under the
Securities Act of 1933, as amended, the Class A Common and the Class B Common
shall combine and become of one and the same class, the Common Stock. Each
reference herein to Class A Common or Class B Common shall be deemed to be a
reference to the Common Stock. Subject to the rights of the Preferred Stock
provided for by resolution or resolutions of the Board of Directors, pursuant to
these Articles of Incorporation or the North Carolina Business Corporation Act
or provided for in these Articles of Incorporation, the holders of shares of the
combined Common Stock shall have one vote per share on all matters on which
holders of shares of Common Stock are entitled to vote. Subject to the rights of
the Preferred Stock, the holders of shares of Common Stock shall receive the net
assets of the Corporation upon dissolution.
(a) Dividends. Subject to the rights of the Preferred Stock, the Class A
Common and the Class B Common shall be entitled, when and if declared by the
Board of Directors of the Corporation, consistent with North Carolina law, to
cash dividends, distributions and redemptions out of funds of the Corporation
legally available for that purpose. Each outstanding share of the Class A Common
and the Class B Common shall be entitled to participate ratably in
distributions, dividends and redemptions paid on the Common Stock.
(b) Voting.
(1) Except as otherwise required by the laws of North Carolina, the
Bylaws of the Corporation or as provided herein, the Class A Common shall
have one vote per share. Holders of the Class B Common shall not be
entitled to vote for the election of Directors or any other purpose and
shall not be entitled to receive notice of any meeting shareholders, unless
otherwise required by North Carolina law.
(2) In addition to any other rights provided by law or as set forth in
these Articles of Incorporation, so long as any Series A Preferred Stock
shall be outstanding, the Corporation shall not, without first obtaining
the affirmative vote or written consent of the holders of not less than a
majority of the then-outstanding shares of Series A Preferred Stock
consenting or voting (as the case may be) separately as a class:
(i) take any action that materially and adversely alters or
changes the rights, preferences or privileges of the Series A
Preferred Stock;
(ii) take any action that increases or decreases the total number
of authorized shares of Series A Preferred Stock; or
(iii) pay or declare any dividend or distribution on any shares
of its capital stock (other than on the Preferred Stock), or apply any
of its assets to the redemption, retirement, purchase or acquisition,
directly or indirectly, through subsidiaries or otherwise, of any
shares of its capital stock, except for repurchases of shares from
former employees upon
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<PAGE>
termination of employment pursuant to the terms of such former
employees' stock purchase agreements providing for such repurchases at
the original issuance prices for such shares.
(c) Liquidation Preference.
(1) Except as otherwise provided herein, in the event of any
liquidation, dissolution or winding up of the Corporation, either voluntary
or involuntary (collectively, a "Liquidating Event"), the holders of each
series of Preferred Stock shall be entitled to receive, prior and in
preference to any distribution of any of the assets of the Corporation to
the holders of the Class A Common and Class B Common by reason of their
ownership thereof, an amount equal to the consideration paid per share of
the Preferred Stock (the "Liquidation Preference") plus an amount equal to
accrued and unpaid dividends on such shares, if any. The Liquidation
Preference of the Series A Preferred Stock shall be $6.10 per share (as
adjusted for stock splits, combinations or similar events). Written notice
of any such liquidation, dissolution or winding up, stating a payment date,
the place where such payment shall be made, the amount of each payment in
liquidation and the amount of accrued dividends to be paid shall be given
by first class mail, postage prepaid, not less than 30 days prior to the
payment date stated therein, to each holder of record of the Preferred
Stock at such holder's address as shown in the records of the Corporation.
If upon the occurrence of such event, the assets and funds to be thus
distributed among the holders of the Preferred shall be insufficient to
permit the payment to such holders of the full aforesaid preferential
amount, then the total assets and funds distributed to each series of
Preferred Stock shall be in the proportions which the product of (a) the
number of outstanding shares of such series and (b) the Liquidation
Preference of such series bears to the sum of such products for all such
series.
(2) Any assets of the Corporation remaining after the payments
specified in paragraph (1) above shall be distributed pro rata with respect
to the outstanding shares of Common Stock.
(3) For the purposes of this Section 4.3(c), any merger or
consolidation of the Corporation into or with any other corporation or
entity, or a sale, conveyance, mortgage, transfer, license, pledge, lease
or other disposition of all or substantially all of the assets of the
Corporation, shall be deemed to be a liquidation, dissolution, or winding
up of the Corporation, unless the shareholders of the Corporation
immediately prior thereto shall, immediately thereafter, hold as a group
the right to cast at least a majority of the votes of all holders of voting
securities of the resulting or surviving corporation or entity on any
matter on which any such holders of voting securities shall be entitled to
vote.
(4) For purposes of this Section 4.3(c), if any assets distributed to
shareholders upon liquidation of the Corporation consist of property other
than cash, the amount of such distribution shall be deemed to be the fair
market value thereof at the time of such distribution, as determined in
good faith by the Board of Directors of the Corporation.
Section 4.4. Designation of Series A, Series B and Series C Preferred
Stock.
3
<PAGE>
(a) Series A Preferred Stock. Eighty Two Thousand Six Hundred Thirty-Four
(82,634) of the authorized shares of Preferred Stock are hereby designated
Series A Convertible Preferred Stock (the "Series A Preferred Stock").
(1) Voting Rights. Holders of Series A Preferred Stock shall have the
number of votes equal to the number of shares of Common into which their
Series A Preferred Stock is convertible, as adjusted pursuant to Section
4.4(a)(3) hereof.
(2) Cumulative Dividends. Holders of Series A Preferred Stock shall be
entitled, when and if declared by the Board of Directors of the
Corporation, consistent with North Carolina law, to cumulative cash
dividends out of funds of the Corporation legally available for that
purpose, at an annual rate of eight percent (8%), before any dividend shall
be declared, set apart for, or paid on any share of the Common Stock or any
other series of the Preferred Stock. Each outstanding share of Series A
Preferred Stock shall be entitled to participate ratably in dividends paid
on the Series A Preferred Stock.
Such dividends shall accrue on each outstanding share of Series A
Preferred Stock whether or not earned or declared; so that, if, such
dividends with respect to any previous dividend period at the rate provided
for herein have not been paid on all shares of the Series A Preferred Stock
then outstanding, the deficiency shall be fully paid, or provision for the
full payment thereof shall have been made, before any dividend or other
distribution shall be paid on or declared on any shares of the Common Stock
or any other series of the Preferred Stock.
(3) Conversion. The holders of Series A Preferred Stock shall have
conversion rights as follows:
(a) Right to Convert. Each share of Series A Preferred Stock
shall be convertible, at the option of the holder thereof, at any time
and from time to time, and without the payment of additional
consideration by the holder thereof, into such number of fully paid
and nonassessable shares of Class A Common as is determined by
dividing $6.10 by the Conversion Price (as defined below) in effect
at the time of conversion. The "Conversion Price" for Series A
Preferred Stock shall initially be $6.10. Such initial Conversion
Price, and the rate at which shares of Series A Preferred Stock may be
converted into shares of Class A Common, shall be subject to
adjustment as provided below.
(b) Mechanics of Conversion. Before any holder of Series A
Preferred Stock shall be entitled to convert the same into full shares
of Class A Common, the holder shall surrender the certificate or
certificates therefor, duly endorsed for transfer, at the office of
the Corporation or any transfer agent of the Corporation and shall
give written notice to the Corporation at such office that he elects
to convert the same, such notice to state the name or names and
addresses to which certificates for Class A Common will be issued. No
fractional shares of Class A Common shall be issued upon conversion of
Series A Preferred Stock. In lieu of any fractional shares to which
the holder would otherwise be entitled, the Corporation shall pay cash
equal to such fraction multiplied by the then effective Conversion
Price. The
4
<PAGE>
Corporation shall, as soon as practicable thereafter, issue and
deliver at such office to such holder of Series A Preferred Stock, or
to a third party such holder may designate in writing, a certificate
or certificates for the number of shares of Class A Common to which he
shall be entitled as aforesaid and, a check payable to the holder in
the amount of any cash amounts payable as the result of conversion
into fractional shares of Class A Common plus unpaid dividends, and if
less than all the shares of the Series A Preferred Stock represented
by such certificates are converted, a certificate representing the
shares of Series A Preferred Stock not converted. Such conversion
shall be deemed to have been made immediately prior to the close of
business on the date of such surrender of the shares of Series A
Preferred Stock to be converted, and the person or persons entitled to
receive the shares of Class A Common issuable upon such conversion
shall be treated for all purposes as the record holder or holders of
such shares of Class A Common on such date. If the conversion is in
connection with an underwritten offering of securities registered
pursuant to the Securities Act of 1933, as amended, the conversion
may, at the option of any holder surrendering Series A Preferred Stock
for conversion, be conditioned upon the closing with the underwriter
of the sale of securities pursuant to such offering, in which event
the person(s) entitled to receive the Class A Common or other property
issuable upon such conversion of the Series A Preferred Stock shall
not be deemed to have converted such Series A Preferred Stock until
immediately prior to the closing of such sale of securities. Notice of
such conversion in connection with an underwritten offering of
securities shall be given by the Corporation by mail, postage
pre-paid, to the holders of the Series A Preferred Stock at their
addresses shown on the Corporation's records, at least ten (10) days
prior to the closing date of the sale of such securities. On or after
the closing date as specified in such notice, each holder of Series A
Preferred Stock shall surrender his certificate or certificates
representing such Series A Preferred Stock for the number of shares of
Class A Common to which he is entitled at the office of the
Corporation or any transfer agent for the Class A Common. The
Corporation shall, as soon as practicable thereafter, issue and
deliver at such office to such holder of Series A Preferred Stock, a
certificate or certificates for the number of shares of Class A Common
to which he shall be entitled as aforesaid, and a check payable to the
holder in the amount of any cash amounts payable as the result of a
conversion into fractional shares of Class A Common and any declared
but unpaid dividends. The conversion shall be deemed to have occurred
as of the close of business on the actual closing date with respect to
the sale of such securities, and, notwithstanding that any certificate
representing the Series A Preferred Stock to be converted shall not
have been surrendered, each holder of such Series A Preferred Stock
shall thereafter be treated for all purposes as the record holder of
the number of shares of Class A Common issuable to such holder upon
such conversion.
(c) Adjustment of Conversion Price Upon Issuance of Additional
Shares of Class A Common.
(i) The Corporation has issued options to acquire 607,500
shares of Class A Common and Class B Common of the Corporation
(the "Performance Options"). In the event the Corporation shall
issue additional shares of Class A Common upon the exercise of
any Performance Option on or after the date hereof, then and in
such event, the Conversion Price in effect on the date of, and
immediately prior to, such issue shall be reduced, concurrently
with such issue, to a price (calculated to the nearest cent)
determined by multiplying
5
<PAGE>
such Conversion Price by a fraction, the numerator of which shall
be the number of shares of Class A Common outstanding immediately
prior to such issue and the denominator of which shall be the
number of shares of Class A Common outstanding immediately prior
to such issue plus the number of such additional shares of Class
A Common so issued. For the purpose of the above calculation, the
number of shares of Class A Common outstanding immediately prior
to such issue shall be calculated on a fully diluted basis, as if
all shares of Preferred Stock and all convertible securities had
been fully converted into share of Class A Common immediately
prior to such issuance and any outstanding warrants, options or
other rights for the purchase of shares of stock or convertible
securities had been fully exercised immediately prior to such
issuance (and the resulting securities fully converted into
shares of Class A Common, if so convertible) as of such date, but
not including in such calculation any (i) additional shares of
Class A Common issuable with respect to shares of Preferred
Stock, convertible securities, or outstanding options, warrants
or other rights for the purchase of shares of stock or
convertible securities, solely as a result of the adjustment of
the respective Conversion Prices (or other conversion ratios)
resulting from the issuance of additional shares of Class A
Common causing such adjustment or (ii) Incentive Stock Options
that have become exercisable solely as a result of the passage of
time (and not as a result of a change in control).
(ii) Adjustments for Subdivisions, Class A Common Stock
Dividends, Combinations or Consolidations of Class A Common. In
the event the outstanding shares of Class A Common shall be
subdivided or increased, by stock split or stock dividend, into a
greater number of shares of Class A Common, the Conversion Price
then in effect shall concurrently with the effectiveness of such
subdivision or payment of such stock dividend, be proportionately
decreased. In the event the outstanding shares of Class A Common
shall be combined or consolidated, by reclassification or
otherwise, into a lesser number of shares of Class A Common, the
Conversion Price then in effect shall, concurrently with the
effectiveness of such combination or consolidation, be
proportionately increased.
(iii) Adjustments for Reclassification, Exchange and
Substitution. If the Class A Common issuable upon conversion of
the Series A Preferred Stock shall be changed into the same or a
different number of shares of any other class or classes of
stock, whether by capital reorganization, reclassification or
otherwise (other than a subdivision or combination of shares
provided for above), the Conversion Price then in effect shall,
concurrently with the effectiveness of such reorganization or
reclassification, be proportionately adjusted such that the
Series A Preferred Stock shall be convertible into, in lieu of
the number of shares of Class A Common which the holders would
otherwise have been entitled to receive, a number of shares of
such other class or classes of stock equivalent to the number of
shares of Class A Common that would have been subject to receipt
by the holders upon conversion of the Series A Preferred Stock
immediately before that change.
(iv) Adjustments for Merger, Sale, Lease or Conveyance. In
case of any consolidation with or merger of the Corporation with
or into another corporation, or in case of any sale, lease or
conveyance to another corporation of the assets of the
Corporation as an entirety or substantially as an entirety, the
Series A Preferred Stock shall after the date of such
consolidation, merger, sale, lease or conveyance be convertible
into the number of shares of
6
<PAGE>
stock or other securities or property (including cash) to which
the Class A Common issuable (at the time of such consolidation,
merger, sale, lease or conveyance) upon conversion of the Series
A Preferred Stock would have been entitled upon such
consolidation, merger, sale, lease or conveyance; and in any such
case, if necessary, the provisions set forth herein with respect
to the rights and interests thereafter of the holders of the
Series A Preferred Stock shall be appropriately adjusted so as to
be applicable, as nearly as may reasonably be, to any shares of
stock or other securities or property thereafter deliverable on
the conversion of the shares of Series A Preferred Stock.
(d) Mandatory Conversion. Each share of Series A Preferred Stock
shall automatically be converted into such number of fully paid and
nonassessable shares of Class A Common as is determined by dividing
$6.10 by the Conversion Price (as defined and adjusted above) in
effect at the time of conversion upon the occurrence of the closing of
an underwritten public offering pursuant to an effective registration
statement under the Securities Act of 1933, as amended, covering the
offer and sale of Class A Common of the Corporation to the public with
an aggregate gross offering price of not less than $10,000,000 and a
per share offering price of not less than $6.10. All holders of record
of shares of Series A Preferred Stock will be given at least twenty
(20) days' prior written notice of the date fixed and place designated
for mandatory conversion of the Series A Preferred Stock and the event
which resulted in the mandatory conversion of the Series A Preferred
Stock into Class A Common. Such notice shall be sent by first class
mail, postage prepaid, to each holder of record of the Series A
Preferred Stock at such holder's address shown in the records of the
Corporation. On or before the date so fixed for conversion, each
holder of shares of the Series A Preferred Stock shall surrender his
or its certificate or certificates for all such shares to the
Corporation at the place designated in such notice and shall
thereafter receive certificates for the number of shares of Class A
Common to which such holder is entitled. The mechanics for conversion
and other provisions relating to conversion of Series A Preferred
Stock into Class A Common set forth elsewhere in these Articles of
Incorporation shall apply to the mandatory conversion of the Series A
Preferred Stock.
(e) Certificate as to Adjustments. Upon the occurrence of each
adjustment or readjustment of the Conversion Price pursuant to this
Section 4.4(a)(3), the Corporation at its expense shall promptly
compute such adjustment or readjustment in accordance with the terms
hereof and furnish to each holder of Series A Preferred Stock a
certificate setting forth such adjustment or readjustment in
accordance with the terms hereof showing in detail the facts upon
which such adjustment or readjustment is based. The Corporation shall,
upon the written request at any time of any holder of Series A
Preferred Stock, furnish or cause to be furnished to such holder a
like certificate setting forth (i) such adjustments and readjustments,
(ii) the Conversion Price at the time in effect, and (iii) the number
of shares of Class A Common and the amount, if any, of other property
which at the time would be received upon the conversion of Series A
Preferred Stock.
(f) Notices of Record Date. In the event that this Corporation
shall propose at any time:
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(i) to declare any dividend or distribution (other than by
purchase of Class A Common of employees, officers and directors
pursuant to the termination of such persons or pursuant to the
Corporation's exercise of rights of first refusal with respect to
Class A Common held by such persons) upon its Class A Common,
whether in cash, property, stock or other securities, whether or
not a regular cash dividend and whether or not out of earnings or
earned surplus;
(ii) to offer for subscription pro rata to the holders of
any class or series of its stock any additional shares of stock
of any class or series or other rights;
(iii) to effect any reclassification or recapitalization of
its Class A Common shares outstanding involving a change in the
Class A Common; or
(iv) to merge or consolidate with or into any other
corporation, or sell, lease or convey all or substantially all
its property or business, or to liquidate, dissolve or wind up;
then, in connection with each such event, the Corporation shall send
to the holders of the Series A Preferred Stock:
(1) at least twenty (20) days' prior written notice of
the date on which a record shall be taken for such dividend,
distribution or subscription rights (and specifying the date
on which the holders of Class A Common shares shall be
entitled thereto) or for determining rights to vote in
respect of the matters referred to in (i) and (ii) above;
and
(2) in the case of the matters referred to in (iii) and
(iv) above, at least twenty (20) days' prior written notice
of the date when the same shall take place (and specifying
the date on which the holders of Class A Common shares shall
be entitled to exchange their Class A Common shares for
securities or other property deliverable upon the occurrence
of such event).
Each such written notice shall be given by first class mail,
postage prepaid, addressed to the holders of Series A Preferred Stock
at the address for each such holder as shown on the books of this
Corporation.
(g) No Impairment. The Corporation will not, by amendment of its
Articles of Incorporation or through any reorganization, transfer of
assets, consolidation, merger, dissolution, issue or sale of
securities or any other voluntary action (other than actions taken in
good faith), avoid the observance or performance of any of the terms
to be observed or performed hereunder by the Corporation but will at
all times in good faith assist in carrying out all the provisions of
this Section 4.4(a) and in taking all such action as may be necessary
or appropriate in order to protect the conversion rights of the
holders of the Series A Preferred Stock against impairment.
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(h) Reservation of Class A Common Stock. The Corporation shall,
at all times when the Series A Preferred Stock shall be outstanding,
reserve and keep available out of its authorized but unissued stock,
for the purpose of effecting the conversion of the Series A Preferred
Stock, such number of its duly authorized shares of Class A Common as
shall from time to time be sufficient to effect the conversion of all
outstanding Series A Preferred Stock. Before taking any action which
could cause an adjustment reducing the conversion price below the then
par value of the shares of Class A Common issuable upon conversion of
the Series A Preferred Stock or which would cause the effective
purchase price for the Series A Preferred Stock to be less than the
par value of the shares of Series A Preferred Stock, the Corporation
will take any corporate action which may, in the opinion of its
counsel, be necessary in order that the Corporation may validly and
legally issue fully paid and nonassessable shares of such Class A
Common at such adjusted Conversion Price or effective purchase price,
as the case may be.
(i) No Adjustment. Upon any voluntary conversion of the Series A
Preferred Stock, no adjustment to the conversion rights shall be made
for declared but unpaid dividends on the Series A Preferred Stock
surrendered for conversion or on the Class A Common delivered.
(j) Cancellation of Series A Preferred Stock. All shares of the
Series A Preferred Stock which shall have been surrendered for
conversion as herein provided shall no longer be deemed to be
outstanding and all rights with respect to such shares, including the
rights, if any, to receive notices and to vote, shall forthwith cease
and terminate except only the right of the holders thereof to receive
shares of Class A Common in exchange therefor and to receive payment
of any declared but unpaid dividends thereon. Any shares of the Series
A Preferred Stock so converted shall be retired and cancelled and
shall not be reissued, and the Corporation may from time to time take
such appropriate action as may be necessary to reduce the authorized
Series A Preferred Stock accordingly.
(4) Preemptive Rights. Holders of Series A Preferred Stock shall not
be entitled on account of holding such shares to preemptive rights or other
rights to acquire or subscribe for additional shares or securities of the
Corporation authorized to be issued.
(b) Series B Preferred Stock. Seven Hundred Seventy-Eight Thousand
Seven Hundred Forty-Six (778,746) shares of the authorized shares of
Preferred Stock of the Corporation are hereby designated Series B Convertible
Preferred Stock (the "Series B Preferred Stock").
(1) Dividend Provisions.
(a) Subject to the rights of any series of Preferred Stock of the
Corporation the terms of which specifically provide that such series
ranks senior to the Series B Preferred Stock and the Series C
Preferred Stock, or the terms of which specifically provide that such
series ranks pari passu with the Series B Preferred Stock and the
Series C Preferred Stock, the holders of shares of the Series B
Preferred Stock and the Series C Preferred Stock shall be entitled to
receive dividends, out of any assets legally available therefor, prior
and in preference to any declaration or payment of any dividend
(payable other than in Class A Common or Class
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B Common of the Corporation or other securities and rights convertible
into or entitling the holder thereof to receive, directly or
indirectly, additional shares of Common Stock) on the Common Stock,
when, as and if declared by the Board of Directors. No dividends shall
be payable upon any Junior Securities (as defined below) of the
Corporation unless equivalent dividends, on an as-converted basis, are
declared and paid concurrently on the Series B Preferred Stock and the
Series C Preferred Stock. For purposes of this Section 4.4(b)(1) only,
the Series A Preferred Stock ranks senior to the Series B Preferred
Stock and the Series C Preferred Stock with respect to dividends.
(b) A "Junior Security" shall include (i) the Common Stock and
(ii) any series of Preferred Stock the terms of which provide that
such series ranks junior and subordinate to the Series B Preferred
Stock and the Series C Preferred Stock with respect to dividends and
as to the distribution of assets upon any Liquidation (as defined
below) or deemed liquidation. For purposes of this Section 4.4(b)(1),
the Series B Preferred Stock shall be treated as pari passu with the
Series C Preferred Stock.
(2) Liquidation Preference.
(a) In the event of any liquidation, dissolution or winding-up of
the Corporation, either voluntary or involuntary (a "Liquidation"),
the holders of shares of Series B Preferred Stock shall be entitled to
receive, in pari passu with the holders of the Series A Preferred
Stock and the Series C Preferred Stock, and prior and in preference to
any distribution of any of the assets of the Corporation to the
holders of any Junior Securities (as defined above) by reason of their
ownership thereof, an amount per share equal to $4.52 (as adjusted
for stock splits, combinations or similar events) for each outstanding
share of Series B Preferred Stock plus any accrued or declared but
unpaid dividends (the "Series B Liquidation Preference"). If, upon the
occurrence of such an event, the assets and funds thus distributed
among the holders of the Series A Preferred Stock, the Series B
Preferred Stock and the Series C Preferred Stock shall be insufficient
to permit the payment to such holders of the full aforesaid
preferential amounts, then the entire assets and funds of the
Corporation legally available for distribution shall be distributed
ratably among the holders of the Series A Preferred Stock, the Series
B Preferred Stock and the Series C Preferred Stock in proportion to
the preferential amount each such holder is otherwise entitled to
receive.
(b) Upon the completion of the distributions required by
subsection (a) of this Section 4.4(b)(2) and any other distribution
that may be required with respect to series of Preferred Stock that
may from time to time come into existence, the remaining assets of the
Corporation available for distribution to shareholders shall be
distributed among the holders of the Common Stock pro rata based on
the number of shares of Common Stock held by each such holder.
(c) For purposes of this Section 4.4(b)(2), a Liquidation shall
be deemed to be occasioned by, or to include (i) the acquisition of
the Corporation by another entity or person by means of any
transaction or series of related transactions (including, without
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limitation, any reorganization, merger or consolidation, but excluding
any merger effected exclusively for the purpose of changing the
domicile of the Corporation) or (ii) a sale of all or substantially
all of the assets of the Corporation; unless the Corporation's
shareholders of record as constituted immediately prior to such
acquisition or sale will, immediately after such acquisition or sale
(by virtue of securities issued as consideration for the Corporation's
acquisition or sale or otherwise) hold at least 51% of the voting
power of the surviving or acquiring entity. Nothing contained in this
Section 4.4(b)(2)(c) shall in any way restrict or prohibit the holders
of Series B Preferred Stock from exercising their conversion rights
pursuant to Section 4.4(b)(4) hereof prior to the effective date of
the Liquidation to be effected hereunder.
(3) Redemption. The shares of Series B Preferred Stock shall not be
redeemable.
(4) Conversion. The holders of the Series B Preferred Stock shall have
conversion rights as follows (the "Conversion Rights"):
(a) Automatic Conversion. (i) Each share of Series B Preferred
Stock shall automatically be converted into fully paid and
nonassessable shares of Class A Common at the then effective
Conversion Rate for such series (determined in accordance with Section
4.4(a)(4)(d) below) immediately upon the closing of a Sale Event
(defined below) in which the Company Valuation (defined below) equals
or exceeds $27,000,000. (ii) Each share of Series B Preferred Stock
shall automatically be so converted at the then effective Conversion
Rate on the date specified by written consent or agreement of the
holders of two-thirds of the then outstanding shares of such series of
Series B Preferred Stock.
(b) A "Sale Event" shall include (i) an initial public offering
of the Corporation's securities in a firm commitment underwriting
pursuant to a registration statement on Form S-1 or SB-2 (or any
equivalent successor form) under the Securities Act of 1933, as
amended (an "IPO"), (ii) the consummation by the Corporation of a
merger or consolidation or other acquisition transaction in which more
than fifty percent (50%) of the voting power of the Corporation is
transferred (excluding any merger effected exclusively for the purpose
of changing the domicile of the Corporation) (a "Change in Control")
or (iii) a sale or other disposition of all or substantially all of
the assets of the Corporation (a "Sale").
(c) Right to Convert. Each share of Series B Preferred Stock
shall be convertible, at the option of the holder thereof at any time
after the date of issuance of such share at the office of the
Corporation or any transfer agent for such stock. Each share of Series
B Preferred Stock shall be convertible on a pro rata basis into the
number of fully paid and nonassessable shares of Class A Common
determined at the then effective Conversion Rate.
(d) Determination of Conversion Rate. The number of shares of
Class A Common into which the Series B Preferred Stock is convertible
is hereinafter collectively referred to as the "Conversion Rate" for
such series. The Conversion Rate for the Series B Preferred Stock
shall be determined by multiplying a fraction, the numerator of which
is the
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<PAGE>
Applicable Percentage (determined in accordance with this Section
4.4(b)(4)(d)) and the denominator of which is the difference between
1.0 and the Applicable Percentage, by the Total Number of Shares
Outstanding (as defined in Section 4.4(b)(4)(d)(iv)) on the date of
determination. The Applicable Percentage shall be determined as
follows:
(i) if the Company Valuation (defined below) is less than
$42,500,000, the Applicable Percentage shall be 0.11475;
(ii) if the Company Valuation is greater than or equal to
$42,500,000, the Applicable Percentage shall be a fraction, the
numerator of which is the sum of (A) 0.11475 multiplied by the
Company Valuation and (B) the product of 0.3 multiplied by the
difference between the Company Valuation and $42,500,000, and the
denominator of which is the Company Valuation; provided, that in
no event shall the Applicable Percentage be greater than 0.29.
(iii) The Company Valuation shall be determined as follows:
(A) in the case of an IPO, the aggregate valuation of
the Corporation taken as a whole assigned to the Corporation
by the managing underwriter on the effective date of the
registration statement relating to such IPO;
(B) in the case of any Change in Control that results
in the transfer of one hundred percent (100%) of the capital
stock of the Corporation to an unaffiliated entity, by the
aggregate cash and non-cash consideration received or to be
received by the Corporation or its securityholders (in their
capacity as securityholders and not as employees) as
consideration for their shares transferred in connection
with the transaction;
(C) in the case of any Change in Control in which more
than fifty percent (50%) but less than one hundred percent
(100%) of the voting power of the Corporation is
transferred, by multiplying the Total Number of Shares
Outstanding by a fraction, the numerator of which is the
aggregate cash and non-cash consideration received or to be
received by the Corporation or its securityholders (in their
capacity as securityholders and not as employees) as
consideration for the shares transferred in connection with
the transaction and the denominator of which is the number
of shares of Common Stock transferred in connection with the
Change in Control;
(D) in the case of any Sale, by the aggregate cash and
non-cash consideration received or to be received by the
Corporation or its securityholders (in their capacity as
securityholders and not as employees) in connection with the
transaction plus the assumption of all liabilities; or
(E) In all other cases,
(x) if the Class A Common Stock is listed on a national
securities exchange or admitted to unlisted trading
privileges on such exchange or listed
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<PAGE>
for trading on the Nasdaq National Market, by multiplying
the last reported sale price of the Class A Common on such
exchange or market on the last business day prior to the
date of determination, or if no such sale is made on such
day, the average closing bid and asked prices for such day
on such exchange or market by the Total Number of Shares
Outstanding on such date;
(y) if the Class A Common Stock is not so listed or
admitted to unlisted trading privileges, but is traded on
the Nasdaq SmallCap Market, by multiplying the average of
the closing bid and asked prices for such day on such
market, or if the Class A Common Stock is not so traded, the
mean of the last reported bid and asked prices reported by
the National Quotation Bureau, Inc. on the last business day
prior to the date of determination by the Total Number of
Shares Outstanding on such date; or
(z) if the Class A Common Stock is not so listed or
admitted to unlisted trading privileges and bid and asked
prices are not so reported, the Company Valuation shall be
an amount, not less than book value of the Corporation at
the end of the most recent fiscal year of the Corporation
ending prior to the date of determination, determined in
good faith and in such reasonable manner as may be
prescribed by the Board of Directors of the Corporation.
(iv) On any date of determination, the "Total Number of
Shares Outstanding" shall equal (A) the aggregate number of
shares of Common Stock outstanding on such date, plus (B) the
aggregate maximum number of shares of Common Stock (the
"Underlying Shares") issuable upon exercise, conversion or
exchange (assuming the satisfaction of any conditions thereto
including, without limitation, the passage of time) of securities
of the Company ("Convertible Securities") outstanding on such
date that are exercisable for, convertible into or exchangeable
for, shares of Common Stock, minus (C) Convertible Securities
exercisable for, convertible into or exchangeable for 450,000
of the Underlying Shares (subject to adjustment for stock splits,
combinations or similar events), or such lesser amount if there
are outstanding on such date of determination Convertible
Securities exercisable for, convertible into or exchangeable for
less than 450,000 shares of Common Stock. Notwithstanding
anything to the contrary herein, the Total Number of Shares
Outstanding shall not include any portion of any Convertible
Securities to the extent that such Convertible Securities, by
their explicit terms, can no longer be exercised due to their
expiration or the irrevocable failure of any precondition to
their exercisability, including the failure to achieve
performance goals required for exercisability.
(v) Notwithstanding Section 4.4(b)(4)(d)(iv), in the event
that, prior to any Sale Event, the Corporation shall issue shares
of Common Stock as consideration for any strategic acquisition by
the Corporation of another entity (the "Acquisition Shares"), and
the per share value of the Acquisition Shares multiplied by the
Total Number of Shares Outstanding immediately prior to such
acquisition (such number hereinafter referred to as the
"Acquisition Valuation") exceeds $35,000,000, the Total Number of
Shares Outstanding on the Sale Event shall be reduced by the
number of shares equal to the number of Acquisition Shares
multiplied by a fraction, the numerator of which is the
difference between the Acquisition Valuation and $35,000,000 and
the denominator of which is the Acquisition Valuation.
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(vi) If in connection with any Sale Event that is not an
IPO, any provisions are made with respect to any Convertible
Securities such that such Convertible Securities become entitled
to any cash or non-cash consideration in connection with such
Sale Event and, as a result of such provisions, the aggregate
number of shares of Common Stock and Convertible Securities
entitled to receive compensation in connection with such Sale
Event exceeds the Total Number of Shares Outstanding, then for
purposes of this Section 4.4(b)(4), the Total Number of Shares
Outstanding shall be increased by such additional number of
shares and/or Convertible Securities.
(d) Mechanics of Conversion. Before any holder of Series B
Preferred Stock shall be entitled to convert the same into shares of
Class A Common Stock, such holder shall surrender the certificate or
certificates therefor, duly endorsed, at the office of the Corporation
or of any transfer agent for the Series B Preferred Stock, and shall
give written notice to the Corporation at its principal corporate
office, of the election to convert the same and shall state therein
the name or names in which the certificate or certificates for shares
of Class A Common Stock are to be issued. The Corporation shall, as
soon as practicable thereafter, issue and deliver to such holder of
Series B Preferred Stock, or to the nominee or nominees of such
holder, a certificate or certificates for the number of shares of
Class A Common Stock to which such holder shall be entitled as
aforesaid. Such conversion shall be deemed to have been made
immediately prior to the close of business on the date of such
surrender of the shares of Series B Preferred Stock to be converted,
and the person or persons entitled to receive the shares of' Class A
Common Stock issuable upon such conversion shall be treated for all
purposes as the record holder or holders of such shares of Class A
Common Stock as of such date. If the conversion is in connection with
an underwritten offering of securities registered pursuant to the
Securities Act of 1933, as amended, the conversion may, at the option
of any holder tendering Series B Preferred Stock for conversion, be
conditioned upon the closing with the underwriters of the sale of
securities pursuant to such offering, in which event the person(s)
entitled to receive the Class A Common Stock upon conversion of the
Series B Preferred Stock shall not be deemed to have converted such
Series B Preferred Stock until immediately prior to the closing of
such sale of securities.
(e) Other Distributions. In the event the Corporation shall
declare a distribution payable in securities of other persons,
evidences of indebtedness issued by the Corporation or other persons,
assets (excluding cash dividends) or options or rights, then, in each
such case, the holders of the Series B Preferred Stock shall be
entitled to a proportionate share of any such distribution as though
they were the holders of the number of shares of Class A Common Stock
of the Corporation into which their shares of Series B Preferred Stock
are convertible as of the record date fixed for the determination of
the holders of Common Stock of the Corporation entitled to receive
such distribution.
(f) Recapitalizations. If at any time or from time to time there
shall be a recapitalization of the Common Stock (other than a merger
or sale of assets transaction provided for in Section 4.4(b)(2))
provision shall be made so that the holders of the Series B Preferred
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Stock shall thereafter be entitled to receive upon conversion of the
Series B Preferred Stock the number of shares of stock or other
securities or property of the Corporation or otherwise, to which a
holder of Class A Common Stock deliverable upon conversion would have
been entitled on such recapitalization. In any such case, appropriate
adjustment shall be made in the application of the provisions of this
Section 4.4(b)(2) with respect to the rights of the holders of the
Series B Preferred Stock after the recapitalization to the end that
the provisions of this Section 4.4(b) (including adjustment of the
number of shares issuable upon conversion of the Series B Preferred
Stock) shall be applicable after that event as nearly equivalent as
may be practicable.
(g) No Impairment. The Corporation will not, by amendment of its
Articles of Incorporation or through any reorganization,
recapitalization, transfer of assets, consolidation, merger,
dissolution, issue or sale of securities or any other voluntary
action, avoid or seek to avoid the observance or performance of any of
the terms to be observed or performed hereunder by the Corporation,
but will at all times in good faith assist in the carrying out of all
the provisions of this Section 4.4(b)(4) and in the taking of all such
action as may be necessary or appropriate in order to protect the
conversion rights of the holders of the Series B Preferred Stock
against impairment.
(h) No Fractional Shares. No fractional shares shall be issued
upon the conversion of any share or shares of the Series B Preferred
Stock, and the number of shares of Class A Common Stock to be issued
shall be rounded to the nearest whole share. Whether or not fractional
shares are issuable upon such conversion shall be determined on the
basis of the total number of shares of Series B Preferred Stock the
holder is at the time converting into Class A Common Stock and the
number of shares of Class A Common Stock issuable upon such aggregate
conversion.
(i) Notices of Record Date. In the event of any taking by the
Corporation of a record of the holders of any class of securities for
the purpose of determining the holders thereof who are entitled to
receive any dividend (other than a cash dividend) or other
distribution, any right to subscribe for, purchase or otherwise
acquire any shares of stock of any class or any other securities or
property, or to receive any other right, the Corporation shall mail to
each holder of Series B Preferred Stock, at least twenty (20) days
prior to the date specified therein, a notice specifying the date on
which any such record is to be taken for the purpose of such dividend,
distribution or right, and the amount and character of such dividend,
distribution or right.
(j) Reservation of Stock Issuable Upon Conversion. The
Corporation shall at all times reserve and keep available out of its
authorized but unissued shares of Class A Common Stock, solely for the
purpose of effecting the conversion of the shares of the Series B
Preferred Stock, such number of its shares of Class A Common Stock as
shall from time to time be sufficient to effect the conversion of all
outstanding shares of the Series B Preferred Stock; and if at any time
the number of authorized but unissued shares of Class A Common Stock
shall not be sufficient to effect the conversion of all then
outstanding shares of the Series B Preferred Stock, in addition to
such other remedies as shall be available to the holder of such
Preferred Stock, the Corporation will take such corporate action as
may, in the opinion of its counsel, be
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<PAGE>
necessary to increase its authorized but unissued shares of Class A
Common Stock to such number of shares as shall be sufficient for such
purposes, including, without limitation, engaging in best efforts to
obtain the requisite shareholder approval of any necessary amendment
to these provisions.
(k) Notices. Any notice required by the provisions of this
Section 4.4(b)(4)to be given to the holders of shares of Series B
Preferred Stock shall be deemed given upon personal delivery or upon
delivery by registered or certified mail, postage prepaid, return
receipt requested and addressed to each holder of record at his
address appearing on the books of the Corporation, or at such other
address as such party may designate by ten (10) days' advance written
notice to the Corporation.
(5) Voting Rights. Except as may otherwise be provided in these
Articles of Incorporation or by law or by contract, the Series B Preferred
Stock shall be entitled to vote, as a single class with the holders of
Class A Common Stock and the holders of any other classes or series of
stock of the Corporation so entitled to vote, on all matters as to which
the holders of Class A Common Stock shall be entitled to vote. Each share
of Series B Preferred Stock shall have that number of votes equal to the
number of shares of Class A Common Stock into which it is then convertible,
the holders of Series B Preferred Stock shall be entitled to notice of any
shareholders' meeting in accordance with the bylaws of the Corporation.
(6) Status of Converted Stock. In the event any shares of Series B
Preferred Stock shall be converted pursuant to Section 4.4(b)(4) hereof,
the shares so converted shall be cancelled by the Corporation. Any shares
so cancelled shall revert to the status of authorized but unissued
Preferred Stock without designation. The Articles of Incorporation of the
Corporation may be appropriately amended from time to time to effect the
corresponding reduction, if any, in the Corporation's authorized capital
stock.
(7) Right to Elect Director. The holders of Series B Preferred Stock,
voting as a separate class, shall have the night to elect one individual to
the Corporation's Board of Directors (the "Series B Director"). In the
event of the resignation or removal of a Series B Director, a special
meeting shall be convened at which elections shall be held for the election
of a substitute Series B Director, provided that the holders of Series B
Preferred Stock may act by written consent in lieu of such meeting.
(8) Covenants. So long as any shares of Series B Preferred Stock are
outstanding, the Corporation shall not without first obtaining the written
consent of the holders of at least two-thirds of the then outstanding
shares of Series B Preferred Stock:
(a) except in the case of a Sale Event in which the Company
Valuation is greater than or equal to $50,000,000, (i) sell, convey,
or otherwise dispose of all or substantially all of its property or
business or (ii) merge into or consolidate with any other corporation
(other than a wholly-owned subsidiary corporation or for the exclusive
purpose of changing the domicile of the Corporation) or effect any
transaction or series of related transactions if, in the case of this
subsection (ii), the Corporation's shareholders of record
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immediately prior to such transaction or series of related
transactions do not immediately after such transaction or series of
related transactions (by virtue of securities issued as consideration
for such transaction or series of related transactions) hold at least
fifty-one percent (51%) of the voting power of the Corporation;
(b) increase or decrease (other than by conversion) the total
number of authorized shares of Series B Preferred Stock or amend the
terms of the Series B Preferred Stock (or any other capital stock of
the Corporation) so as to affect the Series B Preferred Stock
adversely;
(c) authorize or issue, or obligate itself to issue, any other
equity security, including any other security or debt instrument
convertible into or exercisable for any such equity security, having a
preference over, or being on a parity with, the Series B Preferred
Stock with respect to dividends, redemption or liquidation;
(d) increase the authorized number of directors of the
Corporation to more than seven (7) members;
(e) engage in or consummate any Sale Event in which the Company
Valuation is less than $50,000,000;
(f) issue any shares of Common Stock (or any options to purchase
or rights to subscribe for Common Stock, securities by their terms
convertible into or exchangeable for Common Stock or options to
purchase or rights to subscribe for such convertible or exchangeable
securities) without consideration or for a consideration per share
less than the fair market value (determined on a per share basis in
accordance with subsection 4.4(b)(d)(iii) hereof) in effect
immediately prior to the issuance of such securities; provided, that
this restriction shall not apply to (i) shares of Common Stock
issuable or issued to employees, advisors, consultants or outside
directors of the Corporation directly or pursuant to a stock option
plan or restricted stock plan approved by the Board of Directors of
the Corporation, (ii) shares of Common Stock issuable upon exercise of
options and warrants outstanding on February 2, 1998, or (iii) Class A
Common Stock issued or issuable upon conversion of the Series A
Preferred Stock, Series B Preferred Stock or Series C Preferred Stock;
or
(g) liquidate, dissolve or otherwise wind up the affairs of the
Corporation.
(9) Amendments. No provision of these Articles of Incorporation
relating to the Series B Preferred Stock may be amended, modified or waived
without the written consent or affirmative vote of the holders of at least
two-thirds of the then outstanding shares of Series B Preferred Stock.
(c) Series C Preferred Stock. One Hundred Thirty-Two Thousand Seven
Hundred Forty-Three (132,743) shares of the authorized shares of Preferred
Stock of the Corporation are hereby designated as Series C Preferred Stock (the
"Series C Preferred Stock").
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(1) Dividend Provisions.
(a) Subject to the rights of any series of Preferred Stock of the
Corporation the terms of which specifically provide that such series
ranks senior to the Series B Preferred Stock and the Series C
Preferred Stock, or the terms of which specifically provide that such
series ranks pari passu with the Series B Preferred Stock and the
Series C Preferred Stock, the holders of shares of the Series B
Preferred Stock and the Series C Preferred Stock shall be entitled to
receive dividends, out of any assets legally available therefor, prior
and in preference to any declaration or payment of any dividend
(payable other than in Common Stock) or other securities and rights
convertible into or entitling the holder thereof to receive, directly
or indirectly, additional shares of Common Stock) on the Common Stock,
when, as and if declared by the Board of Directors. No dividends shall
be payable upon any Junior Securities of the Corporation unless
equivalent dividends, on an as-converted basis, are declared and paid
concurrently on the Series B Preferred Stock and the Series C
Preferred Stock. For purposes of this Section 4.4(c)(1), the Series C
Preferred Stock shall be treated as pari passu with the Series B
Preferred Stock and the Series A Preferred Stock ranks senior to the
Series B Preferred Stock and the Series C Preferred Stock with respect
to dividends.
(2) Liquidation Preference.
(a) In the event of any Liquidation, the holders of shares of
Series C Preferred Stock shall be entitled to receive, in pari passu
with the holders of shares of the Series A Preferred Stock and the
Series B Preferred Stock, and prior and in preference to any
distribution of any of the assets of the Corporation to the holders of
any Junior Securities by reason of their ownership thereof, an amount
per share equal to $4.52 as adjusted for stock splits, combinations
or similar events) for each outstanding share of Series C Preferred
Stock plus any accrued or declared but unpaid dividends (the "Series C
Liquidation Preference"), If, upon the occurrence of such an event,
the assets and funds thus distributed among the holders of the Series
A Preferred Stock, the Series B Preferred Stock and the Series C
Preferred Stock shall be insufficient to permit the payment to such
holders of the full aforesaid preferential amounts, then the entire
assets and funds of the Corporation legally available for distribution
shall be distributed ratably among the holders of the Series A
Preferred Stock, the Series B Preferred Stock and the Series C
Preferred Stock in proportion to the preferential amount each such
holder is otherwise entitled to receive.
(b) Upon the completion of the distributions required by
subsection (a) of this Section 4.4(c)(2) and any other distribution
that may be required with respect to series of Preferred Stock that
may from time to time come into existence, the remaining assets of the
Corporation available for distribution to shareholders shall be
distributed among the holders of the Common Stock pro rata based on
the number of shares of Common Stock held by each such holder.
(c) For purposes of this Section 4.4(c)(2), a Liquidation shall
be deemed to be occasioned by, or to include (i) the acquisition of
the Corporation by another entity or person by means of any
transaction or series of related transactions (including, without
18
<PAGE>
limitation, any reorganization, merger or consolidation, but excluding
any merger effected exclusively for the purpose of changing the
domicile of the Corporation) or (ii) a sale of all or substantially
all of the assets of the Corporation; unless the Corporation's
shareholders of record as constituted immediately prior to such
acquisition or sale will, immediately after such acquisition or sale
(by virtue of securities issued as consideration for the Corporation's
acquisition or sale or otherwise) hold at least 51% of the voting
power of the surviving or acquiring entity.
(3) Redemption.
(a) Mandatory Redemption by the Corporation.
(i) Subject to the rights of the holders of Series C
Preferred Stock set forth in Section 4.4(c)(4) below, the
Corporation shall, to the extent it may do so under applicable
law, redeem the then outstanding shares of Series C Preferred
Stock upon the occurrence of a Sale Event that results in gross
proceeds of at least $15,000,000 (the "Redemption Date"). In the
event shares of Series C Preferred Stock scheduled for redemption
are not redeemed because of a prohibition under applicable law,
such shares shall be redeemed as soon as such prohibition no
longer exists.
(ii) The redemption price (the "Redemption Price") for each
share of Series C Preferred Stock redeemed pursuant to this
Section 4.4(c)(3)(a) shall be equal to the Series C Liquidation
Preference.
(b) Surrender of Certificates. Each holder of shares of Series C
Preferred Stock to be redeemed under this Section 4.4(c)(3) shall
surrender the certificate or certificates representing such shares to
the Corporation on the Redemption Date, and thereupon the Redemption
Price for such shares as set forth in this Section 4.4(c)(3) shall be
paid to the order of the person whose name appears on such certificate
or certificates. Irrespective of whether the certificates therefor
shall have been surrendered, all shares of Series C Preferred Stock
shall be deemed to have been redeemed and shall be cancelled effective
as of the Redemption Date, unless the Corporation shall default in the
payment of the applicable Redemption Price.
(4) Conversion. Each share of the Series C Preferred Stock shall be
convertible at the option of the holder thereof at any time into such
number of shares of Class A Common Stock as determined by dividing $4.52
by the Conversion Price of $4.52.
(5) Voting Rights. Except as may otherwise be provided in these
Articles of Incorporation or by law or by contract, the Series C Preferred
Stock shall be entitled to vote, as a single class with the holders of
Class A Common Stock and the holders of any other classes or series of
stock of the Corporation so entitled to vote, on all matters as to which
the holders of Class A Common Stock shall be entitled to vote. Each share
of Series C Preferred Stock shall have that number of votes equal to
600,000 divided by 4.52. The holders of Series C Preferred
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<PAGE>
Stock shall be entitled to notice of any stockholders' meeting in
accordance with the bylaws of the Corporation.
(6) Covenants. So long as any shares of Series C Preferred Stock are
outstanding, the Corporation shall not, without first obtaining the written
consent of the holders of at least two-thirds of the then outstanding
shares of Series C Preferred Stock, increase or decrease the total number
of authorized shares of Series C Preferred Stock or amend the terms of the
Series C Preferred Stock (or any other capital stock of the Corporation) so
as to affect the Series C Preferred Stock adversely.
(7) Amendments. No provision of these Articles of Incorporation
relating to the Series C Preferred Stock may be amended, modified or waived
without the written consent or affirmative vote of the holders of at least
two-thirds of the then outstanding shares of Series C Preferred Stock.
ARTICLE V
The address of the initial registered office of the Corporation is 215
Southport Drive, Suite 1000, Morrisville, Wake County, North Carolina 27560, and
the name of its initial registered agent at such address is J.W. Stealey.
20
<PAGE>
ARTICLE VI
Section 6.1. Number of Directors. The number of directors constituting the
Board of Directors shall be not less than five (5) nor more than fifteen (15),
as specified in the Corporation's Bylaws.
Section 6.2. Classified Board of Directors. Upon such time as the number of
directors constituting the Board of Directors shall be fixed at nine (9) or
more, the Board of Directors shall be divided into three (3) classes, Class I,
Class II, and Class III, which shall be as nearly equal in number as possible.
The term of office of each Director in Class I shall expire at the first annual
meeting of shareholders of the Corporation following the effectiveness of the
resolution or bylaw fixing the number of directors at nine or more. The term of
office of each Director in Class II shall expire at the second annual meeting of
shareholders of the Corporation following the effectiveness of the resolution or
bylaw fixing the number of directors at nine or more. The term of office of each
Director in Class III shall expire at the third annual meeting of shareholders
of the Corporation following the effectiveness of the resolution or bylaw fixing
the number of directors at nine or more. Each Director shall serve until the
election and qualification of a successor or until such Director's earlier
resignation, death, or removal from office. Upon the expiration of the term of
office for each class of Directors, the Directors of such class shall be elected
for a term of three (3) years, to serve until the election and qualification of
their successors or until their earlier resignation, death, or removal from
office.
Section 6.3. Directors. The names of those persons who are to serve as the
Directors of the Corporation following the effectiveness of these Articles of
Incorporation are set forth below. The address for each such director is 215
Southport Drive, Suite 1000, Morrisville, North Carolina 27560.
J. Nicholas England
David H. Kestel
W. Joseph McClelland
Avi Suriel
J. W. Stealey
Section 6.4. Removal of Directors. Any Director, or the entire Board of
Directors, may be removed from office at any time, with or without cause, but
only by the affirmative vote of the holders of at least sixty-six and two-thirds
percent (66-2/3%) of the voting power of all of the shares of capital stock of
the Corporation then entitled to vote generally in the election of Directors. If
a Director was elected by the holders of one class or series of capital stock,
or of a group of such classes or series, only members of that voting group may
participate in the vote to remove him.
Section 6.5. Factors to be Considered by the Directors. In connection with
the exercise of its or his judgment in determining what is in the best interests
of the Corporation and its shareholders, the Board of Directors of the
Corporation, any committee of the Board of Directors, or any individual director
may, but shall not be required to, in addition to considering
21
<PAGE>
the long-term and short-term interests of the shareholders, consider any of the
following factors and any other factors that it or he deems relevant: (i) the
social and economic effects of the matter to be considered on the Corporation
and its subsidiaries, its and their employees, clients, and creditors, and the
communities in which the Corporation and its subsidiaries operate or are
located; and (ii) when evaluating a business combination or a proposal by
another Person or Persons to make a business combination or a tender or exchange
offer or any other proposal relating to a potential change of control of the
Corporation (x) the business and financial condition and earnings prospects of
the acquiring Person or Persons, including, but not limited to, debt service and
other existing financial obligations, financial obligations to be incurred in
connection with the acquisition, and other likely financial obligations of the
acquiring Person or Persons, and the possible effect of such conditions upon the
Corporation and its subsidiaries and the communities in which the Corporation
and its subsidiaries operate or are located, (y) the competence, experience, and
integrity of the acquiring Person or Persons and its or their management, and
(z) the prospects for successful conclusion of the business combination, offer
or proposal. The provisions of this Section shall be deemed solely to grant
discretionary authority to the directors and shall not be deemed to provide to
any constituency the right to be considered. As used in this Section, the term
"Person" means any individual, partnership, firm, corporation, limited liability
company, association, trust, unincorporated organization or other entity; when
two or more Persons act as a partnership, limited partnership, syndicate, or
other group acting in concert for the purpose of acquiring, holding, voting or
disposing of securities of the Corporation, such partnership, limited
partnership, syndicate or group shall also be deemed a "Person" for purposes of
this Section.
ARTICLE VII
Section 7.1. Approval of Business Combinations. With regard to any Business
Combination (as defined in Section 7.5(b)) between the Corporation and any other
corporation, person, or other entity, excluding its Subsidiaries (as defined in
Section 7.5(g)) except as provided in section 7.5(b), such Business Combination
must be approved only as follows unless otherwise more restrictively required by
applicable North Carolina law:
(a) The Business Combination must be approved by resolution adopted by
affirmative vote of a majority of a quorum of the Board of Directors;
(b) In addition to the Board approval specified in Section 7.1(a), the
Business Combination must receive one of the following levels of
shareholder approval:
(1) To the extent a shareholder's vote is required by law, at a
special or annual meeting of shareholders by an affirmative vote of
the shareholders holding at least a majority of the shares of capital
stock of the Corporation issued and outstanding and entitled to vote
thereon if such Business Combination has received the prior approval
by resolution adopted by an affirmative vote of at least sixty-six and
two-thirds percent (66 2/3%) of the full Board of Directors before
such Business Combination is submitted for approval to the
shareholders; or
22
<PAGE>
(2) At a special or annual meeting of shareholders by an
affirmative vote of the shareholders holding at least sixty-six and
two-thirds percent (66-2/3%) of the shares of capital stock of the
Corporation issued and outstanding and entitled to vote thereon if
such Business Combination has received the prior approval by
resolution adopted by an affirmative vote of a majority of a quorum
(but less than sixty-six and two-thirds percent (66-2/3%)) of the
Board of Directors; and
(c) If the Business Combination is to be approved pursuant to Section
7.1(b)(2), the Business Combination as approved must grant to shareholders
not voting to approve the Business Combination the rights set forth in
Section 7.2.
Section 7.2. Fair Price. When any Business Combination above is approved
pursuant to Section 7.1(b)(2), any shareholder not voting to approve the
Business Combination may elect to sell his shares for cash to the Corporation at
their "Fair Price" (as defined in Section 7.5(f)), upon so notifying the
Corporation in writing within twenty (20) days after receiving written
notification of his rights hereunder and that the Business Combination was
approved by the Corporation's shareholders. The Corporation shall have ten (10)
days after receipt of the shareholder's tender of shares to make payment in
cash. Tender of shares may be made simultaneously with, or after, the
shareholder's written notification that he is electing to be paid the Fair Price
of his shares. The Business Combination shall not be consummated until all
shareholders electing to sell their shares for cash to the Corporation at their
Fair Price pursuant to this Article VII have been paid in full by the
Corporation.
Section 7.3. Certain Restrictions on Business Combinations. Notwithstanding
any other provision of this Article VII, prior to the consummation of any
Business Combination between the Corporation and a Control Person (as defined in
Section 7.5(c)):
(a) such Control Person shall not have received the benefit, directly
or indirectly (except proportionately as a shareholder), of any loans,
advances, guarantees, pledges or other financial assistance or tax credits
provided by the Corporation; and
(b) there shall have been no increase or reduction in the annual rate
of dividends paid on the Corporation's common stock after the Control
Person became such (except as necessary to reflect any subdivision of the
common stock), unless such increase or reduction has been approved by a
majority of Disinterested Directors (as defined in Section 7.5(e)).
Section 7.4. Amendments to Articles of Incorporation. Amendments to these
Articles of Incorporation shall be adopted only upon receiving the affirmative
vote of the holders of at least sixty-six and two-thirds percent (66 2/3%) of
all the shares of capital stock of the Corporation issued and outstanding and
entitled to vote thereon; provided, however, that if such amendment shall have
received prior approval by resolution adopted by an affirmative vote of a
majority of Disinterested Directors, then the affirmative vote of the holders of
at least a majority of all the shares of capital stock of the Corporation issued
and outstanding and entitled to vote, or such greater percentage approval as
required by North Carolina law, shall be sufficient to amend these Articles of
Incorporation.
23
<PAGE>
Section 7.5. Definitions. As used in this Article VII, the following terms
shall have the following meanings:
(a) "Affiliate," as used in defining "Control Person," shall mean a
corporation, person, group, or other entity that directly or indirectly
controls, is controlled by, or is under common control with the Control
Person.
(b) "Business Combination" shall mean (i) any merger or consolidation
of the Corporation into any other corporation, person, group or other
entity where the Corporation is not the surviving or resulting entity; (ii)
any merger or consolidation of the Corporation with or into any Control
Person or with any corporation, person, group or other entity where the
merger or consolidation is proposed by or on behalf of a Control Person;
(iii) any sale, lease, exchange, transfer, hypothecation or other
disposition of all or substantially all of the assets of the Corporation;
(iv) any sale, lease, exchange, transfer, hypothecation or other
disposition of a Substantial Part (as defined in Section 7.5(h)) of the
assets of the Corporation to a Control Person, whether in a single
transaction or in related transactions; (v) the issuance of any securities
of the Corporation to a Control Person; (vi) the acquisition by the
Corporation of any securities of a Control Person unless such acquisition
commences prior to the person becoming a Control Person or is an attempt to
prevent the Control Person from obtaining greater control of the
Corporation; (vii) the acquisition by the Corporation of all or
substantially all of the assets of any Control Person or any corporation,
person, group or other entity where the acquisition is proposed by or on
behalf of a Control Person; (viii) the adoption of any plan or proposal for
the liquidation or dissolution of the corporation which is proposed by or
on behalf of a Control Person; (ix) any reclassification of securities
(including any reverse stock split), or recapitalization of the Corporation
which has the effect, directly or indirectly, of increasing the
proportionate share of the outstanding shares of any class of equity or
convertible securities of the Corporation which is beneficially owned or
controlled by a Control Person; (x) any of the transactions described in
this definition of Business Combination which are between the Corporation
and any of its Subsidiaries and which are proposed by or on behalf of any
Control Person; or (xi) any agreement, plan, contract or other arrangement
providing for any of the transactions described in this definition of
Business Combination.
(c) "Control Person" shall mean and include any corporation, person,
group or other entity which, together with its Affiliates prior to a
Business Combination beneficially owns (as the term is defined by federal
securities law) ten percent (10%) or more of the shares of any class of
equity or convertible securities of the Corporation, and any Affiliate of
any such corporation, person, group or other entity; provided, however, any
corporation, person, group or other entity which, together with its
Affiliates, prior to June 30, 1998 beneficially owned (as the term is
defined by federal securities law) ten percent (10%) or more of the shares
of any class of equity or convertible securities of the Corporation, and
any Affiliate of any such corporation, person, group or other entity shall
not be considered to be a Control Person for the purposes hereof.
(d) "Corporation" shall mean I-Magic Mergeco, Inc. and its
Subsidiaries, or any one of them, and their successors.
24
<PAGE>
(e) "Disinterested Director" shall mean any member of the Board of
Directors of the Corporation who is unaffiliated with, and not a nominee
of, a Control Person and was a member of the Board of Directors prior to
the time a Control Person became such, and any successor of a Disinterested
Director who is unaffiliated with, and not a nominee of, a Control Person
and who is recommended to succeed a Disinterested Director by a majority of
Disinterested Directors then on the Board of Directors.
(f) "Fair Price" shall mean the highest of the following: (i) the
highest price per share paid for the Corporation's shares during the four
years immediately preceding the Section 7.1(b)(2) vote of shareholders by
any shareholder who, at the time of the Section 7.1(b)(2) shareholder vote,
beneficially owned five percent (5%) or more of the Corporation's common
stock and who, in whole or in part, votes in favor of the Business
Combination; (ii) the cash value of the highest price per share previously
offered pursuant to a tender offer to the shareholders of the Corporation
within the four years immediately preceding the Section 7.1(b)(2)
shareholder vote; and (iii) the highest price per share (including
brokerage commissions, soliciting dealers' fees and dealer-management
compensation) paid by a Control Person in acquiring any of its holdings of
the Corporation's common stock.
(g) "Subsidiaries" shall mean any entity in which the Corporation
owns, directly or indirectly, a majority of the voting interests.
(h) "Substantial Part" shall mean more than ten percent (10%) of the
total assets of the Corporation, as of the end of the Corporation's most
recent fiscal year prior to the time the determination is being made.
ARTICLE VIII
The Board of Directors shall have the power to adopt, amend, alter, change,
and repeal the Bylaws of the Corporation. In addition to any requirements of the
Bylaws and the North Carolina Business Corporation Act as in effect from time to
time (and notwithstanding the fact that a lesser percentage may be specified by
the Bylaws or the North Carolina Business Corporation Act), the affirmative vote
of the holders of at least sixty-six and two-thirds percent (66-2/3%) of the
voting power of all the shares of capital stock of the Corporation then entitled
to vote generally in the election of directors, voting together as a single
class, shall be required for the shareholders of the Corporation to adopt,
amend, alter, change, or repeal the Bylaws of the Corporation.
ARTICLE IX
Except to the extent that the North Carolina General Statutes prohibit such
limitation or elimination of liability of directors for breaches of duty, no
director of the Corporation shall have any personal liability arising out of an
action whether by or in the right of the Corporation or otherwise for monetary
damages for breach of any duty as a director. No amendment to or repeal of this
article shall apply to or have any effect on the liability or alleged liability
of any director
25
<PAGE>
of the Corporation for or with respect to any acts or omissions of such director
occurring prior to such amendment or repeal. The provisions of this article
shall not be deemed to limit or preclude indemnification of a director by the
Corporation for any liability that has not been eliminated by the provisions of
this article.
ARTICLE X
Section 10.1. Opt-Out of North Carolina Shareholder Protection Act. The
provisions of the North Carolina Shareholder Protection Act, as amended from
time to time, shall not be applicable to the Corporation.
Section 10.2. Opt-Out of North Carolina Control Share Acquisition Act. The
provisions of the North Carolina Control Share Acquisition Act, as amended from
time to time, shall not be applicable to the Corporation.
IN WITNESS WHEREOF, I have hereunto set my hand this 9th day of June, 1998.
/s/ Robert L. Pickens
--------------------------------
Robert L. Pickens, Incorporator
215 Southport Drive, Suite 1000
Morrisville, North Carolina 27560
<PAGE>
ARTICLES OF CORRECTION
TO
ARTICLES OF INCORPORATION
OF
INTERACTIVE MAGIC, INC. (F/K/A I-MAGIC MERGECO, INC.)
Pursuant to Section 55-1-24 of the North Carolina General Statutes, the
undersigned corporation hereby submits these Articles of Correction for the
purpose of correcting a document filed with the Secretary of State:
1. The name of the corporation is Interactive Magic, Inc.
2. On June 11, 1998, the corporation filed Articles of Incorporation
under the name I-Magic Mergeco, Inc.
3. The Articles of Incorporation contain a statement that is incorrect
as of the date hereof and that was incorrect when the Articles of Incorporation
were filed. Article VII, Section 7.5(c) improperly references an incorrect date
(June 30, 1998). Article VII, Section 7.5(c) provides as follows:
(c) "Control Person" shall mean and include any corporation,
person, group or other entity which, together with its
Affiliates prior to a Business Combination beneficially owns
(as the term is defined by federal securities law) ten percent
(10%) or more of the shares of any class of equity or
convertible securities of the Corporation, and any Affiliate
of any such corporation, person, group or other entity;
provided, however, any corporation, person, group or other
entity which, together with its Affiliates, prior to June 30,
1998, beneficially owned (as the term is defined by federal
securities law) ten percent (10%) or more of the shares of any
class of equity or convertible securities of the Corporation,
and any Affiliate of any such corporation, person, group or
other entity shall not be considered to be a Control Person
for the purposes hereof.
4. The correct reference should be July 2, 1998. Article VII, Section
7.5(c) shall be corrected by deleting it in its entirety and substituting
therefor the following:
(c) "Control Person" shall mean and include any corporation,
person, group or other entity which, together with its
Affiliates prior to a Business Combination beneficially owns
(as the term is defined by federal securities law) ten percent
(10%) or more of the shares of any class of equity or
<PAGE>
convertible securities of the Corporation, and any Affiliate
of any such corporation, person, group or other entity;
provided, however, any corporation, person, group or other
entity which, together with its Affiliates, prior to July 2,
1998, beneficially owned (as the term is defined by federal
securities law) ten percent (10%) or more of the shares of any
class of equity or convertible securities of the Corporation,
and any Affiliate of any such corporation, person, group or
other entity shall not be considered to be a Control Person
for the purposes hereof.
This the 13th day of July, 1998.
INTERACTIVE MAGIC, INC.
By: /s/ Robert L. Pickens
----------------------
Robert L. Pickens
President
EXHIBIT 4.01
Common Stock [Interactive Magic logo]
INCORPORATED UNDER THE LAWS
OF THE STATE OF NORTH CAROLINA
NUMBER Shares
IM ______________ _________________________
See Reverse for Certain Definitions
CUSIP 45838M 10 4
This Certifies that __________ is the owner of __________ fully paid and
non-assessable Shares of the Common Stock, Par Value $.10 per Share of
Interactive Magic, Inc. transferable on the books of the Corporation by the
holders hereof in person or by duly authorized attorney upon surrender of this
Certificate properly endorsed.
This Certificate is not valid unless countersigned by the Transfer
Agent and registered by the Registrar.
Witness the facsimile seal of the Corporation and the facsimile
signatures of its duly authorized officers.
Dated: __________
/s/ William H. Marks /s/ Robert L. Pickens
Secretary President
COUNTERSIGNED AND REGISTERED: TRANSFER AGENT AND REGISTRAR
WACHOVIA BANK, N.A.
By:______________________________
Authorized Signature
<PAGE>
INTERACTIVE MAGIC, INC.
The record holder of this Certificate may obtain from the Secretary
of the Corporation, upon request and without charge, a full statement of the
designation, relative rights, preferences and limitations of the shares of each
class authorized to be issued and the designation, relative rights, preferences
and limitations of each series of preferred shares authorized to be issued so
far as the same have been fixed and the authority of the Board of Directors to
designate and fix the relative rights, preferences and limitations of other
series.
The following abbreviations, when used in the inscription on the face
of this certificate, shall be construed as though they were written out in full
according to applicable laws or regulations:
<TABLE>
<CAPTION>
<S> <C>
TEN COM as tenants in common
TEN ENT as tenants by the entirety
JT TEN as joint tenants with right of survivorship
UNIF TRANS MIN ACT ___________ Custodian ______________
(Cust) (Minor)
Under Uniform Transfers to Minors Act __________________
(State)
Additional abbreviations may also be used though not in the above list.
For value received hereby sell, assign and transfer unto
----------------------------------
</TABLE>
Please insert Social Security or other identifying number of assignee
- -----------------------------------------------------------------------
- ----------------------------------------------------------------------
Please print or type/write name and address of assignee
- -----------------------------------------------------------------------
- -----------------------------------------------------------------------
Shares
- --------------------------------------------------------------------
of the Stock represented by the within Certificate, and do hereby irrevocably
constitute and appoint __________________ Attorney, to transfer the said shares
on the books of the within name Corporation with full power of substitution.
Dated, __________________
__________________
__________________
NOTICE: THE SIGNATURE(S) TO
THIS ASSIGNMENT MUST
CORRESPOND WITH THE
NAMES(S) AS WRITTEN UPON
THE FACE OF THE
CERTIFICATE, IN EVERY
PARTICULAR, WITHOUT
ALTERATION OR ENLARGEMENT
OR ANY CHANGE WHATSOEVER.
<PAGE>
Signature(s) Guaranteed: ___________________________
THE SIGNATURE(S) SHOULD BE
GUARANTEED BY AN ELIGIBLE
GUARANTOR INSTITUTION, AS
DEFINED IN RULE 17A-15
UNDER THE SECURITIES AND
EXCHANGE ACT OF 1934, AS
AMENDED.
KEEP THIS CERTIFICATE IN A SAFE PLACE. IF IT IS LOST, STOLEN, OR DESTROYED, THE
CORPORATION MAY REQUIRE A BOND OF INDEMNITY AS A CONDITION TO THE ISSUANCE OF A
REPLACEMENT CERTIFICATE.
WARRANT AGREEMENT dated as of _____ __, 1998 between Interactive Magic,
Inc., a North Carolina corporation (the "Company"), on one hand, and BlueStone
Capital Partners, L.P. ("BlueStone") and Royce Investment Group, Inc. (together
with BlueStone collectively hereinafter referred to as the "Representatives"),
on the other hand.
W I T N E S S E T H:
WHEREAS, the Company proposes to issue to the Representatives, in their
individual capacity and not as representatives of the several Underwriters
(defined below), warrants ("Warrants") to purchase up to 260,000 (as such number
may be adjusted from time to time pursuant to Article 8 of this Agreement)
shares (the "Shares") of common stock, par value $.10 per share, of the Company
(the "Common Stock"); and
WHEREAS, the Representatives have agreed, pursuant to the underwriting
agreement (the "Underwriting Agreement") dated _______ __, 1998 between the
Representatives, as representatives of the several underwriters named in
Schedule A to the Underwriting Agreement (the "Underwriters") and the Company,
to act as representatives of the several Underwriters in connection with the
Company's proposed public offering (the "Public Offering") of 2,600,000 shares
of Common Stock (the "Public Shares") at an initial public offering price of
$____ per share; and
WHEREAS, the Warrants issued pursuant to this Agreement are being
issued by the Company to the Representatives and/or to their designees who are
officers or partners of the Representatives and/or, at the Representatives'
direction, to members of the selling group or underwriting syndicate and/or
their respective officers or partners (collectively, the "Designees"), in
consideration for, and as part of the Representatives' compensation in
connection with, the Representatives' acting as representatives of the several
Underwriters pursuant to the Underwriting Agreement;
NOW, THEREFORE, in consideration of the premises, the payment by the
Representatives to the Company of TWO HUNDRED AND SIXTY DOLLARS ($260), the
agreements herein set forth and other good and valuable consideration, the
receipt and sufficiency of which are hereby acknowledged, the parties hereto
agree as follows:
1. Grant.
The Representatives and/or their Designees are hereby granted the right
to purchase, at any time from ______ __, 1999 until 5:00 P.M., New York City
time, on ______ __, 2003, (the "Warrant Exercise Term"), up to 260,000 fully
paid and non-
<PAGE>
assessable Shares at an initial exercise price (subject to adjustment as
provided in Article 8 hereof) of $_______ per Share.
2. Warrant Certificates.
The warrant certificates delivered and to be delivered pursuant to this
Agreement (the "Warrant Certificates") shall be in the form set forth as Exhibit
A attached hereto and made a part hereof, with such appropriate insertions,
omissions, substitutions and other variations as required or permitted by this
Agreement.
3. Exercise of Warrants.
3.1 Cash Exercise. The Warrants initially are exercisable at a
price of $______ per Share, payable in cash or by check to the order of the
Company, or any combination thereof, subject to adjustment as provided in
Article 8 hereof. Upon surrender of a Warrant Certificate with the annexed Form
of Election to Purchase duly executed, together with payment of the Exercise
Price (as hereinafter defined) for the Shares purchased, at the Company's
principal offices in North Carolina (currently located at 215 Southport Drive,
suite 1000, Morrisville, North Carolina 27560) the registered holder of a
Warrant Certificate ("Holder" or "Holders") shall be entitled to receive a
certificate or certificates for the Shares so purchased. The purchase rights
represented by each Warrant Certificate are exercisable at the option of the
Holder thereof, in whole or in part (but not as to fractional shares of the
Common Stock). In the case of the purchase of less than all the Shares
purchasable under any Warrant Certificate, the Company shall cancel said Warrant
Certificate upon the surrender thereof and shall execute and deliver a new
Warrant Certificate of like tenor for the balance of the Shares purchasable
thereunder.
3.2 Cashless Exercise. At any time during the Warrant Exercise
Term, the Holder may, at the Holder's option, exchange, in whole or in part, the
Warrants represented by such Holder's Warrant Certificate (a "Warrant
Exchange"), into the number of Shares determined in accordance with this Section
3.2, by surrendering such Warrant Certificate at the principal office of the
Company or at the office of its transfer agent, accompanied by a notice stating
such Holder's intent to effect such exchange, the number of Warrants to be so
exchanged and the date on which the Holder requests that such Warrant Exchange
occur (the "Notice of Exchange"). The Warrant Exchange shall take place on the
date specified in the Notice of Exchange or, if later, the date the Notice of
Exchange is received by the Company (the "Exchange Date"). Certificates for the
Shares issuable upon such Warrant Exchange and, if applicable, a new Warrant
Certificate of like tenor representing the Warrants which were subject to the
surrendered Warrant Certificate and not included
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in the Warrant Exchange, shall be issued as of the Exchange Date and delivered
to the Holder within three (3) days following the Exchange Date. In connection
with any Warrant Exchange, the Holder shall be entitled to subscribe for and
acquire (i) the number of Shares (rounded to the next highest integer) which
would, but for the Warrant Exchange, then be issuable pursuant to the provision
of Section 3.1 above upon the exercise of the Warrants specified by the Holder
in its Notice of Exchange (the "Total Number") less (ii) the number of Shares
equal to the quotient obtained by dividing (a) the product of the Total Number
and the existing Exercise Price (as hereinafter defined) by (b) the Market Price
(as hereinafter defined) of a Public Share on the day preceding the Warrant
Exchange. "Market Price" at any date shall be deemed to be the last reported
sale price, or, in case no such reported sales takes place on such day, the
average of the last reported sale prices for the last three (3) trading days, in
either case as officially reported by the principal securities exchange on which
the Common Stock is listed or admitted to trading or as reported in the NASDAQ
National Market system, or, if the Common Stock is not listed or admitted to
trading on any national securities exchange or quoted on the NASDAQ National
Market System, the closing bid price as furnished by (i) the National
Association of Securities Dealers, Inc. through NASDAQ or (ii) a similar
organization if NASDAQ is no longer reporting such information.
4. Issuance of Certificates.
Upon the exercise of the Warrants, the issuance of certificates for the
Shares purchased shall be made forthwith (and in any event within three (3)
business days thereafter) without charge to the Holder thereof including,
without limitation, any tax which may be payable in respect of the issuance
thereof, and such certificates shall (subject to the provisions of Article 5
hereof) be issued in the name of, or in such names as may be directed by, the
Holder thereof; provided, however, that the Company shall not be required to pay
any tax which may be payable in respect of any transfer involved in the issuance
and delivery of any such certificates in a name other than that of the Holder
and the Company shall not be required to issue or deliver such certificates
unless or until the person or persons requesting the issuance thereof shall have
paid to the Company the amount of such tax or shall have established to the
satisfaction of the Company that such tax has been paid.
The Warrant Certificates and the certificates representing the Shares
shall be executed on behalf of the Company by the manual or facsimile signature
of the present or any future Chairman or Vice Chairman of the Board of Directors
or President or Vice President of the Company under its corporate seal
reproduced thereon, attested to by the manual or facsimile signature of the
present or any future Secretary or Assistant Secretary of the Company. Warrant
Certificates shall be dated
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the date of execution by the Company upon initial issuance, division, exchange,
substitution or transfer.
Upon exercise, in part or in whole, of the Warrants, certificates
representing the Shares shall bear a legend substantially similar to the
following:
"The securities represented by this certificate have not been registered
for purposes of public distribution under the Securities Act of 1933, as
amended (the "Act"), and may not be offered or sold except (i) pursuant to
an effective registration statement under the Act, (ii) to the extent
applicable, pursuant to Rule 144 under the Act (or any similar rule under
such Act relating to the disposition of securities), or (iii) upon the
delivery by the holder to the Company of an opinion of counsel, reasonably
satisfactory to counsel to the Company, stating that an exemption from
registration under such Act is available."
5. Restriction on Transfer of Warrants.
The Holder of a Warrant Certificate, by the Holder's acceptance
thereof, covenants and agrees that the Warrants are being acquired as an
investment and not with a view to the distribution thereof, and that the
Warrants may not be sold, transferred, assigned, hypothecated or otherwise
disposed of, in whole or in part, for a period of one (1) year from the date
hereof, except to the Designees.
6. Price.
6.1. Initial and Adjusted Exercise Price. The initial exercise
price of each Warrant shall be $____ per Share. The adjusted exercise price per
Share shall be the price which shall result from time to time from any and all
adjustments of the initial exercise price in accordance with the provisions of
Article 8 hereof.
6.2. Exercise Price. The term "Exercise Price" herein shall mean
the initial exercise price per Share or the adjusted exercise price per Share,
depending upon the context.
7. Registration Rights.
7.1. Registration Under the Securities Act of 1933. None of the
Warrants or Shares have been registered for purposes of public distribution
under the Securities Act of 1933, as amended (the "Act").
7.2. Registrable Securities. As used herein the
term "Registrable Security" means each of the Warrants, the
Shares and any shares of Common Stock issued upon any stock split
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or stock dividend in respect of such Shares; provided, however, that with
respect to any particular Registrable Security, such security shall cease to be
a Registrable Security when, as of the date of determination, (i) it has been
effectively registered under the Act and disposed of pursuant thereto, (ii)
registration under the Act is no longer required for the subsequent public
distribution of such security or (iii) it has ceased to be outstanding. The term
"Registrable Securities" means any and/or all of the securities falling within
the foregoing definition of a "Registrable Security." In the event of any
merger, reorganization, consolidation, recapitalization or other change in
corporate structure affecting the Common Stock, such adjustment shall be made in
the definition of "Registrable Security" as is appropriate in order to prevent
any dilution or enlargement of the rights granted pursuant to this Article 7.
7.3. Piggyback Registration. If, at any time during the seven
years following the effective date of the Public Offering, the Company proposes
to prepare and file one or more post-effective amendments to the registration
statement filed in connection with the Public Offering or any new registration
statement or post-effective amendments thereto covering equity or debt
securities of the Company, or any such securities of the Company held by its
shareholders (in any such case, other than in connection with a merger,
acquisition or pursuant to Form S-8 or successor form), (for purposes of this
Article 7, collectively, the "Registration Statement"), it will give written
notice of its intention to do so by registered mail ("Notice"), at least thirty
(30) days prior to the filing of each such Registration Statement, to all
holders of the Registrable Securities. Upon the written request of such a holder
(a "Requesting Holder"), made within twenty (20) days after receipt of the
Notice, that the Company include any of the Requesting Holder's Registrable
Securities in the proposed Registration Statement, the Company shall, as to each
such Requesting Holder, use its best efforts to effect the registration under
the Act of the Registrable Securities which it has been so requested to register
("Piggyback Registration"), at the Company's sole cost and expense and at no
cost or expense to the Requesting Holders (expect as provided in Section 7.5(b)
hereof); provided, however, that if, in the written opinion of the Company's
managing underwriter, if any, for such offering, the inclusion of all or a
portion of the Registrable Securities requested to be registered, when added to
the securities being registered by the Company or the selling shareholder(s),
will exceed the maximum amount of the Company's securities which can be marketed
(i) at a price reasonably related to their then current market value, or (ii)
without otherwise materially adversely affecting the entire offering, then the
Company may exclude from such offering all or a portion of the Registrable
Securities which it has been requested to register.
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Notwithstanding the provisions of this Section 7.3, the Company shall
have the right at any time after it shall have given written notice pursuant to
this Section 7.3 (irrespective of whether any written request for inclusion of
Registrable Securities shall have already been made) to elect not to file any
such proposed Registration Statement, or to withdraw the same after the filing
but prior to the effective date thereof.
7.4. Demand Registration.
(a) At any time during the Warrant Exercise Term, any
"Majority Holder" (as such term is defined in Section 7.4.(c) below) of the
Registrable Securities shall have the right (which right is in addition to the
piggyback registration rights provided for under Section 7.3 hereof),
exercisable by written notice to the Company (the "Demand Registration
Request"), to have the Company prepare and file with the Securities and Exchange
Commission (the "Commission"), on one occasion, at the sole expense of the
Company (except as provided in Section 7.5.(b) hereof), a Registration Statement
and such other documents, including a prospectus, as may be necessary (in the
opinion of both counsel for the Company and counsel for such Majority Holder),
in order to comply with the provisions of the Act, so as to permit a public
offering and sale of the Registrable Securities by the holders thereof. The
Company shall use its best efforts to cause the Registration Statement to become
effective under the Act, so as to permit a public offering and sale of the
Registrable Securities by the holders thereof. Once effective, the Company will
use its best efforts to maintain the effectiveness of the Registration Statement
until the earlier of (i) the date that all of the Registrable Securities have
been sold or (ii) the date that the holders of the Registrable Securities
receive an opinion of counsel to the Company that all of the Registrable
Securities may be freely traded (without limitation or restriction as to
quantity or timing and without registration under the Act) under Rule 144(k)
promulgated under the Act or otherwise. Notwithstanding the foregoing, if (i) in
the good faith judgment of the Board of Directors of the Company, such
registration would be materially detrimental to the Company, and the Board of
Directors of the Company concludes, as a result, that it is essential to defer
the filing of such Registration Statement at such time, and (ii) the Company
shall furnish to such Holders a certificate signed by the President of the
Company stating that, in the good faith judgment of the Board of Directors of
the Company, it would be materially detrimental to the Company for such
Registration Statement to be filed in the near future and that it is, therefore,
essential to defer the filing of such Registration Statement, then the Company
shall have the right to defer such filing for a period of not more than one
hundred twenty (120) days after receipt of the Demand Registration Request, and
provided further, that the Company shall not defer its obligation in this manner
more than two (2) times in any rolling twelve (12) month period and should the
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Company delay the filing of a Registration Statement upon receipt of a Demand
Registration Request, the exercise period of the Warrants shall be extended, for
each such delay, for a period of time equal in length to the delay in
registration.
(b) The Company covenants and agrees to give written notice of
any Demand Registration Request to all holders of the Registrable Securities
within ten (10) business days from the date of the Company's receipt of any such
Demand Registration Request. After receiving notice from the Company as provided
in this Section 7.4(b), holders of Registrable Securities may request the
Company to include their Registrable Securities in the Registration Statement to
be filed pursuant to Section 7.4(a) hereof by notifying the Company of their
decision to have such securities included within ten (10) days of their receipt
of the Company's notice.
(c) The term "Majority Holder" as used in Section 7.4 hereof
shall mean any holder or any combination of holders of Registrable Securities,
if included in such holders' Registrable Securities are that aggregate number of
Shares (including Shares already issued and Shares issuable pursuant to the
exercise of outstanding Warrants) as would constitute a majority of the
aggregate number of Shares (including Shares already issued and Shares issuable
pursuant to the exercise of outstanding Warrants) included in all the
Registrable Securities.
7.5. Covenants of the Company With Respect to
Registration. The Company covenants and agrees as follows:
(a) In connection with any registration under Section 7.4
hereof, the Company shall file the Registration Statement as expeditiously as
possible, but in any event no later than thirty (30) business days following
receipt of any demand therefor, shall use its best efforts to have any such
Registration Statement declared effective at the earliest possible time, and
shall furnish each holder of Registrable Securities such number of prospectuses
as shall reasonably be requested.
(b) The Company shall pay all costs, fees and expenses (other
than underwriting fees, discounts and nonaccountable expense allowances
applicable to the Registrable Securities and the fees and expenses of counsel
retained by the holders of the Registrable Securities) in connection with all
Registration Statements filed pursuant to Sections 7.3. and 7.4.(a) hereof
including, without limitation, the Company's legal and accounting fees, printing
expenses, and blue sky fees and expenses.
(c) The Company will take all necessary action which may be
required in qualifying or registering the Registrable Securities included in the
Registration Statement for offering and sale under the securities or blue sky
laws of such
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states as are reasonably requested by the holders of such securities, provided
that the Company shall not be obligated to execute or file any general consent
to service of process or to qualify as a foreign corporation to do business
under the laws of any such jurisdiction.
(d) The Company shall indemnify any holder of the Registrable
Securities to be sold pursuant to any Registration Statement and any underwriter
or person deemed to be an underwriter under the Act and each person, if any, who
controls such holder or underwriter or person deemed to be an underwriter within
the meaning of Section 15 of the Act or Section 20(a) of the Securities Exchange
Act of 1934, as amended ("Exchange Act"), against all loss, claim, damage,
expense or liability (including all expenses reasonably incurred in
investigating, preparing or defending against any claim whatsoever) to which any
of them may become subject under the Act, the Exchange Act or otherwise, arising
from such registration statement to the same extent and with the same effect as
the provisions pursuant to which the Company has agreed to indemnify the
Underwriters as set forth in Section 7 of the Underwriting Agreement and to
provide for just and equitable contribution as set forth in Section 8 of the
Underwriting Agreement.
(e) Any holder of Registrable Securities to be sold pursuant
to a Registration Statement, and such Holder's successors and assigns, shall
severally, and not jointly, indemnify, the Company, its officers and directors
and each person, if any, who controls the Company within the meaning of Section
15 of the Act or Section 20(a) of the Exchange Act, against all loss, claim,
damage or expense or liability (including all expenses reasonably incurred in
investigating, preparing or defending against any claim whatsoever) to which
they may become subject under the Act, the Exchange Act or otherwise, arising
from information furnished by or on behalf of such Holder, or such Holder's
successors or assigns, for specific inclusion in such Registration Statement to
the same extent and with the same effect as the provisions pursuant to which the
Underwriters have agreed to indemnify the Company as set forth in Section 7 of
the Underwriting Agreement and to provide for just and equitable contribution as
set forth in Section 8 of the Underwriting Agreement.
(f) Nothing contained in this Agreement shall be construed as
requiring any Holder to exercise the Warrants held by such Holder prior to the
initial filing of any Registration Statement or the effectiveness thereof.
(g) The Company shall promptly deliver copies of all
correspondence between the Commission and the Company, its counsel or auditors
and all memoranda relating to discussions with the Commission or its staff with
respect to the Registration Statement to each Holder of Registrable Securities
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included for registration in such Registration Statement pursuant to Section 7.3
or Section 7.4 hereof that requests such correspondence and memoranda and to the
managing underwriter, if any, of the offering in connection with which such
Holder's Registrable Securities are being registered and shall permit each such
Holder and managing underwriter to do such investigation, upon reasonable
advance notice, with respect to information contained in or omitted from the
Registration Statement as it deems reasonably necessary to comply with
applicable securities laws or rules of the National Association of Securities
Dealers, Inc. Such investigation shall include access to books, records and
properties and opportunities to discuss the business of the Company with its
officers and independent auditors, all to such reasonable extent and at such
reasonable times and as often as any such Holder or managing underwriter shall
reasonably request.
8. Adjustments of Exercise Price and Number of
Shares.
8.1 Computation of Adjusted Price. In case the Company shall at
any time after the date hereof pay a dividend in shares of Common Stock or make
a distribution in shares of Common Stock, then upon such dividend or
distribution, the Exercise Price in effect immediately prior to such dividend or
distribution shall forthwith be reduced to a price determined by dividing:
(a) an amount equal to the total number
of shares of Common Stock outstanding immediately prior to such dividend or
distribution multiplied by the Exercise Price in effect immediately prior to
such dividend or distribution, by
(b) the total number of shares of
Common Stock outstanding immediately after such issuance or sale.
For the purposes of any computation to be made in accordance
with the provisions of this Section 8.1, the Common Stock issuable by way of
dividend or other distribution on any stock of the Company shall be deemed to
have been issued immediately after the opening of business on the date following
the date fixed for the determination of stockholders entitled to receive such
dividend or other distribution.
8.2. Subdivision and Combination. In case the Company shall at any
time subdivide or combine the outstanding shares of Common Stock, the Exercise
Price shall forthwith be proportionately decreased in the case of subdivision or
increased in the case of combination.
8.3. Adjustment in Number of Shares. Upon each adjustment of the
Exercise Price pursuant to the provisions of this Article 8, the number of
Shares issuable upon the exercise of each Warrant shall be adjusted to the
nearest full number by multiplying a number equal to the Exercise Price in
effect immediately prior to such adjustment by the number of Shares
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issuable upon exercise of the Warrants immediately prior to such adjustment and
dividing the product so obtained by the adjusted Exercise Price.
8.4. Reclassification, Consolidation, Merger, etc. In case of any
reclassification or change of the outstanding shares of Common Stock (other than
a change in par value to no par value, or from no par value to par value, or as
a result of a subdivision or combination), or in the case of any consolidation
of the Company with, or merger of the Company into, another corporation (other
than a consolidation or merger in which the Company is the surviving corporation
and which does not result in any reclassification or change of the outstanding
shares of Common Stock, except a change as a result of a subdivision or
combination of such shares or a change in par value, as aforesaid), or in the
case of a sale or conveyance to another corporation of the property of the
Company as an entirety, the Holders shall thereafter have the right to purchase
the kind and number of shares of stock and other securities and property
receivable upon such reclassification, change, consolidation, merger, sale or
conveyance as if the Holders were the owners of the shares of Common Stock
underlying the Warrants immediately prior to any such events at a price equal to
the product of (x) the number of shares of Common Stock issuable upon exercise
of the Holder's Warrants and (y) the Exercise Price in effect immediately prior
to the record date for such reclassification, change, consolidation, merger,
sale or conveyance as if such Holders had exercised the Warrants.
8.5. Determination of Outstanding Shares of Common Stock. The
number of shares of Common Stock at any one time outstanding shall include the
aggregate number of shares of Common Stock issued and the aggregate number of
shares of Common Stock issuable upon the exercise of options, rights, warrants
and upon the conversion or exchange of convertible or exchangeable securities.
8.6 Dividends and Other Distributions with Respect to Outstanding
Securities. In the event that the Company shall at any time prior to the
exercise of all Warrants make any distribution of its assets to holders of its
Common Stock as a liquidating or a partial liquidating dividend, then the holder
of Warrants who exercises its Warrants after the record date for the
determination of those holders of Common Stock entitled to such distribution of
assets as a liquidating or partial liquidating dividend shall be entitled to
receive for the Warrant Price per Warrant, in addition to each share of Common
Stock, the amount of such distribution (or, at the option of the Company, a sum
equal to the value of any such assets at the time of such distribution as
determined by the Board of Directors of the Company in good faith) which would
have been payable to such holder had he been the holder of record of the Common
Stock receivable upon exercise of his Warrant on the record date for the
determination of those
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entitled to such distribution. At the time of any such dividend or distribution,
the Company shall make appropriate reserves to ensure the timely performance of
the provisions of this Subsection 8.6.
8.7 Subscription Rights for Shares of Common Stock or Other
Securities. In the case the Company or an affiliate of the Company shall at any
time after the date hereof and prior to the exercise of all the Warrants issue
any rights, warrants or options to subscribe for shares of Common Stock or any
other securities of the Company or of such affiliate to all the shareholders of
the Company, the Holders of unexercised Warrants on the record date set by the
Company or such affiliate in connection with such issuance of rights, warrants
or options shall be entitled, in addition to the shares of Common Stock or other
securities receivable upon the exercise of the Warrants, to receive such rights,
warrants or options that such Holders would have been entitled to receive had
they been, on such record date, the holders of record of the number of whole
shares of Common Stock then issuable upon exercise of their outstanding Warrants
(assuming for purposes of this Section 8.7), that the exercise of the Warrants
is permissible immediately upon issuance).
9. Exchange and Replacement of Warrant Certificates.
Each Warrant Certificate is exchangeable without expense, upon the
surrender thereof by the registered Holder at the principal executive office of
the Company, for a new Warrant Certificate of like tenor and date representing
in the aggregate the right to purchase the same number of Shares in such
denominations as shall be designated by the Holder thereof at the time of such
surrender.
Upon receipt by the Company of evidence reasonably satisfactory to it
of the loss, theft, destruction or mutilation of any Warrant Certificate, and,
in case of loss, theft or destruction, of indemnity or security reasonably
satisfactory to it, and reimbursement to the Company of all reasonable expenses
incidental thereto, and upon surrender and cancellation of the Warrant
Certificate, if mutilated, the Company will make and deliver a new Warrant
Certificate of like tenor, in lieu thereof.
10. Elimination of Fractional Interests.
The Company shall not be required to issue certificates representing
fractions of Shares, nor shall it be required to issue scrip or pay cash in lieu
of fractional interests, it being the intent of the parties that all fractional
interests shall be eliminated by rounding any fraction up to the nearest whole
number of Shares.
11. Reservation and Listing of Securities.
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The Company shall at all times reserve and keep available out of its
authorized shares of Common Stock, solely for the purpose of issuance upon the
exercise of the Warrants, such number of shares of Common Stock as shall be
issuable upon the exercise thereof. The Company covenants and agrees that, upon
exercise of the Warrants and payment of the Exercise Price therefor, all Shares
issuable upon such exercise shall be duly and validly issued, fully paid,
non-assessable and not subject to the preemptive rights of any shareholder. As
long as the Warrants shall be outstanding, the Company shall use its best
efforts to cause all shares of Common Stock issuable upon the exercise of the
Warrants to be listed on the Nasdaq National Market or listed on such national
securities exchanges as the Common Stock is listed at such time.
12. Notices to Warrant Holders.
Nothing contained in this Agreement shall be construed as conferring
upon the Holder or Holders the right to vote or to consent or to receive notice
as a shareholder in respect of any meetings of shareholders for the election of
directors or any other matter, or as having any rights whatsoever as a
shareholder of the Company. If, however, at any time prior to the expiration of
the Warrants and their exercise, any of the following events shall occur:
(a) the Company shall take a record of the holders of its shares
of Common Stock for the purpose of entitling them to receive a dividend or
distribution payable otherwise than in cash, or a cash dividend or distribution
payable otherwise than out of current or retained earnings, as indicated by the
accounting treatment of such dividend or distribution on the books of the
Company; or
(b) the Company shall offer to all the holders of its Common Stock
any additional shares of capital stock of the Company or securities convertible
into or exchangeable for shares of capital stock of the Company, or any option,
right or warrant to subscribe therefor; or
(c) a dissolution, liquidation or winding up of the Company (other
than in connection with a consolidation or merger) or a sale of all or
substantially all of its property, assets and business as an entirety shall be
proposed; or
(d) reclassification or change of the outstanding shares of Common
Stock (other than a change in par value to no par value, or from no par
value to par value, or as a result of a subdivision or combination),
consolidation of the Company with, or merger of the Company into, another
corporation (other than a consolidation or merger in which the Company is
the surviving corporation and which does not result in any reclassification
or change of the outstanding
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shares of Common Stock, except a change as a result of a subdivision or
combination of such shares or a change in par value, as aforesaid), or a
sale or conveyance to another corporation of the property of the Company as
an entirety is proposed; or
(e) The Company or an affiliate of the Company shall propose to
issue any rights to subscribe for shares of Common Stock or any other
securities of the Company or of such affiliate to all the shareholders of
the Company;
then, in any one or more of said events, the Company shall give written notice
to the Holder or Holders of such event at least fifteen (15) days prior to the
date fixed as a record date or the date of closing the transfer books for the
determination of the shareholders entitled to such dividend, distribution,
convertible or exchangeable securities or subscription rights, options or
warrants, or entitled to vote on such proposed dissolution, liquidation, winding
up or sale. Such notice shall specify such record date or the date of closing
the transfer books, as the case may be. Failure to give such notice or any
defect therein shall not affect the validity of any action taken in connection
with the declaration or payment of any such dividend or distribution, or the
issuance of any convertible or exchangeable securities or subscription rights,
options or warrants, or any proposed dissolution, liquidation, winding up or
sale.
13. Notices.
All notices, requests, consents and other communications hereunder
shall be in writing and shall be deemed to have been duly made when delivered,
or mailed by registered or certified mail, return receipt requested:
(a) If to a registered Holder of the Warrants, to the address of such
Holder as shown on the books of the Company; or
(b) If to the Company, to the address set forth in Section 3 of this
Agreement or to such other address as the Company may designate by notice to the
Holders.
14. Supplements and Amendments.
The Company and BlueStone may from time to time supplement or amend
this Agreement without the approval of any Holders of Warrant Certificates in
order to cure any ambiguity, to correct or supplement any provision contained
herein which may be defective or inconsistent with any provisions herein, or to
make any other provisions in regard to matters or questions arising hereunder
which the Company and BlueStone may deem necessary or desirable and which the
Company and the BlueStone deem not to adversely affect the interests of the
Holders of Warrant Certificates.
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15. Successors.
All the covenants and provisions of this Agreement by or for the
benefit of the Company and the Holders inure to the benefit of their respective
successors and assigns hereunder.
16. Termination.
This Agreement shall terminate at the close of business on _______ __,
2006. Notwithstanding the foregoing, this Agreement will terminate on any
earlier date when all Warrants have been exercised and all the Shares have been
resold to the public; provided, however, that the provisions of Section 7.5.
hereof shall survive any termination pursuant to this Section 16 until the close
of business on _______ __, 2009.
17. Governing Law.
This Agreement and each Warrant Certificate issued hereunder shall be
deemed to be a contract made under the laws of the State of New York and for all
purposes shall be construed in accordance with the laws of said State, except to
the extent that the North Carolina Business Corporation Act mandatorily governs
the Warrants and Warrant Certificates.
18. Benefits of This Agreement.
Nothing in this Agreement shall be construed to give to any person or
corporation other than the Company and the Representatives and any other
registered holder or holders of the Warrant Certificates, Warrants or the Shares
any legal or equitable right, remedy or claim under this Agreement; and this
Agreement shall be for the sole and exclusive benefit of the Company and the
Representatives and any other holder or holders of the Warrant Certificates,
Warrants or the Shares.
19. Counterparts.
This Agreement may be executed in any number of counterparts and each
of such counterparts shall for all purposes be deemed to be an original, and
such counterparts shall together constitute but one and the same instrument.
-14-
<PAGE>
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be
duly executed, as of the day and year first above written.
[SEAL] INTERACTIVE MAGIC, INC.
By:
Name:
Title:
Attest:
- -----------------------
BLUESTONE CAPITAL PARTNERS, L.P.
By: BlueStone Capital Management, Inc.,
By:
Kerry J. Dukes,
President
ROYCE INVESTMENT GROUP, INC.
By:
Name:
Title:
-15-
<PAGE>
EXHIBIT A
THE WARRANTS REPRESENTED BY THIS CERTIFICATE AND THE OTHER SECURITIES ISSUABLE
UPON EXERCISE THEREOF HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933,
AS AMENDED (THE "ACT"), AND MAY NOT BE OFFERED OR SOLD EXCEPT (i) PURSUANT TO AN
EFFECTIVE REGISTRATION STATEMENT UNDER THE ACT, (ii) TO THE EXTENT APPLICABLE,
PURSUANT TO RULE 144 UNDER SUCH ACT (OR ANY SIMILAR RULE UNDER SUCH ACT RELATING
TO THE DISPOSITION OF SECURITIES), OR (iii) UPON THE DELIVERY BY THE HOLDER TO
THE COMPANY OF AN OPINION OF COUNSEL, REASONABLY SATISFACTORY TO COUNSEL FOR THE
COMPANY, STATING THAT AN EXEMPTION FROM REGISTRATION UNDER SUCH ACT IS
AVAILABLE.
THE TRANSFER OR EXCHANGE OF THE WARRANTS REPRESENTED BY THIS
CERTIFICATE IS RESTRICTED IN ACCORDANCE WITH THE WARRANT AGREE-
MENT REFERRED TO HEREIN.
EXERCISABLE ON OR BEFORE
5:00 P.M., NEW YORK TIME, _______ __, 2003
No. W- _______ Warrants
WARRANT CERTIFICATE
This Warrant Certificate certifies that _______________ ____________ or
registered assigns, is the registered holder of _______ Warrants to purchase, at
any time from _______ __, 1999 until 5:00 P.M. New York City time on ______ __,
2003 ("Expiration Date"), up to _____ fully-paid and non-assessable shares
("Shares") of common stock, no par value (the "Common Stock"), of Interactive
Magic, Inc., a North Carolina corporation (the "Company"), at the initial
exercise price, subject to adjustment in certain events (the "Exercise Price"),
of $____ per Share upon surrender of this Warrant Certificate and payment of the
Exercise Price at an office or agency of the Company, but subject to the
conditions set forth herein and in the warrant agreement dated as of ______ __,
1998 between the Company and BlueStone Capital Partners, L.P. and Royce
Investment Group, Inc. (the "Warrant Agreement"). Payment of the Exercise Price
may be made in cash, or by certified or official bank check in New York Clearing
House funds payable to the order of the Company, or any combination thereof.
No Warrant may be exercised after 5:00 P.M., New York City time, on the
Expiration Date, at which time all Warrants evidenced hereby, unless exercised
prior thereto, shall thereafter be void.
The Warrants evidenced by this Warrant Certificate are part of a duly
authorized issue of Warrants issued pursuant to the Warrant Agreement, which
Warrant Agreement is hereby incorporated by reference in and made a part of this
instrument and is
<PAGE>
hereby referred to for a description of the rights, limitation of rights,
obligations, duties and immunities thereunder of the Company and the holders
(the words "holders" or "holder" meaning the registered holders or registered
holder) of the Warrants.
The Warrant Agreement provides that upon the occurrence of certain
events, the Exercise Price and/or number of the Company's securities issuable
thereupon may, subject to certain conditions, be adjusted. In such event, the
Company will, at the request of the holder, issue a new Warrant Certificate
evidencing the adjustment in the Exercise Price and the number and/or type of
securities issuable upon the exercise of the Warrants; provided, however, that
the failure of the Company to issue such new Warrant Certificates shall not in
any way change, alter, or otherwise impair, the rights of the holder as set
forth in the Warrant Agreement.
Upon due presentment for registration of transfer of this Warrant
Certificate at an office or agency of the Company, a new Warrant Certificate or
Warrant Certificates of like tenor and evidencing in the aggregate a like number
of Warrants shall be issued to the transferee(s) in exchange for this Warrant
Certificate, subject to the limitations provided herein and in the Warrant
Agreement, without any charge except for any tax, or other governmental charge
imposed in connection therewith.
Upon the exercise of less than all of the Warrants evidenced by this
Certificate, the Company shall forthwith issue to the holder hereof a new
Warrant Certificate representing such number of unexercised Warrants.
The Company may deem and treat the registered holder(s) hereof as the
absolute owner(s) of this Warrant Certificate (notwithstanding any notation of
ownership or other writing hereon made by anyone), for the purpose of any
exercise hereof, and of any distribution to the holder(s) hereof, and for all
other purposes, and the Company shall not be affected by any notice to the
contrary.
All terms used in this Warrant Certificate which are defined in the
Warrant Agreement shall have the meanings assigned to them in the Warrant
Agreement.
-2-
<PAGE>
IN WITNESS WHEREOF, the Company has caused this Warrant Certificate to
be duly executed under its corporate seal.
Dated: _______ __, 1998 Interactive Magic, Inc.
[SEAL] By:__________________________
Name:
Title:
Attest:
- ----------------------
-3-
<PAGE>
[FORM OF ELECTION TO PURCHASE]
The undersigned hereby irrevocably elects to exercise the right,
represented by this Warrant Certificate, to purchase _________ Shares and
herewith tenders in payment for such Shares cash or a certified or official bank
check payable in New York Clearing House Funds to the order of Interactive
Magic, Inc. in the amount of $___________________ , all in accordance with the
terms hereof. The undersigned requests that a certificate for such Shares be
registered in the name of , whose address is __________________, and that such
Certificate be delivered to __________________, whose address is _____________.
Dated: Signature:___________________________________________
(Signature must conform in all respects to name of
holder as specified on the face of the Warrant
Certificate.)
--------------------------------
--------------------------------
(Insert Social Security or Other
Identifying Number of Holder)
<PAGE>
[FORM OF ASSIGNMENT]
(To be executed by the registered holder if such holder desires to transfer
the Warrant Certificate.)
FOR VALUE RECEIVED_____________________________________________________
hereby sells, assigns and transfers unto
________________________________________________________________________________
(Please print name and address of transferee)
this Warrant Certificate, together with all right, title and interest therein,
and does hereby irrevocably constitute and appoint _______________, Attorney, to
transfer the within Warrant Certificate on the books of the within-named
Company, with full power of substitution.
Dated: Signature:___________________________________________
(Signature must conform in all
respects to name of holder as
specified on the face of the
Warrant Certificate)
- -------------------------------
- -------------------------------
(Insert Social Security or Other
Identifying Number of Assignee)
Exhibit 5.01
SMITH, ANDERSON, BLOUNT,
DORSETT, MITCHELL & JERNIGAN, L.L.P.
LAWYERS
RALEIGH, NORTH CAROLINA
MAILING ADDRESS OFFICES
Post Office Box 2611 2500 First Union Capitol Center
Raleigh, North Carolina 27602-2611 Raleigh, North Carolina 27601
FAX: 919-821-6800 TELEPHONE: 919-821-1220
July 16, 1998
Interactive Magic, Inc.
215 Southport Drive, Suite 1000
Morrisville, North Carolina 27560
Re: Registration Statement on Form SB-2
Registration No. 333-53755
Ladies and Gentlemen:
We have acted as counsel to Interactive Magic, Inc., a North Carolina
corporation (the "Company"), in connection with the issuance and sale of up to
2,990,000 shares of the Company's common stock, par value $.10 per share
(including 390,000 shares of common stock subject to the underwriters'
over-allotment option). These shares are described in the Company's Registration
Statement on Form SB-2 (the "Registration Statement") filed with the Securities
and Exchange Commission (the "Commission"), Registration No. 333-53755, under
the Securities Act of 1933, as amended (the "Act"), on May 28, 1998, as amended
on July 7, 1998 by Amendment No. 1 and to be amended by Amendment No. 2 with
which this opinion will be filed as an exhibit (the Registration Statement, as
amended, being hereinafter referred to as the "Registration Statement"). This
opinion supersedes and replaces the opinion of our firm dated July 6, 1998,
which was filed as Exhibit 5.01 to Amendment No. 1 to the Registration Statement
filed with the Commission on July 7, 1998.
We have examined the Articles of Incorporation and the Bylaws of the
Company, minutes of meetings of its Board of Directors, and such other corporate
records of the Company and other documents and have made such examination of law
as we have deemed necessary for purposes of this opinion. In our examination, we
have assumed the genuineness of all signatures, the authenticity of all
documents as originals, the conformity to originals of all documents submitted
to us as certified copies or photocopies, and the authenticity of the originals
of such latter documents. In rendering the opinion set forth below, we have
relied on a certificate of Company officers.
Based on the foregoing, it is our opinion, as of the date hereof, that
the 2,990,000 shares of common stock of the Company which are being registered
pursuant to the Registration Statement, when issued and delivered against
payment therefor as contemplated by the Registration Statement and form of
Underwriting Agreement by and among the Company, BlueStone Capital Partners,
L.P. and Royce Investment Group, Inc. filed as Exhibit 1.01 to the Registration
Statement, such shares will be validly issued, fully paid and non-assessable.
The opinion expressed herein does not extend to compliance with state
and federal securities laws relating to the sale of these securities.
We hereby consent to the reference to our firm in the Registration
Statement under the heading "Legal Matters" and to the filing of this opinion as
Exhibit 5.01 to the Registration Statement. Such consent shall not be deemed to
be an admission that this firm is within the category of persons whose consent
is required under Section 7 of the Act or the regulations promulgated by the
Commission pursuant to the Act.
Sincerely yours,
SMITH, ANDERSON, BLOUNT, DORSETT,
MITCHELL & JERNIGAN, L.L.P.
/s/ Smith, Anderson, Blount, Dorsett, Mitchell &
Jernigan, L.L.P.
We consent to the reference to our firm under the caption "Experts" and to the
use of our report dated May 6, 1998, in Amendment No. 2 to the Registration
Statement (Form SB-2 No. 333-53755) and related Prospectus of Interactive Magic,
Inc. for the registration of 2,990,000 shares of its common stock.
/s/ Ernst & Young LLP
Raleigh, North Carolina
July 16, 1998
