U.S. Securities and Exchange Commission
WASHINGTON, D.C. 20549
FORM 10-KSB/A
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
Commission file number 000-29750
INTERACTIVE MAGIC, INC.
(Exact name of small business issuer as specified in its charter)
North Carolina 56-2092059
(State of incorporation) (I.R.S. Employer Identification Number)
215 Southport Drive, Suite 1000
Morrisville, North Carolina 27560
(Address of principal executive office)
(919) 461-0722
(Issuer's telephone number)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock
($.10 par value
per share
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90 days.
Yes |X| No | |
Indicate by checkmark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy 10-KSB or any
amendment to this Form 10-KSB.
| Yes | | No | X|
Issuer's revenue for the year ended December 31,1998 were $ 12,566,000.
The aggregate market value of the voting stock held by non-affiliates
of the registrant based upon the closing price of the common stock on March 31,
1999, on the NASDAQ National Market System was approximately $ 25,600,000 as of
such date. Shares of common stock held by each executive officer and director
and by each person who owns 10% or more of the outstanding common stock have
been excluded in that such persons may be deemed to be affiliates. This
determination of affiliates may not be conclusive for other purposes.
As of June 30, 1999 (the most recent practicable date), there were
10,690,183 shares of the issuer's Common Stock, $.10 par value per share,
outstanding.
Transitional Small Business Disclosure Format (check one)
Yes |_| No |X|
The Company hereby amends its Annual Report on Form 10-KSB for the year ended
December 31, 1998 to reflect the disclosures described in Footnote 15 to the
accompanying consolidated financial statements.
<PAGE>
INDEX
PART 1
Item 1 Description of Business
Item 2 Description of Property
Item 3 Legal Proceedings
Item 4 Submission of Matters to Vote of Security Holders
PART II
Item 5 Market for Common Equity and Related Stockholder Matters
Item 6 Management's Discussion and Analysis or Plan of Operations
Item 7 Financial Statements
Item 8 Changes in and Disagreements With Accountants on
Accounting and Financial Disclosure
PART III
Item 9 Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act
Item 10 Executive Compensation
Item 11 Security Ownership of Certain Beneficial Owners
And Management
Item 12 Certain Relationships and Related Transactions
Item 13 Exhibits and Reports
<PAGE>
PART I
ITEM 1. DESCRIPTION OF BUSINESS
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 as well as the sale of advertising space at its online sites.
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 over 40 CD-ROM products which have been distributed
through more than 15,000 retail outlets in over 30 countries. Additionally, the
Company has sold over 1.5 million hours of online game time over the Internet to
players in more than 70 countries.
On January 29, 1999 the Company entered into an Agreement and Plan of Merger
with MPG-Net, Inc. pursuant to which MPG-Net was merged into the Company. The
Company exchanged 600,000 shares of its common stock for all of the outstanding
common stock of MPG-Net and issued 150,000 shares of its common stock in full
settlement of certain debt obligations of MPG-Net. MPG-Net is primarily in the
business of developing, publishing and distributing interactive, real time 3D
entertainment for multi-user online/Internet play, as well as creating
entertainment platforms on the Internet such as online game channels, game hubs
and websites. The merger was accounted for as a pooling of interests under
Accounting Principles Board No. 16 ("APB 16").
RISK FACTORS
The following factors should be reviewed carefully, in conjunction with the
other information in this Form 10-KSB and our consolidated financial statements.
These factors, among others, could cause actual results to differ materially
from those currently anticipated and contained in forward-looking statements
made in this Form 10-KSB and presented elsewhere by our management from time to
time. See "Note Regarding Forward-Looking Statements."
Company Risks
We have a History of Net Losses and an Accumulated Deficit; We Anticipate Future
Losses
We have experienced significant losses since inception. Our losses result
primarily from overhead and other costs incurred in our development and
expansion. For the years ended December 31, 1998 and 1997, we incurred net
losses of approximately $11.7 million and $4.3 million, respectively. At
December 31, 1998, we had an accumulated deficit of approximately $25.9 million.
We expect to incur substantial up-front expenditures and operating costs in
connection with the expansion of our marketing efforts and product lines. These
activities are expected to result in significant losses for the foreseeable
future. We cannot predict the extent of future losses or whether we will ever be
able to achieve or sustain profitable operations.
Risks Related to New Business Focus; We Have a Limited Relevant Operating
History
To date, a substantial portion of our revenues have been generated from sales of
our CD-ROM software products. In March 1999 we announced our intention to sell
our CD-ROM business unit. We cannot guarantee that such transaction will be
consummated. If the sale is consummated, our business will primarily focus on
the Internet entertainment business, specifically online games. Although we
recently completed the acquisition of MPG-Net, Inc. to expand our Internet
business, to date, we have generated limited revenues from sales of our Internet
products. As a result, we have a limited relevant operating history upon which
an evaluation of the prospects of our business can be made. Such prospects must
be considered in light of the risks, expenses and difficulties frequently
encountered by companies in connection with the operation and expansion of a new
business. We are subject to the risks associated with the rapidly evolving
interactive entertainment software industry, which is characterized by:
o an increasing number of market entrants;
o intense competition;
o substantial capital requirements; and
o a high failure rate.
Further, online game play is a new and evolving concept. We cannot assess or
predict the size of the market for online games or its prospects for growth.
1
<PAGE>
We Have Significant Capital Requirements; We Experience Negative Cash Flow From
Operations; We Will Need Additional Financing
Our capital requirements have been and will continue to be significant. To date,
our cash requirements have exceeded our cash flow from operations. Based on our
currently proposed plans and assumptions relating to operations (including
assumptions regarding the progress and timing of our new product development
efforts), net proceeds from our recent private placement, together with
anticipated revenues from operations, we anticipate to have sufficient funds on
hand to continue operations. However, our future cash requirements may vary
significantly from what we expect them to be based on factors such as:
o the cost and timing of expansion of research and product
development efforts and the success of these efforts;
o the cost and timing of expansion of sales and marketing
activities;
o the extent our existing and new products gain market acceptance;
o competing technological and market developments;
o the cost involved in maintaining and enforcing patent claims and
other intellectual property rights; and
o our ability to sell the CD-ROM business.
We do not have any current arrangements or commitments for any future financing.
We may not be able to obtain sufficient additional financing to satisfy cash
requirements. We may be required to obtain financing on terms that are not
favorable to us and our shareholders. If we are unable to obtain additional
financing when needed, we may be required to delay or scale back product
development and marketing programs.
We May Not Be Able to Manage and Sustain Growth; We Face Risks Associated with
Future Acquisitions
An integral part of our business strategy is growth through acquisition. The
success of our acquisition strategy will depend upon, among other things, our
ability to:
o hire and retain skilled management, marketing, technical and
other personnel;
o develop and improve upon our operational, management and
financial systems and controls in order to properly monitor our
expanded operations; and
o control our costs and maintain effective quality controls.
2
<PAGE>
We cannot predict whether we will be able to expand our operations or
effectively manage any such expansion. Our growth strategy will place
significant demands on our management, technical, financial and other resources.
We may be unable to anticipate and satisfy all of the changing demands and
requirements that such growth will impose upon our operations. Acquisitions
involve numerous additional risks that could materially adversely affect our
business and financial performance. Such risks include:
o difficulties in the assimilation of the operations and products
of the acquired companies;
o the expenses incurred in connection with the acquisition and
subsequent assimilation of operations and products;
o the diversion of management's attention from other business
concerns; and
o the potential loss of key employees of the acquired company.
As part of our acquisition strategy, we may seek opportunities to continue to
expand into markets outside the United States. Acquisitions of foreign companies
also may involve the additional risks of assimilating differences in foreign
business practices and overcoming language barriers. We might not be able to
integrate the acquired operations successfully.
We currently have one transaction underway which is awaiting the completion of a
definitive asset purchase agreement. In addition, we intend to evaluate, on an
ongoing basis, potential acquisitions of, or investments in, other software
publishers or developers, distributors or other businesses which we believe will
complement or enhance our existing business. Under North Carolina law, various
forms of business combinations can be effected without shareholder approval.
Accordingly, in certain instances shareholders will neither receive nor
otherwise have the opportunity to evaluate any financial or other information
concerning any potential acquisition. Shareholders will have to rely entirely
upon the ability of management to select, structure and consummate acquisitions
that are consistent with our business objectives.
We May Not Be Able to Retain Our Key Personnel
Our success depends to a significant extent on the performance and continued
service of our senior management and certain key employees. During the second
half of 1998, three of our executive officers resigned. The loss of services of,
or a material reduction in the amount of time devoted to our business by, such
individuals could adversely affect our operations and financial condition.
Competition for highly skilled employees with technical, management, marketing,
sales, product development and other specialized training is intense. We may not
be successful in attracting or retaining such qualified personnel. Specifically,
we may experience increased costs in order to attract and retain skilled
employees. Employees might compete against us if they resign.
We Have Substantial Indebtedness
As of March 31, 1999, our indebtedness was approximately $5.3 million,
consisting of:
o borrowings under a check overdraft bank facility in the aggregate
maximum principal amount of approximately $1.3, which is payable
on demand; and
o an unsecured convertible note in the aggregate principal amount
of $4.0 million.
3
<PAGE>
Accordingly, we are subject to all of the risks associated with substantial
indebtedness, including:
o a substantial portion of our cash flow from operations will be
used to pay our indebtedness;
o we have reduced the funds available to us for operations, future
business opportunities and other purposes;
o our ability to obtain additional financing for acquisitions,
working capital, capital expenditures, general corporate or other
purposes may be impaired; and
o we will be more vulnerable to economic downturns, less able to
withstand competitive pressures and less flexible in reacting to
changes in our industry and general economic conditions.
In the event we default under any of our debt instruments or if our creditors
demand payment of a portion or all of our indebtedness, we may not have
sufficient funds available to make such payments. Failure to repay such
indebtedness would materially adversely affect our operations and financial
condition.
Industry Risks
A number of the following risk factors relate to our CD-ROM software business.
If the sale of our CD-ROM software business is consummated, such risk factors
will only be applicable to the extent we retain an interest in the CD-ROM
software business.
We Experience Fluctuations in Quarterly Operating Results
Our quarterly operating results have fluctuated significantly in the past and
will likely fluctuate significantly in the future. These fluctuations in
operating results depend on a variety of factors, including:
o the demand for our products and the products of our competitors;
o the level of usage of the Internet;
o the size and rate of growth of the interactive entertainment
software market;
o development and promotional expenses related to the introduction
of new products or enhancements;
o the degree of market acceptance for our new product introductions
and enhancements;
o the timing of orders from significant customers;
o delays in shipment;
o the level of price competition;
4
<PAGE>
o changes in computing platforms;
o the nature and magnitude of product returns;
o order cancellations;
o software defects and other quality problems;
o the length of product life cycles; and
o the percentage of our sales related to international sales.
As a software business, we operate with little backlog and net revenues in any
quarter are substantially dependent on orders booked and shipped in that
quarter. Our operating expenses are based to a significant degree on planned
expenditures and expectations regarding future sales. Failure to meet our sales
expectations could disproportionately adversely affect our operating results in
any given quarter. As a result, we believe that period-to-period comparisons of
operating results should not be relied upon as indicative of future results.
We Depend on the Frequent Introduction of New Products
The market for interactive CD-ROM software games is characterized by short
product life cycles and frequent introduction of new products. Most CD-ROM
software games do not achieve sustained market acceptance or ever 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. Our success will depend upon our
ability to develop new, commercially successful products and replace revenues
from such products at the later stages of their life cycles. We believe that
competition in the interactive entertainment software market may require us to
increase our development, acquisition and marketing costs in order to:
o develop higher quality, distinctive products that incorporate
increasingly sophisticated effects; and
o support new product releases with increased marketing.
We Depend On a Limited Number of Products
We derive a significant portion of our revenues from a limited number of
software products released each year. Many of these products have substantial
development or acquisition costs and marketing budgets. Due to our dependence on
a limited number of products, we may be adversely affected if one or more of our
principal products fail to achieve anticipated results. We cannot predict
whether we will:
o continue to remain dependent upon non-recurring sales of a
limited number of products for a substantial portion of our
revenues;
o introduce products which are commercially viable; or
o introduce products which have life cycles sufficient to permit us
to recoup the development, marketing and other costs associated
with their development.
5
<PAGE>
Our Products Have a Lengthy Development Cycle; We Face Product Development Risks
Our success will depend on the timely introduction of successful new products.
The development of new interactive entertainment software products is lengthy,
expensive and uncertain. The development of a product typically requires 12 to
24 months to complete from the time a new concept is approved. Product
development of online products continues for the life of the product. Many of
our proposed products are in the early stages of development and will require us
to commit considerable time, effort and resources to complete their development.
The development of new products is subject to a variety of risks, including:
o unanticipated delays;
o increased costs and expenses for product development; and
o technical problems or other difficulties prior to or after the
introduction of a new product.
We have, in the past, experienced significant delays in the introduction of
certain new products. It is likely that we will experience delays in developing
and introducing new products in the future. Many of our products are developed
for us by third parties. As a result, we cannot always control the timing of
their introduction. Delays in the work performed by third parties or poor
quality of such work may result in product delays. Unanticipated delays,
expenses, technical problems or difficulties could cause us to miss an important
selling season or result in abandonment or material change in product
commercialization.
Our software products are complex and may contain undetected errors when first
introduced. Despite extensive product testing, we have, in the past, released
products with defects and have discovered software errors in certain of our
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. Errors may be found in new products or releases after
commencement of commercial shipments. Remedying such errors may:
o delay sales of our products;
o cause us to incur additional costs; and
o adversely affect our reputation.
Industry Factors May Adversely Affect Our Operating Results; We Face the Risks
of Changing Consumer Preferences and Uncertainty of Market Acceptance of our
Products
The level of demand and market acceptance of our newly introduced products is
subject to a high degree of uncertainty. In recent years, the potential earnings
derived from software sales has decreased. This decrease is due to the
significant increases in:
6
<PAGE>
o software acquisition and development costs;
o promotion and marketing expenses; and
o royalties and third-party participations payable to software
developers, creative personnel, musicians and others.
Our future operating results will depend on numerous factors beyond our control.
These factors include:
o the popularity, price and timing of new entertainment software
products being released and distributed;
o international, national, regional and local economic conditions
(particularly economic conditions adversely affecting
discretionary consumer spending);
o changes in consumer demographics;
o the availability of other forms of entertainment; and
o critical reviews and public tastes and preferences.
Our ability to plan for product development and promotional activities will be
significantly affected by our ability to anticipate and respond to relatively
rapid changes in consumer tastes and preferences. In particular, the tastes and
preferences of those consumers, primarily males over age 25 with annual
household incomes of $50,000 or more, who comprise our 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 our business and prospects.
Our strategy is to primarily focus on online games. The level of demand or the
market acceptance for our Internet online game products is uncertain. The
success of our strategy 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. Demand and market acceptance for recently introduced products and
services are subject to a high level of uncertainty and risk. We cannot predict
whether:
o a viable market for online games will develop;
o we will be able to attract and retain subscribers to our online
game products;
o we will be successful in developing additional products for
online use; or
o our online game products will ever achieve widespread market
acceptance.
We Depend on the Continued Growth in Use of the Internet
Rapid growth of interest in and use of the Internet is a recent phenomenon. Our
success is highly dependent upon the increased acceptance and use of the
Internet. The novelty of the Internet may adversely affect our ability to retain
new subscribers. New subscribers who are unfamiliar with the Internet may be
more likely to discontinue our services after an initial trial period.
7
<PAGE>
Risks Related to Online Games
We do not currently derive significant revenues from online games. However, if
the sale of our CD-ROM business is consummated, online games will become a
significant factor in the success of our business. Online games, and
particularly multiplayer online games such as our Warbirds product, have risks
not associated with sales of our CD-ROM products. Such risks include:
o the speed and reliability of the Internet and the fact that we do
not control the performance of a player's Internet service
provider which impacts game performance;
o in multiplayer games, unanticipated player conduct can
significantly affect the performance of the game and determine
player satisfaction;
o the uncertainty of whether subscription revenues will be
sufficient to maintain the significant support, service and
product enhancement demands of online users;
o our limited experience in pricing strategies for online games or
in predicting usage patterns of our customers; and
o our inability to predict the legal standards that may apply to
online products in the future.
The viability of our online game business, and our ability to compete in this
business, will depend significantly on these and other factors outside our
control.
We Face Infrastructure Risks of Online Game Play
The development and maintenance of an industry infrastructure for providing
consumer access to online games will effect the extent and timing of the
revenues we generate from online games. We cannot predict whether 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.
Further, if developed, we cannot predict whether 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, we will be unable to generate
significant revenues from online products.
Changes in Technology and Industry Standards May Make Our Products Obsolete or
Unmarketable
The interactive entertainment software industry is undergoing rapid changes,
including:
8
<PAGE>
o evolving industry standards;
o frequent new platform introductions; and
o changes in consumer requirements and preferences.
The introduction of new technologies, technologies that support multiplayer
games and new media formats such as online delivery and digital video disks,
could render our previously released products obsolete or unmarketable. The
development cycle for products utilizing new operating systems, microprocessors
or formats may be significantly longer than the current development cycle for
our products. We may be required to invest resources in products that may not
become profitable. We cannot predict whether:
o our future product offerings will keep pace with technological
changes
o we 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.
The overall market for the Internet is characterized by:
o rapidly changing technology;
o evolving industry standards;
o emerging competition; and
o frequent product and service introductions.
We may not successfully identify new product opportunities for Internet use and
develop and bring such new products to market in a timely manner. Products or
technologies developed by others could render our products or technology
obsolete. We are also at risk with respect 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. We may
have to develop new technology or modify our existing technology if the Internet
becomes:
o accessible by screen-based telephones, television or other
consumer electronic devices; or
o deliverable through other means such as coaxial cable or wireless
transmission.
Pursuit of such technological advances may require us to expend substantial time
and resources. We cannot predict whether we will succeed in adapting our
products to alternate access devices and conduits.
9
<PAGE>
We Face Intense Competition
The interactive entertainment software industry is intensely and increasingly
competitive. Industry competition is based primarily upon:
o product quality and features;
o the compatibility of products with popular platforms;
o access to distribution channels (including access to retail shelf
space);
o marketing effectiveness;
o reliability and ease of use; and
o price and the quality of user support services.
As compared to us, many of our competitors have:
o significantly greater financial, technical, marketing, sales and
customer support and other resources; and
o established reputations for success in the development, licensing
and sale of their products and technology.
As a result, our competitors may be able to:
o carry larger inventories;
o undertake more extensive marketing campaigns;
o adopt more aggressive pricing policies; and
o make higher offers or guarantees to third party software
developers and licensors.
Increased competition may result in significant price competition, increased
product development and production costs and reduced profit margins. Competition
may also limit our ability to grow and retain our subscriber base for online
game play. We may not be able to compete successfully against current or future
competitors.
We Face Competition for Shelf Space
Retailers of our CD-ROM products typically have a limited amount of shelf space
and promotional resources. 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:
o price discounts;
o marketing and display fees; and
o product return policies.
10
<PAGE>
Our CD-ROM products constitute a relatively small percentage of any retailer's
sales volume. As a result, we cannot predict whether retailers will continue to
purchase our products or provide our products with adequate levels of shelf
space and promotional support.
We Depend on Third-Party Software Developers
We rely on third-party software developers to develop a significant number of
our products. Our payment of advances and guaranteed royalties to such
independent software developers has increased and may continue to increase
primarily due to the increased demand for quality interactive entertainment
software programs. Sales of products associated with such royalties may not be
sufficient to cover the amount of our prepayments. Moreover, independent
developers are in high demand. As a result, we cannot predict whether such
developers, including those that have developed products for us in the past,
will be available to develop products for us in the future. The failure to
obtain or renew product development agreements with such developers could
materially adversely affect our future operations. In addition, many independent
developers have limited financial resources. Therefore, we are subject to the
risk that such developers may go out of business prior to completing a project.
We Depend on Third-Party Distribution Channels
We intend to expand the distribution of our online products by seeking out
relationships with third-party providers of online or Internet services in the
United States and abroad. We cannot predict whether we will be able to
successfully negotiate relationships with providers of online or Internet
services or, if completed, that such arrangements will generate significant
revenues. Further, we are subject to the risk that:
o the cost of any proposed online or Internet distributor
relationship will exceed our expectations; or
o we will incur significant costs in anticipation of an online or
Internet distributor arrangement and such arrangement is delayed
or abandoned.
We currently sell our 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 our net revenues.
11
<PAGE>
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 we sell to
such retailers may be adversely affected by the terms imposed by such
intermediary. If our relationships with current distributors and retailers are
terminated, we may be unable to find other means to market and distribute our
CD-ROM products. The loss of, or a significant reduction in sales attributable
to, any of our principal distributors or retailers, in the absence of comparable
new relationships or the development of independent means of marketing and
distributing our CD-ROM games, could materially adversely affect our operating
results.
Although we maintain a reserve for uncollectible receivables, actual reserves
maintained may not be sufficient in every circumstance. A payment default by a
significant customer could have a material adverse effect on our operations and
financial condition.
We Face the Risk of Product Returns
We accept returns of our CD-ROM software products or provide markdowns or other
credits in the event that customers hold excess inventory of such products. We
also accept returns of defective, damaged or shelf-worn products at any time. At
the time of product shipment, we establish reserves for stock-balancing, price
protection and returns of defective, damaged and shelf-worn products, based on
historical return rates, retailer inventories of our products and other factors.
If market acceptance of our products is not achieved, we could be forced to
accept substantial product returns to maintain favorable relationships with
retailers and access to distribution channels. Actual returns might exceed our
established reserves.
We Have Limited Protection of Our Proprietary Information
We rely on a combination of the following to establish and protect our
proprietary rights:
o trademark;
o trade secret;
o copyright;
o other proprietary rights laws;
o license agreements; and
o employee and third-party nondisclosure agreements;
We are at risk that competitors may misappropriate our technology or
independently develop software products with features based upon, or otherwise
similar to, those of our products.
12
<PAGE>
To license our products to end users, we primarily rely on "shrink wrap"
licenses that are not signed by the end-user. As a result, such licenses may be
unenforceable under the laws of certain jurisdictions. In addition, effective
copyright and trade secret protection may be unavailable or limited in certain
foreign countries. The global nature of certain wide area networks, particularly
the Internet, makes it virtually impossible to control the ultimate destination
of our products. Despite our efforts to protect our proprietary rights,
unauthorized parties may attempt to copy aspects of our products or to obtain
and use information that we regard as proprietary. Unauthorized copying is
common within the software industry. A significant amount of unauthorized
copying of our products could adversely affect our business. 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. Third parties may assert infringement claims against us
in the future with respect to current or future products. As is common in the
industry, from time to time, we receive notices from third parties claiming
infringement of intellectual property rights of such parties. We investigate
these claims and respond as we deem appropriate. Litigation may be necessary in
the future:
o to enforce our intellectual property rights;
o to protect our trade secrets;
o to determine the validity and scope of the proprietary rights of
others; or
o to defend against claims of infringement of invalidity.
Even if we win, any such litigation could result in substantial costs and
diversion of our resources.
We Depend on Third Parties to Manufacture Our Products
The production of our published products for retail sale involves:
o duplicating software programs onto CD-ROM disks;
o printing user manuals and product packaging materials; and
o packaging finished products.
Third-party vendors perform these activities for us in accordance with our
specifications. Although these services are available from multiple parties and
at multiple sites, an interruption in the manufacture of our products that
cannot be remedied without undue delay, could have a materially adverse affect
on our business. In addition, we compete for CD-ROM duplication services with
our competitors, as well as publishers of music and video CDs. While we engage
in ongoing efforts to ensure an adequate and timely supply of CD-ROMs, we are at
risk that future supplies of CD-ROMs will not be sufficient to meet our
requirements. We must place advance orders for finished goods based on forecasts
of the sales volume of our products. If our forecasts are not accurate, we may
over-produce or under-produce our CD-ROM products.
13
<PAGE>
We Face the Risks of Increased Government Regulation
There are currently few laws or regulations directly applicable to access to or
commerce on the Internet. Due to the increasing popularity and use of the
Internet, it is possible that laws and regulations may be adopted both in the
United States and abroad, covering issues such as:
o user privacy;
o defamation;
o pricing;
o taxation;
o content regulation;
o quality of products and services; and
o intellectual property ownership and infringement.
Such legislation could:
o expose us to substantial liability;
o dampen the growth in use of the Internet;
o decrease the acceptance of the Internet as a communications and
commercial medium; or
o require us to incur significant expense in complying with any new
regulations.
Because the growing popularity and use of the Internet has burdened the existing
telecommunications infrastructure and many areas with high Internet use have
begun to experience interruptions in phone service, local telephone carriers
have petitioned for increased regulations and the imposition of access fees.
Increased regulation or the imposition of access fees could substantially
increase the costs of communicating on the Internet, potentially decreasing the
demand for our products. Also, a number of laws have recently been enacted in
the United States intended to:
o reduce the liability of online service providers for listing or
linking to third-party Web sites that include materials that
infringe copyrights; and
o restrict the distribution of certain materials deemed harmful to
children and impose additional restrictions on the ability of
online services to collect user information from minors.
14
<PAGE>
We are currently reviewing these pieces of legislation, and cannot currently
predict the effect, if any, that such legislation will have on our business. In
addition, a number of other countries have announced or are considering
additional regulations. Such laws and regulations could fundamentally impair our
ability to provide Internet navigation or other services, or substantially
increase the cost of doing so. Moreover, the applicability to the Internet of
existing laws governing issues such as property ownership, copyright,
defamation, obscenity and personal privacy is uncertain. Any such new
legislation or regulation in the United States or abroad or the application of
existing laws and regulations to the Internet could have a material adverse
effect on our business, operating results, and financial condition.
We are Subject to Risks Related to International Revenues and Operations
We distribute our CD-ROM products in over 30 countries worldwide and maintain
sales offices in the United Kingdom and Germany. International sales and
licensing (excluding online revenue) accounted for 41% and 37% of our net
revenues in 1998 and 1997, respectively. International operations and sales of
our products are subject to inherent risks, including:
o fluctuations in exchange rates;
o the impact of possible recessionary environments in economies
outside the United States;
o the costs of transferring and localizing products for foreign
markets;
o longer accounts receivable collection periods and difficulty in
collection of accounts receivable;
o unexpected changes in regulatory requirements;
o tariffs and other barriers;
o difficulties and costs of staffing and managing foreign offices;
and
o potential political and economic instability.
Revenues and expenses from our foreign operations generally are denominated in
local currencies. As a result, exchange rate fluctuations between such local
currencies and the U.S. dollar will subject us to currency translation risk from
the reported results of our foreign operations. We intend to continue to expand
our direct and indirect sales and marketing activities worldwide. We cannot
predict whether we will be able to maintain or increase international market
demand for our products.
Control by Shareholders
Our Officers, Directors and their Affiliated Entities Control Interactive Magic
As of March 31, 1999, our officers, directors and their affiliated entities
owned approximately 44% of our outstanding shares of Common Stock. As a result,
such persons are in the position to influence:
o the election of the Company's directors; and
o the outcome of corporate actions or other matters requiring
shareholder approval.
The concentration of ownership may have the effect of delaying or preventing a
change in control of Interactive Magic.
15
<PAGE>
Stock and Market Risks
Our Stock Price May be Volatile
The market price of our Common Stock has been and could be subject to wide
fluctuations in response to the following:
o variations in quarterly operating results;
o announcements of new products by us or our competitors;
o failures to meet or exceed the expectations of securities
analysts or investors; or
o general economic conditions.
Furthermore, the stock market has experienced significant price and volume
fluctuations unrelated or disproportionate to the operating performance of
particular companies. These market fluctuations may also adversely affect the
market price of our Common Stock.
We Do Not Intend to Pay Dividends to Our Shareholders
We have not paid any cash dividends on our Common Stock and do not expect to do
so in the foreseeable future.
Future Sales of Our Common Stock in the Public Market Could Adversely Affect Our
Stock Price
Sales of shares of our Common Stock by existing shareholders could have an
adverse effect on stock prices. As of March 31, 1999, we had 10.671,448 shares
of Common Stock outstanding. all of these shares are eligible for sale without
restrictions or under Rule 144, subject to the lock-ups described below.
In general, under Rule 144 as currently in effect, a person (or persons whose
shares are aggregated), including persons who may be deemed to be "affiliates"
of the Company as that term is defined under the Securities Act of 1933, is
entitled to sell within any three-month period a number of restricted shares
beneficially owned for at least one year that does not exceed the greater of:
o one percent of the then outstanding shares of Common Stock, or
o the average weekly trading volume in the Common Stock during the
four calendar weeks preceding such sale.
Sales under Rule 144 are also subject to certain requirements as to the manner
of sale, notice and the availability of current public information about us.
However, a person who is not an affiliate and has beneficially owned such shares
for at least two years is entitled to sell such shares without regard to the
volume or other requirements. 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.
16
<PAGE>
The Company's officers, directors and shareholders who hold, in the aggregate,
approximately 2,601,214 shares of Common Stock and approximately 775,056 vested
options and warrants have agreed not to sell or otherwise dispose of any shares
of Common Stock (or exercise any registration rights) until April 21, 1999
without the prior written consent of the underwriters of the Company's initial
public offering. In addition, holders of 3,218,114 shares of Common Stock and
warrants to purchase 500,000 shares of Common Stock have registration rights
with respect to their respective securities The possibility that a substantial
number of our securities may be sold in the public market may adversely affect
prevailing market prices for our Common Stock and could impair our ability to
raise capital through the sale of our equity securities.
We Face the Adverse Effects of Outstanding Options; Warrants and Convertible
Securities
We have outstanding:
o warrants to purchase an aggregate of approximately 729,172 shares
of Common Stock;
o a convertible note, together with related warrants, which are
convertible into and exercisable for an aggregate of up to
2,119,889 shares of Common Stock.
We have granted the following options, and have available for issuance, the
following shares:
o 2,875,000 shares of Common Stock in connection with our 1995
Incentive Stock Option Plan, 2,047,400 of which have been
granted;
o 800,000 shares of Common Stock in connection with our 1998 Stock
Plan, under which options to purchase 484,750 shares have been
granted; and
o 500,000 shares of Common Stock in connection with our 1998 Stock
Purchase Plan, none of which have been issued.
The existence of these securities may adversely affect us or our shareholders
for many reasons, including:
o the market price of our stock may be adversely affected;
o if any of these securities are exercised, the value of the stock
held by our shareholders will be diluted if the value of such
stock immediately prior to the exercise of such securities
exceeds the exercise price;
o some of these securities give the holders the opportunity, at
nominal cost, to profit from a rise in the market price of our
stock;
o the terms upon which we could issue additional common stock or
obtain additional financing may be adversely affected.
17
<PAGE>
Holders of warrants and options are also likely to exercise them when, in all
likelihood, we could obtain additional capital on terms more favorable than
those provided by the warrants and options.
We cannot predict the actual number of shares of our stock that may be issued
upon conversion of the note and exercise of related warrants, which depends on:
o the conversion price in effect from time to time during the term
of the note;
o the timing of any conversion; and
o the decision by us to make any payments of interest in the form
of shares of Common Stock.
However, the maximum number of shares of our Common Stock that we can issue upon
conversion of the note, payment of interest and exercise of related warrants
without stockholder approval is 2,119,889 shares. The conversion price of the
note is likely to be substantially below the market price of our Common Stock on
any date of conversion.
Our Common Stock May be Delisted from the Nasdaq National Market if We do Not
Meet the Listing Criteria.
If we are unable to satisfy the continued listing requirements, our stock may be
delisted from the Nasdaq National Market. If our stock is delisted from the
Nasdaq National Market, the liquidity of our stock could be impaired, not only
in the number of securities which could be bought and sold, but also through
delays in the timing of transactions, reduction in coverage by security analysts
and the news media and lower prices for our common stock than might otherwise be
attained. We cannot assure that we will continue to meet the criteria for
continued listing on the Nasdaq National Market.
If our stock is delisted from the Nasdaq National Market, trading, if any, in
our stock would thereafter be conducted:
o on the Nasdaq SmallCap Market, assuming we meet the requirements
for listing on the Nasdaq SmallCap Market;
o in the over-the-counter market in the "pink sheets;" or
o on the National Association of Securities Dealers, Inc.'s
"Electronic Bulletin Board."
Continued inclusion on the Nasdaq National Market generally requires that we
maintain:
o at least $4,000,000 in "net tangible assets" (total assets less
total liabilities and goodwill);
o a minimum bid price of the Common Stock of $1.00 per share;
o at least 750,000 shares in the public float valued at $5,000,000
or more;
o at least two active market makers for the Common Stock; and
o a least 400 holders of the Common Stock.
18
<PAGE>
If our Common Stock is Delisted from Nasdaq it May Be Subject to Investor
Suitability Requirements Which may Adversely Affect Our Stock's Liquidity.
If our stock was delisted from Nasdaq National Market and could not be
quoted on Nasdaq SmallCap Market, it could become subject to Rule 15g-9 under
the Exchange Act, which imposes additional sales practice requirements on
broker-dealers that sell such securities to persons other than established
customers and "accredited investors" (generally, individuals with net worth in
excess of $1,000,000 or annual incomes exceeding $200,000, or $300,000 together
with their spouses). For transactions covered by this rule, a broker-dealer must
make a special suitability determination for the purchaser and have received the
purchaser's written consent to the transaction prior to sale. Consequently, such
rule may adversely affect the ability of broker-dealers to sell our common stock
and may adversely affect the ability of shareholders to sell any of the shares
of common stock in the secondary market.
If Our Common Stock is Delisted from Nasdaq it May Be a "Penny Stock" Which
Requires Significant Disclosure in Connection with Stock Trades, Which may
Adversely Affect Our Stock's Liquidity.
If our stock is delisted from Nasdaq or we do not meet certain minimum
net tangible assets or average revenue criteria, we may be subject to the
Commission's "penny stock" rules. For any transaction involving a penny stock,
unless exempt, the rules require:
o delivery, prior to any transaction in a penny stock, of a
disclosure schedule relating to the penny stock market;
o disclosure about commissions payable to both the broker-dealer
and the registered representative and current quotations for the
securities; and
o monthly statements to be sent disclosing recent price information
for the penny stock held in the account and information on the
limited market in penny stocks.
Commission regulations, subject to certain exceptions, define a "penny stock" to
be any non-exchange listed equity security:
o that has a market price of less than $5.00 per share; or
o with an exercise price of less than $5.00 per share.
We cannot predict whether our common stock will qualify for exemption from these
restrictions. In any event, even if our stock was exempt from such restrictions,
it would remain subject to Section 15(b)(6) of the Exchange Act, which gives the
Commission the authority to prohibit any person that is engaged in unlawful
conduct while participating in a distribution of a penny stock from associating
with a broker-dealer or participating in a distribution of a penny stock, if the
Commission finds that such a restriction would be in the public interest. If our
stock were subject to the rules on penny stocks, the market liquidity for our
stock could be severely adversely affected.
19
<PAGE>
We are Subject to Risks Associated with 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. The inability to recognize or properly treat the year 2000 may cause our
systems and applications to process critical financial and operational
information incorrectly. In addition, we are assessing the readiness of our
customers and suppliers for the Year 2000 issue. We cannot assess the likelihood
of third parties' year 2000 compliance or the impact that any non compliance may
have on our operations at this time. If there are significant delays or
unanticipated year 2000 issues with key business vendors, the year 2000 issue
could have a material adverse effect on our product development and our future
results of operations and financial condition.
Forward-Looking Information May Prove Inaccurate
This Report contains various forward-looking statements that are based on our
beliefs as well as assumptions made by and information currently available to
us. When used in this Report, 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.
ITEM 2. DESCRIPTION OF PROPERTY
The Company leases approximately 15,000 square feet in an office park in
Morrisville, North Carolina. The lease is noncancellable and expires in May
2001. All of the Company's CD-ROM and corporate operations are conducted from
this facility. The Company also leases approximately 5,000 square feet in an
office building located in Grapevine, Texas. A portion of the Company's on-line
business is conducted from this facility. The Company intends to relocate its
Grapevine, Texas operations to Morrisville, North Carolina in the second quarter
of 1999. The Grapevine, Texas lease expires September 1999. The Company also
leases space for its offices in the United Kingdom and Germany.
ITEM 3. LEGAL PROCEEDINGS
The Company is not currently involved in any material litigation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of 1998.
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock began trading July 22, 1998 (the date of its initial
public offering) on the National Market (ticker symbol IMGK). The approximate
number of record holders as of December 31, 1998 was 160.
20
<PAGE>
High and low stock prices for 1998 were:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------
Sales Price
- ---------------------------------------------------------------------------------------------------
Quarter Ended High Low
- ---------------------------------------------------------------------------------------------------
<S> <C> <C>
- ---------------------------------------------------------------------------------------------------
September 30 $14.00 $6.50
- ---------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------
December 31 6.50 4.13
- ---------------------------------------------------------------------------------------------------
</TABLE>
The Company has never paid a cash dividend on its Common Stock. The Company does
not anticipate paying any cash dividends in the foreseeable future and intends
to retain future earnings, if any, for the development of its business. In
addition, certain of the Company's loan agreements prohibit cash dividends.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN 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 over 40 CD-ROM products,
which have been distributed through more than 15,000 retail outlets in over 30
countries. Additionally, the Company has sold over 2.0 million hours of online
game time over the Internet to players in more than 70 countries.
RESULTS OF OPERATIONS
NET REVENUES. Net revenues decreased by 24 % to $12.6 million in 1998 from $16.5
million in 1997. The decline was attributable to lower net revenues in the
CD-ROM business. Although the Company released a greater number of game titles
in 1998, the average sales per title were lower than the prior year.
COST OF REVENUES. Cost of revenues consist of costs of products sold (including
cost of Internet access) and royalties and amortization of software development
costs. Cost of revenues in 1998 decreased by 3% to $ 6.1 million from $6.3
million in the same period of 1997, resulting in gross margins of 52% and 62%,
respectively. The decrease in gross margin performance reflects the lower
average sales per title in 1998 compared to 1997.
OPERATING EXPENSES
SALES AND MARKETING. Sales and marketing increased in 1998 to $8.5 million from
$6.8 million in 1997. Increased expenditures in this area reflect an increase in
staffing; in addition, there was a higher level of advertising and market
support spending related to the greater number of titles released in 1998
compared to 1997.
21
<PAGE>
PRODUCT DEVELOPMENT. Product development increased 54% to $6.0 million in 1998
from $3.9 million in 1997. The increase was due to the Company devoting more of
its resources in 1998 to internally-developed products, as opposed to third
party products, combined with the larger number of products developed and
released in 1998 compared to 1997.
GENERAL AND ADMINISTRATIVE. General and administrative expenses increased to
$2.7 million in 1998 from $1.9 million in 1997. The increased level of spending
was due to a slight increase in staffing, and to the additional expenses
associated with being a publicly held corporation.
OTHER EXPENSE. Other expense, comprised primarily of interest (income) expense,
decreased in 1998 to $.5 million from $1.9 million in 1997. The decrease was due
to the lower level of interest expense as the Company paid down debt with
proceeds from the Company's initial public offering.
EXTRAORDINARY ITEM. The Company incurred a $.4 million extraordinary loss from
the early extinguishment of debt in 1998. In conjunction with the repayment of
debt from the proceeds from the initial public offering; the unamortized costs
to obtain the original debt were written-off at repayment.
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 private sale of equity securities, customer advances,
capital lease financings and its recent initial public offering.
Net cash used in operations of $10.7 million in 1998 was due primarily to the
Company's operating loss.
The Company's financial statements include an explanatory paragraph from the
Company's independent auditors that indicates substantial doubt may exist about
the Company's ability to continue as a going concern based on net losses of
$11.7 million and $4.3 million for the years ended December 31, 1998 and 1997,
respectively, and negative cash flows from operations. The Company's
continuation as a going concern is dependent on its ability to generate
sufficient cash flow to meet its obligations on a timely basis, to obtain
additional financing or refinancing as may be required, and ultimately attain
profitability. The Company is actively pursuing potential acquirers for the
purchase of the retail CD-ROM portion of its business. Management expects the
anticipated disposition of its CD-ROM operations will substantially reduce or
eliminate its operating losses and substantially alleviate its negative cash
flows from operations and expects to be able to attract additional capital, if
needed, for its online operations. However, there can be no assurance that
management's plans will be executed as anticipated.
22
<PAGE>
The Company maintains a revolving line of credit arrangement with a bank for up
to $2.8 million. The principal balance outstanding at any point in time is
payable on demand with interest payable monthly at the bank's current prime rate
(7.75% at December 31, 1998). The balance outstanding under this line as of
December 31, 1998 was $1.3 million. Advances on the line of credit are
collateralized by a personal guarantee of the Company's majority shareholder. In
consideration for this guarantee, the stockholder will receive from the Company
an amount equal to 6% of the outstanding balance on the line of credit. At
December 31, 1998 and 1997, the Company incurred $64,000 and $144,000 and owed
the stockholder $117,000 and $174,000 relating to this guarantee, respectively.
These amounts are due no earlier than December 31, 2000.
On January 25, 1999, the Company issued a convertible note for net proceeds to
the Company of approximately $3.7 million. The note accrues interest at an
annual interest rate of 6% and is due with principal on January 25, 2002. The
holder of the convertible note may convert all or any portion of the note into
the Company's common stock based on the conversion amount defined in the
securities purchase agreement. The beneficial conversion feature will result in
a portion of the proceeds of the convertible note being allocated to the
conversion feature which will significantly increase the reported interest
expense associated with this note. The Company granted to the holder of the note
warrants to purchase one share of the Company's stock for every two shares of
common stock issued as a result of the note conversion at an exercise price
equal to the note conversion price.
On July 27, 1998, the Company consummated an initial public offering (the
"offering") of 2,600,000 shares of its Common Stock at an initial public
offering price of $8.00 per share. During August 1998, BlueStone Capital
Partners, L.P. and Royce Investment Group, Inc. (collectively, the
"underwriters") exercised in full their overallotment option to purchase an
additional 390,000 shares of the Company's common stock at the initial public
offering price. All such shares were sold by the Company. The net proceeds to
the Company from the offering, including the net proceeds from exercise of the
underwriters' overallotment option, were approximately $20.5 million. Concurrent
with the closing of the offering, 82,634 shares of Series A Convertible
Preferred Stock and 132,744 shares of Series C Redeemable Convertible Preferred
Stock were converted into an equivalent number of shares of common stock, and
778,746 shares of Series B Convertible Preferred Stock were converted into
2,045,649 shares of common stock. The Company utilized $8.9 million in proceeds
from the offering to repay indebtedness as described in the Company's
Registration Statement on Form SB-2 declared effective on July 21, 1998. The
remaining proceeds received by the Company from such offering were used to fund
the operations and support the working capital of the Company.
On April 30, 1998, the Company closed on a one-year $5.0 million revolving line
of credit bearing an interest rate of prime plus 2%. Borrowings on the line of
credit were limited to the lesser of $5.0 million or 65% of the Company's
outstanding eligible receivables and inventory. Borrowings on the line of credit
were collateralized by the Company's accounts receivable, inventory, and
intellectual property. The revolving line of credit was paid off by the Company
in October 1998.
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 will impact the Company's
future capital requirements and the adequacy of its available funds.
23
<PAGE>
YEAR 2000 ISSUE
The Company's products are of a nature that they are not date dependent or
subject to failure because of Year 2000 issues. The Company however, has
assigned full-time information technology professionals to the task of
identifying and resolving Year 2000 problems that may affect the Company's
business, and has adopted a Year 2000 compliance plan. Under the Company's Year
2000 compliance plan, the Company has and will continue to inventory and collect
documentation on all of its computers, computer related equipment, and equipment
with embedded processors. In addition, the Company will contact critical vendors
and suppliers to obtain assurances of their ability to ensure smooth delivery of
products and services after December 1999. Additionally, the Company will
prioritize and implement any necessary repairs or replacements to equipment in
order to achieve Year 2000 compliance, which it expects to complete by the end
of 1999. The Company will also implement a testing program, scheduled for
completion by the end of 1999. The Company has not prepared estimates of costs
for correction of Year 2000 problems. Based on information available at this
time, including the Year 2000 compliance status of equipment that has been
examined as well as the anticipated replacement schedule for equipment, the
Company does not believe that the cost of remedial actions will have a material
adverse effect on the Company's results of operations or financial condition.
There can be no assurance, however, that there will not be a delay in, or
increased costs associated with, the implementation of corrections as the Year
2000 compliance plan is performed. Failure to implement such changes could have
an adverse effect on future results of operations. In addition, unexpected costs
of correcting equipment that has not yet been fully evaluated could have an
adverse effect on future results of operations.
EURO CONVERSION
On January 1, 1999, the European Community began denominating significant
financial transactions in a new monetary unit, the Euro. The Euro is intended to
replace the traditional currencies of the individual EU member countries. The
Company's operations in Europe are continuing to operate in the traditional
currencies and are not converting internal financial systems to the Euro as a
functional currency. The Company is evaluating when to convert its local
currency in Europe to the Euro with as little disruption to customer and vendors
as possible. The Company does not intend to make such a conversion in 1999.
IMPACT OF ADOPTION OF NEW ACCOUNTING STANDARDS
As of January 1, 1998 the Company adopted Statement of Financial Accounting
Standards No. 130, Reporting Comprehensive Income, ("SFAS130"). SFAS 130
requires all non-owner changes in equity that are excluded from net
earnings/loss under existing FASB standards to be included as items of
comprehensive income/loss. Comprehensive loss consists of net loss and foreign
currency translation adjustments and is presented in the consolidated statements
of stockholders' equity (deficit). The adoption of SFAS 130 had no impact on
previously reported stockholders' equity (deficit). Prior year financial
statements have been reclassified to conform with these requirements
Effective January 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 131, Disclosures about Segments of an Enterprise and Related
Information ("SFAS 131"), which superceded Statement of Financial Accounting
Standards No. 14, Financial Reporting for Segments of a Business Enterprise.
SFAS 131 establishes standards for the way that public business enterprises
report information about operating segments in annual financial statements and
requires that those enterprises report selected information about operating
segments in interim financial reports. SFAS 131 also establishes standards for
related disclosures about products and services, geographic areas and major
customers. The adoption of SFAS 131 did not affect the Company's results of
operations, cash flows nor financial position
In June 1998, the Financial Accounting Standards Board issued SFAS
133,"Accounting for Derivative Instruments and Hedging Activities", which is
required to be adopted in years beginning after June 15,1999. Because the
Company's minimal use of derivatives, management does not anticipate the
adoption of the new Statement will have a significant effect on earnings or the
financial position of the Company.
24
<PAGE>
ITEM 7. FINANCIAL STATEMENTS
Report of Independent Auditors
The Board of Directors and Stockholders
Interactive Magic, Inc.
We have audited the accompanying consolidated balance sheets of Interactive
Magic, Inc. (the "Company") as of December 31, 1998, and 1997, and the related
consolidated statements of operations, stockholders' equity (deficit), and cash
flows for the years then ended. 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, 1998, and 1997, and the consolidated
results of its operations and its cash flows for the years then ended in
conformity with generally accepted accounting principles.
As discussed in Note 2 to the consolidated financial statements, the Company's
recurring losses and negative cash flows from operations raise substantial doubt
about its ability to continue as a going concern. Management's plans as to these
matters are also described in Note 2. The 1998 consolidated financial statements
do not include any adjustments that might result from the outcome of this
uncertainty.
/s/ Ernst & Young LLP
Raleigh, North Carolina
February 19, 1999
25
<PAGE>
Interactive Magic, Inc.
Consolidated Balance Sheets
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31
1998 1997
------------------------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $2,943 $ 384
Trade receivables, net of allowances of $2,871 and $3,650,
respectively 2,109 2,830
Inventories 892 637
Advance royalties, net 1,586 1,989
Software development costs, net 912 425
Prepaid expenses and other 252 109
------------------------------
Total current assets 8,694 6,374
Property and equipment, net 1,082 1,196
Noncurrent assets:
Royalties receivable 726 90
Other 18 87
------------------------------
Total noncurrent assets 744 177
------------------------------
Total assets $10,520 $7,747
==============================
26
<PAGE>
DECEMBER 31
1998 1997
------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) Current liabilities:
Accounts payable and accrued expenses $ 1,698 $ 2,776
Royalties and commissions payable 768 858
Lines of credit 1,348 3,983
Current portion of long-term debt - 745
Current portion of capital lease obligations 23 35
------------------------------
Total current liabilities 3,837 8,397
Noncurrent liabilities:
Accrued interest payable to related parties 117 982
Long-term debt, less current portion - 3,759
Capital lease obligations, less current portion 15 38
Notes payable to related parties - 3,470
------------------------------
Total noncurrent liabilities 132 8,249
Stockholders' equity (deficit):
Series A Convertible Preferred Stock, $.10 par value; 82,634 shares
authorized, issued and outstanding at December 31,
1997 - 8
Class A Common Stock, $.10 par value; 10,000,000 shares
authorized; 3,145,696 shares issued and outstanding at
December 31, 1997 - 314
Class B Common Stock, $.10 par value; 10,000,000 shares
authorized; 7,875 shares issued and outstanding at
December 31, 1997 - 1
Common stock, $.10 par value; 50,000,000 shares authorized
9,850,867 shares issued and outstanding at December 31,
1998 985 -
Additional paid-in capital 31,522 5,047
Accumulated deficit (25,862) (14,210)
Accumulated other comprehensive loss (94) (59)
-------------------------------
Total stockholders' equity (deficit) 6,551 (8,899)
------------------------------
Total liabilities and stockholders' equity (deficit) $ 10,520 $ 7,747
==============================
</TABLE>
SEE ACCOMPANYING NOTES.
<PAGE>
Interactive Magic, Inc.
Consolidated Statements of Operations
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1998 1997
----------------------------
<S> <C> <C>
Net revenues:
CD-ROM product sales $ 9,177 $ 14,067
Online sales 1,773 1,615
Royalties and licenses 1,616 820
----------------------------
Total net revenues 12,566 16,502
Cost of revenues:
Cost of products and services 3,157 3,715
Royalties and amortized software costs 2,942 2,634
----------------------------
Total cost of revenues 6,099 6,349
----------------------------
Gross profit 6,467 10,153
Operating expenses:
Sales and marketing 8,490 6,760
Product development 5,983 3,878
General and administrative 2,684 1,941
----------------------------
Total operating expenses 17,157 12,579
----------------------------
Operating loss (10,690) (2,426)
Other (income) expense:
Interest expense - third parties 554 622
Interest expense - related parties 134 1,053
Other (161) 230
----------------------------
Total other (income) expense 527 1,905
----------------------------
Loss before income taxes and extraordinary item (11,217) (4,331)
Income tax (expense) benefit (28) 33
----------------------------
Loss before extraordinary item (11,245) (4,298)
Extraordinary loss on early extinguishment of debt (407) -
----------------------------
Net loss $ (11,652) $ (4,298)
============================
Basic loss per share:
Loss before extraordinary item $ (1.73) $ (1.36)
Extraordinary item (0.06) -
----------------------------
Net loss per share $ (1.79) $ (1.36)
============================
Weighted average shares used in computing basic loss per share 6,515,213 3,152,930
============================
</TABLE>
SEE ACCOMPANYING NOTES.
27
<PAGE>
Interactive Magic, Inc.
Consolidated Statements of Stockholders' Equity (Deficit)
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
SERIES A
CONVERTIBLE SERIES B CONVERTIBLE
PREFERRED STOCK PREFERRED STOCK COMMON STOCK
--------------------------------------------------------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
--------------------------------------------------------------
<S> <C> <C> <C> <C>
Balance at December 31, 1996 82,634 $ 8 - $ - - $ -
Issuance of common stock - - - - - -
Issuance of warrants - - - - - -
Exercise of stock options - - - - - -
Comprehensive loss
Net loss - - - - - -
Other comprehensive loss - - - - - -
Total comprehensive loss
--------------------------------------------------------------
Balance at December 31, 1997 82,634 8 - - - -
Exercise of stock options - - - - - -
Issuance of common stock - - - - - -
Exercise of warrants - - - - - -
Issuance of preferred stock - - 778,746 78 - -
Conversion of notes payable into - - - - - -
common stock
Recapitalization contemporaneous with
the initial public offering
(NOTE 8) (82,634) (8) (778,746) (78) 6,793,699 679
Issuance of common stock - - - - 2,990,000 299
Exercise of warrants - - - - 18,330 2
Exercise of stock options - - - - 48,838 5
Issuance of warrants - - - - - -
Comprehensive loss
Net loss - - - - - -
Other comprehensive loss - - - - - -
Total comprehensive loss - - - - - -
--------------------------------------------------------------
Balance at December 31, 1998 - $ - - $ - 9,850,867 $985
==============================================================
</TABLE>
28
<PAGE>
<TABLE>
<CAPTION>
ACCUMULATED
CLASS A CLASS B ADDITIONAL OTHER
COMMON STOCK COMMON STOCK PAID-IN COMPREHENSIVE ACCUMULATED
-------------------------------------------
SHARES AMOUNT SHARES AMOUNT CAPITAL LOSS DEFICIT TOTAL
------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
3,145,178 $314 6,750 $ 1 $4,703 $(62) $(9,912) $(4,948)
518 - - - 15 - - 15
- - - - 328 - - 328
- - 1,125 - 1 - - 1
- - - - - - (4,298) (4,298)
- - - - - 3 - 3
-------------
(4,295)
- -----------------------------------------------------------------------------------------------
3,145,696 314 7,875 1 5,047 (59) (14,210) (8,899)
268,750 27 102,500 10 381 - - 418
- 48,604 5 (5) - - -
516,769 52 - - (52) - - -
- - - - 3,091 - - 3,169
- 442,478 44 1,956 - - 2,000
(3,931,215) (393) (601,457) (60) 460 - - 600
- - - - 20,176 - - 20,475
- - - - (2) - - -
- - - - 76 - - 81
- - - - 394 - - 394
- - - - - - (11,652) (11,652)
- - - - - (35) - (35)
-------------
- - - - - - - (11,687)
------------------------------------------------------------------------------------------
- $ - - $ - $31,522 $ (94) $(25,862) $ 6,551
==========================================================================================
</TABLE>
SEE ACCOMPANYING NOTES.
29
<PAGE>
Interactive Magic, Inc.
Consolidated Statements of Cash Flows
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1998 1997
------------------------------
<S> <C> <C>
OPERATING ACTIVITIES
Net loss $ (11,652) $ (4,298)
Adjustments to reconcile net loss to net cash used
in operating activities:
Extraordinary loss 407 -
Issuance of warrants 394 -
Depreciation and amortization 461 422
Amortization of capitalized software development costs 963 576
Issuance of common stock for services - 15
Noncash interest expense 39 147
Write-off of investment - 120
Changes in operating assets and liabilities:
Trade and royalties receivables 85 (1,752)
Inventories (255) (227)
Advance royalties 403 (911)
Prepaid expenses and other 126 (87)
Accounts payable and accrued expenses (1,078) 1,084
Royalties and commissions payable (90) 374
Accrued interest (546) 764
------------------------------
Net cash used in operating activities (10,743) (3,773)
INVESTING ACTIVITIES
Increase in note receivable (200) -
Purchase of property and equipment (347) (382)
Software development costs (1,450) (849)
------------------------------
Net cash used in investing activities (1,997) (1,231)
FINANCING ACTIVITIES
Proceeds from issuance of common stock 20,655 -
Proceeds from issuance of preferred stock 3,169 -
Proceeds from long-term debt 350 4,192
Payments on long-term debt (5,300) -
Proceeds from notes payable to related parties - 500
Payments on notes payable to related parties (870) -
Net (payments on) borrowings from lines-of-credit (2,635) 469
Payments on capital lease obligations (35) (68)
------------------------------
Net cash provided by financing activities 15,334 5,093
</TABLE>
30
<PAGE>
Interactive Magic, Inc.
Consolidated Statements of Cash Flows (continued)
(IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31
1998 1997
------------------------------
<S> <C> <C>
Effect of currency exchange rate changes on cash and cash
equivalents (35) 3
-----------------------------
Net increase in cash and cash equivalents 2,559 92
Cash and cash equivalents at beginning of year 384 292
=============================
Cash and cash equivalents at end of year $ 2,943 $ 384
=============================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for interest $ 1,376 $ 760
=============================
Cash paid for income taxes $ - $ 8
=============================
NONCASH INVESTING AND FINANCING ACTIVITIES
Conversion of notes payable into stock $ 2,600 $ -
=============================
Exercise of stock options for forgiveness of accrued interest $ 319 $ -
=============================
</TABLE>
SEE ACCOMPANYING NOTES.
31
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements
December 31, 1998
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 services, the Company also distributes its products
internationally.
2. BASIS OF PRESENTATION
The accompanying consolidated financial statements have been prepared on a going
concern basis, which contemplates the realization of assets and the satisfaction
of liabilities in the normal course of business. As shown in the consolidated
financial statements during the years ended December 31, 1998 and 1997, the
Company incurred losses of $11,652,000 and $4,298,000, respectively, and has
experienced negative cash flows from operations. These factors, among others,
indicate that the Company may be unable to continue as a going concern for a
reasonable period of time. The consolidated financial statements do not include
any adjustments relating to the recoverability and classification of liabilities
that might be necessary should the Company be unable to continue as a going
concern.
The Company's continuation as a going concern is dependent upon its ability to
generate sufficient cash flow to meet its obligations on a timely basis, to
obtain additional financing or refinancing as may be required, and ultimately to
attain profitability. The Company is actively pursuing potential acquirers for
the purchase of the retail CD-ROM portion of its business (see Note 16).
Management expects the anticipated disposition of its CD-ROM operations will
substantially reduce or eliminate its operating losses and expects to be able to
attract additional capital, if needed, for its online operations. However, there
can be no assurance that management's plans will be executed as anticipated.
32
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements (continued)
3. 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
accompanying consolidated financial statements include the operations of the
combined entities for the years ended December 31, 1998 and 1997.
4. 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.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include amounts in demand deposit accounts and
investments with an original maturity date of three months or less when
purchased.
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):
DECEMBER 31
1998 1997
-------------------------
Finished goods $ 1,065 $ 645
Components 117 79
-------------------------
1,182 724
Inventory valuation reserve (290) (87)
=========================
$ 892 $ 637
=========================
33
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements (continued)
4. SIGNIFICANT ACCOUNTING POLICIES AND OTHER MATTERS (CONTINUED)
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. At December 31, 1998 and 1997, the reserve for advance
royalties was $1,654,000 and $1,050,000, respectively.
NOTE RECEIVABLE
In connection with the merger with MPG-Net, Inc. (Note 15), the Company entered
into a loan agreement to assist MPG-Net, Inc. in funding its current operations.
As of December 31, 1998 the Company had advanced MPG-Net, Inc. funds totaling
$200,000 at an 18% annual interest rate. The note receivable is included in
prepaid expenses and other current assets on the balance sheet.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation for equipment, furniture
and fixtures and purchased 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 $461,000 and $415,000 for the years ended December 31, 1998
and 1997, respectively.
Property and equipment consists of the following (IN THOUSANDS):
<TABLE>
<CAPTION>
DECEMBER 31
1998 1997
-------------------------
<S> <C> <C>
Equipment $ 1,547 $ 1,287
Furniture and fixtures 188 167
Software 488 425
Leasehold improvements 59 54
-------------------------
2,282 1,933
Less accumulated depreciation and amortization (1,200) (737)
-------------------------
$ 1,082 $ 1,196
=========================
</TABLE>
34
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements (continued)
4. SIGNIFICANT ACCOUNTING POLICIES AND OTHER MATTERS (CONTINUED)
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.
Information related to net capitalized software development costs is as follows
(IN THOUSANDS):
1998 1997
------------------------
Balance at beginning of year $ 425 $ 152
Capitalized 1,450 849
Amortized (963) (576)
------------------------
Balance at end of year $ 912 $ 425
========================
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying value of cash and cash equivalents, trade receivables, accounts
payable and other liabilities approximates fair value at December 31, 1998 and
1997.
REVENUE RECOGNITION
In October 1997, the Accounting Standards Executive Committee (AcSEC) issued
Statement of Position (SOP) 97-2 Software Revenue Recognition as amended in
March 1998 by SOP 98-4 and October 1998 by SOP 98-9. These SOPs provide guidance
on applying generally accepted accounting principles in recognizing revenue on
software transactions. The Company adopted SOP 97-2 for software transactions
entered into beginning January 1, 1998. Based on the current requirements of the
SOPs, application of these statements did not have a material impact on the
Company's revenue recognition policies. However, AcSEC is currently reviewing
further modifications to the SOP with the objective of providing more
definitive, detailed implementation guidelines. This guidance could lead to
unanticipated changes in the Company's operations and revenue recognition
practices.
35
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements (continued)
4. SIGNIFICANT ACCOUNTING POLICIES AND OTHER MATTERS (CONTINUED)
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 original equipment manufacturers ("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 provided collectibility is probable. 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.
The Company does not require collateral for unpaid balances. Credit losses have
historically 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.
ADVERTISING
The Company expenses advertising costs as incurred. Advertising expense was
approximately $3,590,000 and $2,529,000 for the years ended December 31, 1998
and 1997, 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, warranty provisions, and estimates regarding the recoverability
of prepaid royalty advances and inventory. Actual results could differ from
those estimates.
36
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements (continued)
4. SIGNIFICANT ACCOUNTING POLICIES AND OTHER MATTERS (CONTINUED)
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 component
of accumulated other comprehensive income (loss).
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 "Accounting for Stock-Based Compensation" and make the
required pro forma disclosures required by SFAS No. 123 (see Note 10). 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.
INCOME TAXES
The Company accounts for income taxes under the provisions of SFAS No. 109,
"Accounting for Income Taxes". Under SFAS No. 109, the liability method is used
in accounting for income taxes and deferred tax assets and liabilities are
determined based on differences between the financial reporting and tax bases of
assets and liabilities.
BASIC NET LOSS PER SHARE
Basic net loss per share has been calculated in accordance with SFAS No. 128,
"Earnings Per Share". SFAS No. 128 requires companies to compute earnings per
share under two different methods (basic and diluted). Basic net loss per share
is calculated by dividing net loss by the weighted average shares of common
stock outstanding during the period. All shares used in computing basic net loss
per share reflect the retroactive effect of the Company's July 1998 one-for-two
reverse stock split.
37
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements (continued)
4. SIGNIFICANT ACCOUNTING POLICIES AND OTHER MATTERS (CONTINUED)
Had the Company been in a net income position, diluted earnings per share would
have been presented and would have included potential common shares related to
outstanding options and warrants. The diluted earnings per share computation is
not included, as all potential common shares are antidilutive. The Company
evaluated the requirements of the Securities and Exchange Commission Staff
Accounting Bulletin No. 98 ("SAB 98"), and concluded that there are no nominal
issuances of common stock or potential common stock which would be required to
be shown as outstanding for all periods as outlined in SAB 98.
IMPACT OF RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
Effective January 1, 1998, the Company adopted SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information" which superseded SFAS No. 14,
"Financial Reporting for Segments of a Business Enterprise". SFAS No. 131
establishes standards for the way that public business enterprises report
information about operating segments in annual financial statements and requires
that those enterprises report selected information about operating segments in
interim financial reports. SFAS No. 131 also establishes standards for related
disclosures about products and services, geographic areas and major customers.
The adoption of SFAS No. 131 did not affect net earnings, financial position or
cash flows of the Company in 1998.
As of January 1, 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income". SFAS No. 130 requires all non-owner changes in equity
that are excluded from net earnings/loss under existing FASB standards to be
included as items of comprehensive income/loss. Comprehensive loss consists of
net loss and foreign currency translation adjustments and is presented in the
consolidated statements of stockholders' equity (deficit). The adoption of SFAS
No. 130 had no impact on previously reported stockholders' equity (deficit).
Prior year financial statements have been reclassified to conform with these
requirements.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities", which is
required to be adopted in years beginning after June 15, 1999. Because of the
Company's minimal use of derivatives, management does not anticipate the
adopting of the new statement will have a significant effect on earnings or the
financial position of the Company.
38
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements (continued)
5. 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 (7.75% at
December 31, 1998). The weighted-average interest rate on the line of credit was
8.5% and 8.1% for the years ended December 31, 1998 and 1997, respectively. The
balance outstanding as of December 31, 1998 and 1997 was $1,316,000 and
$2,439,000, respectively. Advances on the line of credit are collateralized by a
personal guarantee of the Company's majority stockholder. In consideration for
this guarantee, the Company will pay the stockholder as additional interest
expense an amount equal to 6% of the outstanding balance on the line of credit.
At December 31, 1998 and 1997, the Company incurred $64,000 and $144,000 and
owed the stockholder $117,000 and $174,000 relating to this guarantee,
respectively. These amounts are due no earlier than January 1, 2000.
The Company also entered into a line of credit agreement with its 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 8.5% and 8.1% for
the years ended December 31, 1998 and 1997, respectively. The balance
outstanding at December 31, 1998 and 1997 was $32,000 and $44,000, respectively.
During 1996, the Company also executed a line of credit agreement with another
bank, the terms of which stipulated that the Company may borrow up to 75% of its
eligible domestic accounts receivable up to a maximum of $1,500,000. The
agreement entitled 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, 1997. Interest was payable monthly at prime plus 2.0%. The
weighted-average interest rate on the line of credit was 10.1% for the year
ended December 31, 1997. Also, monthly fees of an additional 0.5% were 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.
On April 30, 1998, the Company closed on a $5 million line of credit bearing an
interest rate of the bank's prime plus 2%. Borrowings on the line of credit were
limited to the lesser of $5 million or 65% of the Company's outstanding eligible
receivables and inventory. Borrowings on the line of credit were collateralized
by the Company's accounts receivable, inventory, and intellectual property. The
line of credit expired on October 15, 1998 and all outstanding borrowings were
repaid in full.
39
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements (continued)
6. NOTES PAYABLE TO RELATED PARTIES
Notes payable to related parties consisted of the following at December 31,
1997(IN THOUSANDS):
<TABLE>
<CAPTION>
<S> <C>
Note payable to a stockholder, due on demand after January 1, 1999,
interest at 14% per annum $ 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
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
Note payable to related party, principal and interest due January 1,
1999, interest at 10% per annum 870
=============
$3,470
=============
</TABLE>
On February 4, 1998, the $600,000 and the two $1 million notes payable to
stockholders were converted into 132,744 shares of Series C Redeemable
Convertible Preferred Stock and 442,478 shares of Class B Common Stock,
respectively. In connection with the Company's July 1998 initial public
offering, the Series C Redeemable Convertible Preferred Stock was converted into
132,744 shares of common stock and the 442,478 shares of Class B Common Stock
were exchanged for an equal number of shares of common stock (see Note 9).
Utilizing proceeds from the Company's initial public offering, the $870,000 note
payable to a related party was repaid in full during 1998.
40
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements (continued)
7. LONG-TERM DEBT
Long-term debt, other than to related parties, consisted of the following at
December 31, 1997 (IN THOUSANDS):
<TABLE>
<CAPTION>
<S> <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 $5 at December 31, 1997) $ 495
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 at December 31,
1997) 2,724
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 major shareholder 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 at December 31, 1997) 1,035
--------------
4,504
Less current portion 745
--------------
Long-term debt, less current portion $ 3,759
==============
</TABLE>
All of the aforementioned long-term debt was repaid in full utilizing proceeds
from the Company's July 1998 initial public offering. As a result of the early
extinguishment of the long-term debt, the Company recorded an extraordinary loss
of $407,000 which consists of the difference between the principal amount and
the net carrying amount of the extinguished debt.
8. LEASES
The Company rents its facilities and certain office equipment under
noncancelable operating leases which expire at various times through 2001. The
monthly rent under certain facility leases are periodically adjusted based on
changes in the Consumer Price Index.
41
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements (continued)
8. LEASES (CONTINUED)
Property and equipment includes the following amounts for capital leases (IN
THOUSANDS):
<TABLE>
<CAPTION>
DECEMBER 31
1998 1997
-----------------------------
<S> <C> <C>
Leased equipment $ 157 $ 157
Leased furniture and fixtures 53 53
-----------------------------
210 210
Less: accumulated amortization (125) (85)
=============================
$ 85 $ 125
=============================
</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> <C>
1999 $ 28 $ 329
2000 16 247
2001 - 20
--------------------------------
Total future minimum lease payments 44 $ 596
================
Less: amounts representing interest (6)
----------------
Present value of future minimum lease payments 38
Less: current portion (23)
----------------
$ 15
================
</TABLE>
Total rent expense incurred was approximately $462,000 and $309,000 for the
years ended December 31, 1998 and 1997, respectively.
42
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements (continued)
9. STOCKHOLDERS' EQUITY (DEFICIT)
STOCK SPLIT
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 reincorporating 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.
INITIAL PUBLIC OFFERING
On July 27, 1998, the Company consummated an initial public offering ("IPO" or
"Offering") of 2,600,000 shares of its common stock at a price of $8.00 per
share. During August 1998, BlueStone Capital Partners, L.P. and Royce Investment
Group, Inc. (collectively, the "underwriters") exercised in full their
overallotment option to purchase an additional 390,000 shares of the Company's
common stock at the IPO price. All of such shares were sold by the Company. The
net proceeds to the Company from the offering and the exercise of the
overallotment option were approximately $20.5 million.
RECAPITALIZATION
The Company was recapitalized through the exchange of securities which was
effective as of the closing date of the Company's initial public offering as
follows:
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.
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 has authorized capital of
50,000,000 shares of $.10 par value common stock and 25,000,000 shares of $.10
par value preferred stock.
43
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements (continued)
9. STOCKHOLDERS' EQUITY (DEFICIT) (CONTINUED)
During 1997, the Company issued 1,037 shares of its Class A Common Stock for
services rendered. 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
On February 4, 1998, the company issued 778,746 shares of its Series B
Convertible Preferred Stock ("Series B Preferred") for net proceeds of
$3,169,000. These shares were converted into 2,045,649 shares of common stock in
connection with the Company's initial public offering. The Company and an
affiliate of the holders of the Series B Preferred entered into a marketing
agreement pursuant to which the Company was obligated to pay to the affiliate
$400,000 for marketing services related to the Company's IPO. The Company
satisfied its obligation during 1998 from proceeds of the IPO.
10. STOCK OPTIONS, STOCK PLANS AND WARRANTS
EMPLOYEE STOCK OPTIONS AND STOCK 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 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 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.
44
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements (continued)
10. STOCK OPTIONS, STOCK PLANS AND WARRANTS (CONTINUED)
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 twelve-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 as defined
in the option agreement.
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 exercisable as of a change in control as
defined in the agreement.
As the exercise price of the options was not less than the fair value of the
stock on the date of grant, no compensation expense was recorded related to
these options.
During May 1998, the Company's 1998 Stock Plan (the "Plan") was adopted by the
Board of Directors and approved by the shareholders of the Company. The Company
anticipates that no future grants will be made under the Company's 1995
incentive stock plans after the effective date of the 1998 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 incentive stock options. 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
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 the grant. The maximum term of options
granted under the plan is 10 years.
45
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements (continued)
10. STOCK OPTIONS, STOCK PLANS AND WARRANTS (CONTINUED)
During May 1998, 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. The Purchase Plan is intended to qualify under Section
423 of the Internal Revenue Code of 1986, as amended. 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 vale 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.
The following table summarizes the ISO and PSO activity under the Company's 1995
and 1998 Stock Plans:
<TABLE>
<CAPTION>
WEIGHTED-
SHARES SHARES AVERAGE
AVAILABLE AVAILABLE EXERCISE
FOR GRANT FOR GRANT OPTIONS PRICE PER OPTIONS
1995 PLANS 1998 PLANS OUTSTANDING SHARE EXERCISABLE
---------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balances at December 31, 1996 1,004,880 - 1,863,370 $1.78 54,644
Options authorized for grant 607,500 - - - -
Options granted (330,316) - 330,316 5.63 -
Options exercised - - (1,125) 1.00 -
Options canceled 199,513 - (199,513) 4.90 -
---------------------------------------------------------------
Balances at December 31, 1997 1,481,577 - 1,993,048 2.14 1,007,328
Options authorized for grant - 800,000 - - -
Options granted (254,684) (484,750) 739,434 4.80 -
Options exercised - - (420,088) 1.19 -
Options canceled 322,626 7,800 (330,426) 4.70 -
---------------------------------------------------------------
Balances at December 31, 1998 1,549,519 323,050 1,981,968 $2.72 810,797
===============================================================
</TABLE>
46
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements (continued)
10. STOCK OPTIONS, STOCK PLANS AND WARRANTS (CONTINUED)
The following summarizes information about the Company's stock options
outstanding at December 31, 1998:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- --------------------------------------------------------------------------------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
RANGE OF EXERCISE PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
$1.000 999,500 4.38 $1.00 517,377 $1.00
$2.000 - $4.125 481,389 7.65 3.44 84,561 2.06
$4.250 150,000 6.17 4.25 - -
$6.000 351,079 6.49 6.00 208,859 6.00
-------------------------------------------------------------------
1,981,968 5.68 $2.72 810,797 $2.46
===================================================================
</TABLE>
The Company has adopted the disclosure-only provisions of SFAS No. 123. The fair
value for each option was estimated at the date of grant using a Black-Scholes
option pricing model with the following weighted average assumptions:
YEAR ENDED DECEMBER 31
1998 1997
----------------------------
Expected dividend yield 0% 0%
Risk-free interest rate 5% 6%
Expected volatility 66% 59%
Expected life (in years from vesting) 3.4 1.9
For purpose 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 of options was $2.19 and $0.95 per share
for 1998 and 1997, respectively.
47
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements (continued)
10. STOCK OPTIONS, STOCK PLANS AND WARRANTS (CONTINUED)
The following table shows pro forma net loss and net loss per share as if the
fair value accounting method prescribed by SFAS No. 123 had been used to account
for stock based compensation (IN THOUSANDS, EXCEPT PER SHARE DATA):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1998 1997
---------------- -------------
<S> <C> <C>
Net loss as reported $ (11,652) $ (4,298)
Pro forma compensation expense (585) (484)
---------------- -------------
Pro forma net loss $ (12,237) $ (4,782)
================ =============
Net loss per share:
Historical $ (1.79) $ (1.36)
Pro forma (for SFAS 123 disclosure purposes) $ (1.88) $ (1.52)
</TABLE>
STOCK WARRANTS
Warrants issued in connection with notes payable were recorded at their
estimated fair value and credited to additional paid in capital. The resulting
debt discount was amortized to interest expense over the term of the related
debt. Warrants issued to members of the Board of Directors, consultants and
financial advisors are recorded at their estimated fair value and the related
general and administrative expense is charged when the warrants are issued. The
estimated 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.
The following summarizes the activity of warrants:
WARRANTS
OUTSTANDING
-------------------
Balance at December 31, 1996 261,157
Issued 488,897
-------------------
Balance at December 31, 1997 750,054
Issued 514,993
Exercised (535,875)
-------------------
Balance at December 31, 1998 729,172
===================
48
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements (continued)
10. STOCK OPTIONS, STOCK PLANS AND WARRANTS (CONTINUED)
All of the Company's outstanding warrants at December 31, 1998 were exercisable
at prices ranging from $1.00 to $8.00 per share.
In connection with the conversion of a note payable, the Company had an
additional commitment to issue 48,604 shares of its Class B common stock to the
former holder of the note. The Company satisfied its commitment in August 1998
by issuing 48,604 shares of the Company's common stock.
COMMON STOCK RESERVED FOR FUTURE ISSUANCE
The Company has reserved authorized shares of Common Stock for future issuance
as follows at December 31, 1998:
Outstanding incentive stock options 1,374,468
Outstanding performance based stock options 607,500
Possible future issuance under stock option plan 1,872,569
Stock purchase warrants 729,172
-------------------
4,583,709
===================
11. INCOME TAXES
At December 31, 1998, the Company has a cumulative domestic federal net
operating loss carryforward available to offset future taxable income of
approximately $19 million which begins to expire in the year 2011. State tax
losses of approximately $19 million will begin to expire in 2001. The Company
also has $350,000 of research credits to carryforward 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.
49
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements (continued)
11. INCOME TAXES (CONTINUED)
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
1998 1997
-----------------------------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards $7,797 $ 3,669
Sales and accounts receivable reserves 782 1,048
Accrued salaries 42 10
Other reserves 91 191
Accrued interest to related party 77 397
Depreciation (78) 17
Research and development credit carryforward 354 78
-----------------------------
Total deferred tax assets 9,065 5,410
Deferred tax liabilities:
Accounting method change 54 72
-----------------------------
Total deferred tax liabilities 54 72
Less:
Valuation allowance 9,011 5,338
-----------------------------
Total net deferred taxes $ - $ -
=============================
</TABLE>
The Company has recorded a valuation allowance for the full amount of its
deferred income tax assets as of December 31, 1998 and 1997, based on
management's evaluation of the criteria set forth in SFAS No. 109.
For financial reporting purposes, (loss) income before income taxes and
extraordinary item includes the following components (IN THOUSANDS):
<TABLE>
<CAPTION>
DECEMBER 31
1998 1997
-----------------------------
<S> <C> <C>
Pretax (loss) income:
United States $ (11,195) $(4,873)
Foreign (22) 542
-----------------------------
$ (11,217) $(4,331)
=============================
</TABLE>
50
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements (continued)
11. INCOME TAXES (CONTINUED)
Significant components of the provision for income tax (expense) benefit
attributable to continuing operations are as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31
1998 1997
------------------------------
<S> <C> <C>
Current:
Federal $ - $ 41
Foreign (28) (15)
State - 7
------------------------------
Total current (expense) benefit $ (28) $ 33
==============================
</TABLE>
12. 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, 1998 and 1997.
13. SIGNIFICANT CUSTOMERS
Revenues from significant customers, those representing 10% or more of net
revenues for the respective periods, are summarized as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1998 1997
---------------- ----------------
<S> <C> <C>
Customer 1 13% -
Customer 2 16% -
Customer 3 - 19%
Customer 4 - 10%
</TABLE>
Additionally, two customers comprised 22% of accounts receivable at December 31,
1998 and three customers comprised 40% of accounts receivable at December 31,
1997.
51
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements (continued)
14. GEOGRAPHIC INFORMATION
In addition to domestic sales, the Company sells its product through its
subsidiaries to international customers. These sales amounted to 54% and 37% of
net revenues during the years ended December 31, 1998 and 1997, respectively.
The following table presents information related to the Company's operations by
geographic location (IN THOUSANDS):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1998 1997
------------------------------
<S> <C> <C>
Net revenue:
United States $ 6,283 $ 10,396
United Kingdom 2,010 1,650
Germany 1,759 2,310
Other 2,514 2,146
------------------------------
$ 12,566 $ 16,502
==============================
Long-lived assets:
United States $ 989 $ 1,099
United Kingdom 73 80
Germany 20 17
------------------------------
$ 1,082 $ 1,196
==============================
</TABLE>
52
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements (continued)
15. Subsequent Events
On January 25, 1999, the Company issued a $4 million convertible debenture ("the
debenture") for net cash proceeds to the Company of approximately $3.7 million.
The Company also issued 200,000 warrants to the debenture broker, which
represented additional debt issuance costs, valued at $390,000. These warrants
were recorded as additional paid-in capital and the resulting debt issuance
costs will be amortized to interest expense over the term of the debenture.
These warrants have a weighted average exercise price of $4.85 and were
exercisable upon issuance.
The debenture accrues interest at an annual interest rate of 6% and the accrued
interest and principal are due on January 25, 2002. The holder of the
convertible debenture may convert all or any portion of the debenture into the
Company's common stock where the number of shares to be issued will be
determined by dividing the principal plus interest due by the conversion price.
The conversion price will be equal to the lesser of a conversion price ranging
from 77% to 93% of the market price of the Company's common stock (as defined in
the securities purchase agreement) or a conversion price ranging from 104% to
120% of a fixed conversion price (as defined in the securities purchase
agreement). On the date of conversion, if the Company's common stock trades at a
price higher than the fixed conversion price, the Company is obligated to issue
to the holder of the debenture warrants to purchase the Company's stock at a
one-for-two ratio of common stock issued as a result of the debenture conversion
at an exercise price equal to the debenture conversion price (the "contingently
issuable warrants").
The contingently issuable warrants were valued at approximately $1.1 million at
the date of issuance and were recorded as additional paid-in capital. The
beneficial conversion feature of the debenture also resulted in a portion of the
proceeds of the debenture being allocated to the conversion feature based on its
intrinsic value of $2.1 million, which was recorded as additional paid-in
capital. The debenture was convertible at the date of issuance and the value of
the conversion feature was therefore immediately recorded as additional interest
expense and accreted into the carrying value of the debenture. Based on the
recorded fair value of the contingently issuable warrants, the carrying value
assigned to the debenture at the date of issuance was $2.9 million. The
difference between the initial carrying value of the debenture and the $4
million face value will be accreted into the carrying value as additional
interest expense over the term of the debenture.
On February 12, 1999 the Company completed the acquisition of MPG-Net, Inc.
("MPG-Net") Company by exchanging 600,000 shares of its common stock valued at
approximately $3.1 million for all of the outstanding common stock of MPG-Net
and issuing 150,000 shares of its common stock valued at approximately $.8
million in full settlement of certain debt obligations of MPG-Net. MPG-Net is
primarily in the business of developing, publishing and distributing
interactive, real time 3-D entertainment for multi-user online/Internet play, as
well as creating entertainment platforms on the Internet such as online game
channels, game hubs and websites. The merger was originally accounted for under
the pooling-of-interests method in accordance with Accounting Principles Board
Opinion No. 16. Subsequent to the merger, the management of the Company began to
explore and evaluate various business strategies, including the potential sale
of its CD-ROM business. During the second quarter, the Company consummated an
agreement to sell a significant portion of its CD-ROM business. Although the
CD-ROM asset disposition was not contemplated at the time of the MPG-Net merger,
the proximity of the transaction to the closing of the merger made it
impracticable to overcome the presumption that the asset disposition was done in
contemplation of the merger. Therefore, the pooling treatment was rescinded, and
the Company accounted for the MPG-Net merger as a purchase business combination.
The excess of the aggregate purchase price over the fair value of the net assets
acquired of approximately $4.3 million is being amortized over 3 years.
53
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements (continued)
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
PART III.
ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Current Directors
The following table sets forth information regarding the Directors of the
Company:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------
Year First
- ---------------------------------------------------------------------------------------------------
Elected As Term
- ---------------------------------------------------------------------------------------------------
Name Director Expires Age
- ---------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
- ---------------------------------------------------------------------------------------------------
J.W. Stealey (2) 1995 1999 50
- ---------------------------------------------------------------------------------------------------
J. Nicholas England (1) 1997 1999 50
- ---------------------------------------------------------------------------------------------------
David H. Kestel (2) 1997 1999 65
- ---------------------------------------------------------------------------------------------------
W. Joseph McClelland (1) (2) 1997 1999 52
- ---------------------------------------------------------------------------------------------------
Avi Suriel (1) 1998 1999 38
- ---------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------
(1) Member of Audit Committee
- ---------------------------------------------------------------------------------------------------
(2) Member of Compensation Committee
- ---------------------------------------------------------------------------------------------------
</TABLE>
The current executive officers of the Company are as follows:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------
Name Office Officer Since
- ---------------------------------------------------------------------------------------------------
<S> <C> <C>
J.W. Stealey Chairman of the Board of Directors and 1995
Chief Executive Officer
- ---------------------------------------------------------------------------------------------------
Carl L. Linke Vice President-Operations 1998
- ---------------------------------------------------------------------------------------------------
Michael W. Oliver Chief Financial Officer, Secretary and 1999
Treasurer
- ---------------------------------------------------------------------------------------------------
Joseph Rutledge Senior Vice President-Technology 1995
- ---------------------------------------------------------------------------------------------------
Raymond Rutledge Vice President-Licensing 1995
- ---------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------
</TABLE>
54
<PAGE>
Biographies of the Directors and Executive Officers
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 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.
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.
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.
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.
55
<PAGE>
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.
Carl E. Linke has been Vice President of Operations since October 1998. Prior to
joining the Company, Mr. Linke was responsible for the opening and operations of
an office of Academy Graduates Executive Search, a personnel search boutique
focused on former officers from the Nation's military forces. From 1990 to 1995
Mr. Linke served as Vice President of Operations for two software related
companies in the Chicago area. For over twenty years Mr. Linke was an officer in
the United States Army serving in operations positions and unit commands. He
completed his service as a Lieutenant Colonel. Mr. Linke received a B.S. degree
in Engineering from the United States Military Academy in 1970 and a Master of
Science degree in Industrial Relations from the Krannert School of Management at
Purdue University in 1977.
Michael W. Oliver was appointed Chief Financial Officer, Secretary and Treasurer
effective January 1, 1999. Mr. Oliver was President of The Oliver Group from
October 1997 to December, 1998. He was Treasurer of Reichhold Chemicals, Inc.
from July 1990 to September 1997. He was Executive Vice President and Chief
Financial Officer of The Harris Organization from January 1988 to June 1990; and
Controller-Natural Resources of Eastern Enterprises from November 1979 to
December 1987. Mr. Oliver received his B.A. in Economics from the University of
Pittsburgh at Johnstown in 1975 and his M.B.A. from the Katz School of Business
in 1977.
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.
56
<PAGE>
Section 16(A) Beneficial Ownership Reporting Compliance
The Company believes that all directors and executive officers of the Company
and all other persons known by the Company to be subject to Section 16 of the
Securities Exchange Act of 1934, filed all reports required to be filed during
1998 under Section 16(a) of that Act on a timely basis, except for each
executive officer and director whom filed their initial report late. The
Company's belief is based solely on its review of Forms 3,4, and 5 and
amendments thereto, furnished to the Company during, and respect to, its most
recent fiscal year by persons know to be subject to Section 16.
ITEM 10. EXECUTIVE COMPENSATION
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------
Other Restricted
- ---------------------------------------------------------------------------------------------------
Annual Stock
- ---------------------------------------------------------------------------------------------------
Name and Principal Position Year Salary $ Bonus $(1) Compensation Awards
- ---------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
- ---------------------------------------------------------------------------------------------------
J.W. Stealey 1998 170,742 - 14,306(2) (3)
- ---------------------------------------------------------------------------------------------------
Chairman of the Board and 1997 160,000 - 16,832(2) (3)
- ---------------------------------------------------------------------------------------------------
Chief Executive Officer 1996 150,000 - 16,760(2) (3)
- ---------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------
Robert L. Pickens 1998 138,750 20,000 7,215(2) (3)
- ---------------------------------------------------------------------------------------------------
President (4) 1997 114,000 - 5,071(2) (3)
- ---------------------------------------------------------------------------------------------------
1996 122,124 - 3,454(2) (3)
- ---------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------
Joseph Rutledge 1998 125,000 12,508 - (3)
- ---------------------------------------------------------------------------------------------------
Senior Vice President 1997 93,000 - - (3)
- ---------------------------------------------------------------------------------------------------
Technology 1996 92,000 - - (3)
- ---------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------
Raymond Rutledge 1998 120,000 24,396 - (3)
- ---------------------------------------------------------------------------------------------------
Vice President Licensing 1997 93,000 - - (3)
- ---------------------------------------------------------------------------------------------------
1996 92,000 - - (3)
- ---------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------
Douglas B. Kubel 1998 120,000 14,746 - (3)
- ---------------------------------------------------------------------------------------------------
Vice President (5) 1997 93,000 - - (3)
- ---------------------------------------------------------------------------------------------------
1996 92,000 - - (3)
- ---------------------------------------------------------------------------------------------------
</TABLE>
(1) Amount paid during year, earned in prior year
(2) Use of Company auto and country club expenses
(3) None awarded
(4) Mr. Pickens resigned as President effective October 23,1998.
(5) Mr. Kubel resigned as Vice President effective March 15, 1999.
57
<PAGE>
Stock Options Granted During Fiscal Year
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------
Number % of Total
- ---------------------------------------------------------------------------------------------------
Of Securities Options
- ---------------------------------------------------------------------------------------------------
Underlying Granted to Exercise or
- ---------------------------------------------------------------------------------------------------
Options Employees in Base Price Expiration
- ---------------------------------------------------------------------------------------------------
Name Granted Fiscal Year (1) ($ / Share) Date
- ---------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
- ---------------------------------------------------------------------------------------------------
Douglas Kubel 30,000 6% $4.1250 10/8/03
- ---------------------------------------------------------------------------------------------------
Carl Linke 100,000 21% $4.2500 10/7/03
- ---------------------------------------------------------------------------------------------------
Joseph Rutledge 50,000 10% $4.1250 10/8/03
- ---------------------------------------------------------------------------------------------------
Raymond Rutldge 50,000 10% $4.1250 10/8/03
- ---------------------------------------------------------------------------------------------------
J.W. Stealey 50,000 10% $4.1250 10/8/03
- ---------------------------------------------------------------------------------------------------
</TABLE>
(1) Based upon 484,750 total options granted.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth the only shareholders known by the Company to be
the beneficial owners, as of March 31, 1999, of more than five percent (5%) of
the outstanding shares of the Company:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------
Name and Address Shares Beneficially Owned Percent of Shares Outstanding (1)
- ---------------------------------------------------------------------------------------------------
<S> <C> <C>
- ---------------------------------------------------------------------------------------------------
J.W. Stealey 2,725,617 (2) 25.5%
- ---------------------------------------------------------------------------------------------------
215 Southport Drive
- ---------------------------------------------------------------------------------------------------
Morrisville, NC 27560
- ---------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------
Vertical Financial Holdings 2,045,649 (3) 19.7%
- ---------------------------------------------------------------------------------------------------
Hambrechtikerstrasse 61
- ---------------------------------------------------------------------------------------------------
Ch-8640 Rapperswil
- ---------------------------------------------------------------------------------------------------
Switzerland
- ---------------------------------------------------------------------------------------------------
</TABLE>
(1) Based on 10,671,448 shares outstanding
(2) Includes 50,000 shares subject to options and 236,389 shares subject to
warrants. Excludes 600,000 shares held in trusts for Mr. Stealey's children
over which Mr. David Kestel is the trustee. Mr. Stealey has neither voting
power nor dispositive power over the shares held in the trusts. Mr. Stealey
disclaims beneficial ownership of the shares held in the trusts.
(3) Includes 427,394 shares owned by entities beneficially owned by Vertical
Financial Holdings and 1,220,084 shares owned by other entities over which
Vertical Financial Holdings has voting power pursuant to a proxy agreement.
58
<PAGE>
The table below gives the number of shares of Common Stock of the Company
beneficially owned as of March 31, 1999 by persons who were members of the Board
and executive officers of the Company during 1998.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------
Name and Position Shares Beneficially Owned Percent of Shares Outstanding (1)
- -----------------------------------------------------------------------------------------------------
<S> <C> <C>
- -----------------------------------------------------------------------------------------------------
J.W. Stealey 2,725,617 (2) 25.5%
- -----------------------------------------------------------------------------------------------------
Chairman of the Board and
- -----------------------------------------------------------------------------------------------------
Chief Executive Officer
- -----------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------
Robert L. Pickens 300,401 (4) 2.8%
- -----------------------------------------------------------------------------------------------------
President (3)
- -----------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------
Joseph Rutledge 151,038 (5) 1.4%
- -----------------------------------------------------------------------------------------------------
Vice President
- -----------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------
Raymond Rutledge 138,831 (6) 1.3%
- -----------------------------------------------------------------------------------------------------
Vice President
- -----------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------
Doug Kubel 187,582 (8) 1.8%
- -----------------------------------------------------------------------------------------------------
Vice President (7)
- -----------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------
J. Nicholas England 41,000 (9) .4%
- -----------------------------------------------------------------------------------------------------
Director
- -----------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------
David H. Kestel 41,000 (9) .4%
- -----------------------------------------------------------------------------------------------------
Director
- -----------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------
W. Joseph McClelland 41,000 (9) .4%
- -----------------------------------------------------------------------------------------------------
Director
- -----------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------
Avi Suriel 237,784 (10) 2.2%
- -----------------------------------------------------------------------------------------------------
Director
- -----------------------------------------------------------------------------------------------------
</TABLE>
(1) Based on 10,671,448 shares outstanding.
(2) Includes 50,000 shares subject to options and 236,389 shares subject to
warrants. Excludes 600,000 shares held in trusts for Mr. Stealey's children
over which Mr. David Kestel is the trustee. Mr. Stealey has neither voting
power nor dispositive power over the shares held in the trusts. Mr. Stealey
disclaims beneficial ownership of the shares held in the trusts.
(3) Mr. Pickens resigned as President effective October 23,1998.
(4) Includes 62,813 shares subject to options and 13,845 subject to warrants.
(5) Includes 144,375 shares subject to options.
(6) Includes 129,625 shares subject to options.
(7) Mr. Kubel resigned as Vice President effective March 15, 1999.
(8) Includes 180,000 shares subject to options.
(9) Includes 41,000 shares subject to warrants.
(10) Includes 91,667 shares subject to warrants.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Company has 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 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. To date, the Company has paid
approximately $ 345,000 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.
59
<PAGE>
13. EXHIBITS
The following documents (unless indicated) are filed herewith and made a
part of this Registration Statement.
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
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
60
<PAGE>
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
10.27* -Agreement and Plan of Merger by and among the Company, iMagic
Online Corporation, MPG-Net, Inc., Multiplayer Games Network, Inc.
and Tantalus, Inc., James Hettinger and Donn A. Clendenon dated as
of January 25, 1999
10.28* -Securities Purchase Agreement dated as of January 25, 1999
between the Company and RGC International Investors LDC ("RGC")
10.29* -Promissory Note dated January 26, 1999 issued by the Company to
RGC ("Note")
10.30* -Registration Rights Agreement dated as of January 25, 1999
between the Company and RGC
10.31* -Form of Warrant issuable by the Company pursuant to the Note
10.32* -Amendment No. 1 dated February 12, 1999 to the Merger Agreement
61
<PAGE>
10.33* -Escrow Agreement dated as of February 12, 1999 by and among the
Company, Branch Banking and Trust Company, Multiplayer Games
Network, Inc., Tantalus, Inc. and James Hettinger
10.34* -Registration Rights Agreement dated as of February 12, 1999 by
and among the Company, Multiplayer Games Network, Inc. and
Tantalus, Inc.
10.35* -Registration Rights Agreement dated as of February 12, 1999 by
and among the Company, Andrew G.
Burch, IFM Venture Group and James Bailey
- --------------------------------------------------------------------------------
*Previously filed
62
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behlaf by the undersigned, thereunto duly authorized.
Interactive Magic, Inc.
Dated August 5, 1999 By : /S/ Michael W. Oliver
----------------------------------
Michael W. Oliver
Title: Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed by the following person on behalf of the registrant and in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
<S> <C> <C>
/S/ J.W. Stealey Chief Executive Officer (Principal August 5, 1999
- ------------------------------------- Executive Officer) and Director
J.W. Stealey
/S/ Michael W. Oliver Chief Financial Officer (Principal August 5, 1999
- ------------------------------------- Financial Officer and Principal
Michael W. Oliver Accounting Officer)
/S/ J. Nicholas England Director August 5, 1999
- -------------------------------------
J. Nicholas England
/S/ W. Joseph McClelland Director August 5, 1999
- -------------------------------------
W. Joseph McClelland
</TABLE>
63
