As filed with the Securities and Exchange Commission on February 15, 2000
Registration No. 333-
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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM SB-2
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
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IENTERTAINMENT NETWORK, INC.
(Name of small business issuer in its charter)
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North Carolina 7372 56-2092059
(State or jurisdiction of (Primary Standard Industrial (I.R.S. Employer
incorporation or organization) Classification Code Number) Identification No.)
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215 Southport Drive, Suite 1000
Morrisville, North Carolina 27560
(919) 461-0722
(Address and telephone number of principal executive offices)
215 Southport Drive, Suite 1000
Morrisville, North Carolina 27560
(919) 461-0722
(Address of principal place of business or intended principal place of business)
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Michael Pearce
Chief Executive Officer
iEntertainment Network, Inc.
215 Southport Drive, Suite 1000
Morrisville, North Carolina 27560
(919) 461-0722
(Name, address and telephone number of agent for service)
Please send copies of all communications to:
Donald R. Reynolds, Esq.
Kevin A. Prakke, Esq.
Wyrick Robbins Yates & Ponton LLP
4101 Lake Boone Trail, Suite 300
Raleigh, North Carolina 27607
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Approximate date of proposed sale to the public: From time to
time after the registration statement becomes effective.
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If any of the securities being registered on this Form are to be offered on a
delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, other than securities offered only in connection with dividend or interest
reinvestment plans, please check the following box. [X]
If this Form is filed to register additional securities for an offering pursuant
to Rule 462(b) under the Securities Act, please check the following box and list
the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ]
Our principal executive offices are located in Research Triangle Park at
215 Southport Drive, Suite 1000, Morrisville, North Carolina 27560, Attention:
Investor Relations. Our telephone number is (919) 461-0722.
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If this Form is a post-effective amendment filed pursuant to Rule 462(c) under
the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(d) under
the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
CALCULATION OF REGISTRATION FEE
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Title of each class of Amount to be Proposed Maximum Proposed Maximum Amount of
Securities to be registered Offering Price aggregate registration
registered per share (1) offering price fee (3)
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Common Stock, $0.10
per share....... 9,681,692(2) $3.0625 $29,650,182 $7,827.65
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(1) Estimated solely for purposes of calculating the registration fee pursuant
to Rule 457(c) under the Securities Act of 1933 based upon the average high
and low price of our common stock on February 10, 2000.
(2) Includes 616,906 shares remaining unsold and being carried forward from the
Registrant's earlier Registration Statement (No. 333-84691) pursuant to Rule
429. A filing fee of $1,298.35 was previously paid by the Registrant under
this earlier Registrant Statement covering the 2,119,889 shares originally
registered thereunder, $377.83 of which fee relates to the 616,906 shares
being carried forward.
(3) A filing fee of $377.83 was previously paid for the 616,906 shares carried
forward from Registration Statement No. 333-84691 pusuant to Rule 429.
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The Registrant hereby amends this registration statement on such date or dates
as may be necessary to delay its effective date until the registrant shall file
a further amendment which specifically states that this registration statement
shall thereafter become effective in accordance with Section 8(a) of the
Securities Act of 1933 or until the registration statement shall become
effective on such date as the Commission, acting pursuant to said Section 8(a),
may determine.
In accordance with Rule 429 of the General Rules and Regulations under the
Securities Act of 1933, the Prospectus included herein is a combined prospectus
which also relates to the remaining 616,906 shares registered under the
Registrant's earlier Registration Statement No. 333-84691. A filing fee of
$1,298.35 was previously paid under the earlier Registration Statement covering
a total of 2,119,889 shares, $377.83 of which covered the 616,906 remaining
shares.
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PROSPECTUS
The information contained in this prospectus is not complete and may be changed.
We cannot sell these securities until the registration statement that we have
filed with the SEC is effective. This prospectus is not an offer to sell, nor
does it solicit offers to buy, these securities in any state where the offer or
sale is not permitted.
SUBJECT TO COMPLETION DATED FEBRUARY 15, 2000
9,681,692 Shares
iEntertainment Network, Inc.
Common Stock
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This prospectus covers the resale of 9,681,692 shares of our common stock
which may be sold, from time to time, by the following shareholders (the
"Selling Shareholders").
o 6,411,702 shares may be offered and sold by RGC International
Investors, LDC, 5,794,796 of which shares are issuable upon conversion
of shares of preferred stock held by it;
o 1,000,000 shares may be offered and sold by J.W. Stealey, our founder
and one of our directors;
o 700,000 shares may be offered and sold by Vertical Financial Holdings;
o 400,000 shares may be offered and sold by Value Management & Research
AG; and
o 1,169,990 shares may be offered and sold by the remaining Selling
Shareholders identified herein.
We will not receive any money from the Selling Shareholders when they sell
the shares. We will pay substantially all of the costs and expenses relating to
this offering. The Selling Shareholders may offer the shares for resale in
accordance with the "Plan of Distribution" set forth herein.
Our common stock is traded on the Nasdaq SmallCap Market under the symbol
"IENT". On February 10, 2000, the last sale price of our common stock as quoted
on the Nasdaq SmallCap Market was $ 3.0625 per share.
Our principal executive offices are located in Research Triangle Park at
215 Southport Drive, Suite 1000, Morrisville, North Carolina 27560, Attention:
Investor Relations. Our telephone number is (919) 461-0722.
Investing in our common stock involves risks. See "Risk Factors" beginning on
page 5.
Neither the SEC nor any state securities commission has approved or disapproved
our securities or determined that this prospectus is truthful or complete. Any
representation to the contrary is a criminal offense.
The date of this Prospectus is February 15, 2000
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TABLE OF CONTENTS
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Section Page
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Number
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PROSPECTUS SUMMARY.......................................................................... 3
RISK FACTORS................................................................................ 5
USE OF PROCEEDS............................................................................. 16
MARKET FOR COMMON STOCK AND RELATED STOCKHOLDER MATTERS..................................... 16
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.......................................................................... 18
THE COMPANY................................................................................. 24
DIRECTORS AND EXECUTIVE OFFICERS............................................................ 30
EXECUTIVE COMPENSATION...................................................................... 32
CERTAIN TRANSACTIONS........................................................................ 34
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.............................. 36
SELLING SECURITY HOLDERS.................................................................... 38
PLAN OF DISTRIBUTION........................................................................ 39
DESCRIPTION OF SECURITIES................................................................... 39
DISCLOSURE OF COMMISSION POSITION ON INDEMNIFICATION FOR SECURITIES
ACT LIABILITIES........................................................................ 44
LEGAL MATTERS............................................................................... 44
EXPERTS..................................................................................... 44
WHERE YOU CAN FIND MORE INFORMATION......................................................... 44
INDEX TO FINANCIAL STATEMENTS............................................................... 45
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PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information, including "Risk Factors" and the Financial Statements of the
Company and Notes thereto, appearing elsewhere in this Prospectus. The
discussion in this Prospectus contains forward-looking statements that involve
risks and uncertainties. Our actual results could differ materially from those
discussed herein. Factors that could cause or contribute to such differences
include, but are not limited to, those discussed in "Risk Factors,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "The Company" as well as those discussed elsewhere in this
Prospectus.
The Company
iEntertainment Network, Inc. (or the "Company") is a developer and
publisher of Internet and online games and an operator of online game services.
The Company develops and publishes proprietary online multi-player games and is
building the iEntertainment Network ("iEN"), an Internet distribution
infrastructure which will offer online gamers a variety of free, subscription
and pay-per-play games and services, including simulation, parlor, strategy,
role playing and action games.
The Company is the exclusive game site operator for AT&T WorldNet, an
Internet service provider ("ISP"), has been contracted to provide online games
for America Online, the world's leading online Internet services company,
operates EarthLink's Games Arena, and provides content for Time Warner Inc.'s
ENTERTAINDOM site. The Company seeks to establish itself as a major provider of
online gaming services for ISPs, Internet portals and online services in order
to broaden its audience of users. GameHub, AT&T WorldNet's co-branded online
gaming service, was launched in January 1999 and is currently being marketed by
AT&T to new WorldNet subscribers as a premium service included with their
subscription. The GameHub site offers consumers a mix of free and pay-per-play
games in all categories, including strategy, role playing, simulation, action
and parlor games. In addition to games, GameHub will offer chat rooms, forums
and shopping areas. GameHub is expected to generate revenue from subscriber
premiums, e- commerce and advertising. GameHub complements the Company's online
gaming strategy by expanding the Company's network of player communities.
The Offering
Shares of common stock offered by us............ None
Shares of common stock which may be sold by
the Selling Shareholders........................ 9,681,692 (1)
Use of proceeds................................ We will not receive any
proceeds from the resales
of shares offered hereby,
all of which proceeds
will be paid to the
Selling Shareholders.
Risk Factors................................... The purchase of our common
stock involves a high
degree of risk. You should
carefully review and
consider "Risk Factors."
Nasdaq SmallCap Market Trading Symbol.......... IENT
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(1) Includes 5,794,796 shares of common stock issuable upon conversion of
preferred stock held by RGC International Investors, LDC.
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RISK FACTORS
Investment in our common stock involves risk. You should carefully consider
the following factors, among others, before making an investment decision.
Company Risks
We have a History of Net Losses and an Accumulated Deficit; We Anticipate Future
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Losses
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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, 1997 and 1998 and the nine months
ended September 30, 1999, we incurred net losses of approximately $4.3 million,
$11.7 million and $14.0 million, respectively. At September 30, 1999, we had an
accumulated deficit of approximately $39.9 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
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History
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Until June 1999, a substantial portion of our revenues were generated from
sales of our CD-ROM software products. In June 1999 we completed the sale of our
CD-ROM business unit. Our current strategy is to focus our business primarily on
the Internet entertainment business, specifically online games. Although we
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:
. an increasing number of market entrants; . intense competition; .
substantial capital requirements; and . 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.
We Have Significant Capital Requirements; We Experience Negative Cash Flow From
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Operations; We Will Need Additional Financing
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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:
. the cost and timing of expansion of research and product development
efforts and the success of these efforts;
. the cost and timing of expansion of sales and marketing activities; . the
extent our existing and new products gain market acceptance; . competing
technological and market developments; and . the cost involved in
maintaining and enforcing patent claims and other
intellectual property rights.
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 in order to meet our short-term cash
requirements, which could have a material adverse effect on our business,
financial condition and results of operations.
We May Not Be Able to Manage and Sustain Growth; We Face Risks Associated with
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Future Acquisitions
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5
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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:
. difficulties in the assimilation of the operations and products of the
acquired companies;
. the expenses incurred in connection with the acquisition and subsequent
assimilation of operations and products;
. the diversion of management's attention from other business concerns;
and
. the potential loss of key employees of the acquired company.
A part of our business strategy is growth through acquisition. The success
of our acquisition strategy will depend upon, among other things, our ability
to:
. hire and retain skilled management, marketing, technical and other
personnel;
. develop and improve upon our operational, management and financial
systems and controls in order to properly monitor our expanded
operations; and
. control our costs and maintain effective quality controls.
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
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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. In August 1999,
both our then CEO and CFO resigned. Both positions have since been filled with
permanent, full-time replacements. 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.
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Industry Risks
A number of the following risk factors relate to our former CD-ROM
software business. Accordingly, some of such risk factors will only be
applicable to the extent we retain an interest in the CD-ROM software
business,which is limited to the on-line rights to the game rights we sold.
We Experience Fluctuations in Quarterly Operating Results
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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:
. the demand for our products and the products of our competitors; . the
level of usage of the Internet; . the size and rate of growth of the
interactive entertainment software
market;
. development and promotional expenses related to the introduction of new
products or enhancements;
. the degree of market acceptance for our new product introductions and
enhancements;
. the level of price competition; . software defects and other quality
problems; and . the length of product life cycles.
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
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The market for multi-player, interactive internet games is characterized by
short product life cycles and frequent introduction of new products. Most of
these games do not achieve sustained market acceptance or ever generate a
sufficient level of sales to offset the costs associated with product
development. 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 market may require us to increase our development,
acquisition and marketing costs in order to:
. develop higher quality, distinctive products that incorporate
increasingly sophisticated effects; and
. support new product releases with increased marketing.
We Depend On a Limited Number of Products
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We derive a significant portion of our revenues from a limited number of
online 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:
. continue to remain dependent upon non-recurring sales of a limited
number of products for a substantial portion of our revenues;
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. introduce products which are commercially viable; or . introduce products
which have life cycles sufficient to permit us to
recoup the development, marketing and other costs associated with their
development.
Our Products Have a Lengthy Development Cycle; We Face Product Development Risks
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Our success will depend on the timely introduction of successful new
products. The development of new interactive entertainment software products can
be lengthy, expensive and uncertain. The development of some of our products,
particularly our subscription-based multi-player games, require as much as 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:
. unanticipated delays;
. increased costs and expenses for product development; and
. 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 online 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
makes pre-release testing for programming or compatibility errors very difficult
and time-consuming. Errors may be found in new products after their release.
Remedying such errors may:
. delay sales of our products; . cause us to incur additional costs; and .
adversely affect our reputation.
Industry Factors May Adversely Affect Our Operating Results; We Face the Risks
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of Changing Consumer Preferences and Uncertainty of Market Acceptance of our
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Products
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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:
. software acquisition and development costs;
. promotion and marketing expenses; and
. 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:
. the popularity, price and timing of new entertainment software products
being released and distributed;
. international, national, regional and local economic conditions
(particularly economic conditions adversely affecting discretionary
consumer spending);
. changes in consumer demographics; . the availability of other forms of
entertainment; and . critical reviews and public tastes and preferences.
Our ability to plan for product development and promotional activities for
our subscription-based, multi-player interactive internet games 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
8
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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:
. a viable market for online games will develop;
. we will be able to attract and retain subscribers to our online game
products;
. we will be successful in developing additional products for online use;
or
. our online game products will ever achieve widespread market acceptance.
We Depend on the Continued Growth in Use of the Internet
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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.
Risks Related to Online Games
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Having completed the sale of our CD-ROM business, online games have become
the primary 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:
. 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;
. in multiplayer games, unanticipated player conduct can significantly
affect the performance of the game and determine player satisfaction;
. the uncertainty of whether subscription revenues will be sufficient to
maintain the significant support, service and product enhancement
demands of online users;
. our limited experience in pricing strategies for online games or in
predicting usage patterns of our customers; and
. 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 on Online Game Play
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The Internet may not continue as a viable market because of the following:
o the lack of development of high speed modems and communication lines; o
hardware restrictions, such as bandwidth (amount of data capable of
transmission at a single time) and latency (delays introduced by the
network); and
o the inadequate development of the necessary infrastructure.
The Internet has experienced, and is expected to continue to experience
significant growth in the number of users and volume of traffic. Given this
growth, we can not assure you that the Internet infrastructure will provide the
required support. The use of the Internet has the potential risk of security,
cost, quality of service, and ease of use. In addition to these risks, the
Company operates its own internal network which faces all of the same potential
risks.
Changes in Technology and Industry Standards May Make Our Products Obsolete or
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Unmarketable
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The interactive entertainment software industry is undergoing rapid
changes, including:
. evolving industry standards; . frequent new platform introductions; and .
changes in consumer requirements and preferences.
9
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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:
. our future product offerings will keep pace with technological changes;
or
. we will be successful in developing and marketing products for any
future operating system or format.
The overall market for the Internet is characterized by:
. rapidly changing technology;
. evolving industry standards;
. emerging competition; and
. 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:
. accessible by screen-based telephones, television or other consumer
electronic devices; or
. 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.
We Face Intense Competition
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The interactive entertainment software industry is intensely and
increasingly competitive. Industry competition is based primarily upon:
. product quality and features;
. the compatibility of products with popular platforms; . access to
distribution channels (including access to retail shelf
space);
. marketing effectiveness;
. reliability and ease of use; and
. price and the quality of user support services.
As compared to us, many of our competitors have:
. significantly greater financial, technical, marketing, sales and
customer support and other resources; and
. established reputations for success in the development, licensing and
sale of their products and technology.
As a result, our competitors may be able to:
. undertake more extensive marketing campaigns;
. adopt more aggressive pricing policies; and
. make higher offers or guarantees to third party software developers and
licensors.
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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 Depend on Third-Party Software Developers
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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
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We intend to expand the distribution of our online products by seeking out
additional 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 additional 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:
. the cost of any proposed online or Internet distributor relationship
will exceed our expectations; or
. we will incur significant costs in anticipation of an online or Internet
distributor arrangement and such arrangement is delayed or abandoned.
We Have Limited Protection of Our Proprietary Information
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We rely on a combination of the following to establish and protect our
proprietary rights:
. trademark;
. trade secret;
. copyright;
. other proprietary rights laws;
. license agreements; and
. 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.
To license our products to end users, we primarily rely on end-user
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 overlap, 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:
. to enforce our intellectual property rights;
. to protect our trade secrets;
. to determine the validity and scope of the proprietary rights of others;
or
11
<PAGE>
. 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 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:
. user privacy;
. defamation;
. pricing;
. taxation;
. content regulation;
. quality of products and services; and
. intellectual property ownership and infringement.
Such legislation could:
. expose us to substantial liability;
. dampen the growth in use of the Internet;
. decrease the acceptance of the Internet as a communications and
commercial medium; or
. 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:
. reduce the liability of online service providers for listing or linking
to third-party Web sites that include materials that infringe
copyrights; and
. 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.
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 on-line products worldwide. International operations and
sales of our products are subject to inherent risks, including:
. fluctuations in exchange rates;
. the impact of possible recessionary environments in economies outside
the United States;
. the costs of transferring and localizing products for foreign markets; .
longer accounts receivable collection periods and difficulty in
collection of accounts receivable;
. unexpected changes in regulatory requirements;
. tariffs and other barriers; and
12
<PAGE>
. 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 January 31, 2000, our executive officers, directors and their
affiliated entities owned approximately 61% of our outstanding shares of Common
Stock. As a result, such persons are in the position to influence:
. the election of the Company's directors; and
. 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 the Company.
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:
. variations in quarterly operating results; . announcements of new
products by us or our competitors; . failures to meet or exceed the
expectations of securities analysts or
investors; or
. 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, including
under this prospectus, could have an adverse effect on our stock price. As of
January 31, 2000, we had 14,963,174 shares of common stock outstanding. All of
these shares are eligible for sale, subject to Rule 144.
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:
. one percent (1%) of the then outstanding shares of common stock, or . 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.
In addition, holders of a substantial portion of our shares of common stock
and warrants to purchase shares of common stock have registration rights. The
possibility that a substantial number of our securities may be sold in
13
<PAGE>
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
- ----------
As of January 31, 2000, we had outstanding:
. warrants to purchase an aggregate of approximately 1,182,945 shares of
Common Stock;
. 4,910.844 shares of preferred stock which are convertible into up to
4,910,844 shares of common stock.
As of January 31, 2000, we have authorized for issuance and outstanding the
following options:
. 2,875,000 shares of Common Stock in connection with our 1995 Incentive
Stock Option Plan, 1,882,626 of which are outstanding;
. 1,800,000 shares of Common Stock in connection with our 1998 Stock Plan,
under which options to purchase 1,715,667 shares are outstanding; and
. 500,000 shares of Common Stock in connection with our 1998 Stock
Purchase Plan, none of which have been granted.
The existence of these securities may adversely affect us or our
shareholders for many reasons, including:
. the market price of our stock may be adversely affected;
. 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;
. some of these securities give the holders the opportunity, at nominal
cost, to profit from a rise in the market price of our stock;
. the terms upon which we could issue additional common stock or obtain
additional financing may be adversely affected.
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.
14
<PAGE>
The Company has reserved at least 5,794,796 shares of common stock for
issuance upon conversion of preferred stock.
Our Common Stock May be Delisted from the Nasdaq SmallCap Market if We do Not
- -----------------------------------------------------------------------------
Meet the Listing Criteria.
- --------------------------
On October 14, 1999, the Company's common stock was delisted from the
Nasdaq National Market and is now listed on the Nasdaq SmallCap Market, which
may impair the liquidity of our common stock. On November 15, 1999 the Company
filed its Form 10-QSB for the quarter ended September 30, 1999, including pro
forma financial statements demonstrating compliance with Nasdaq's net tangible
assets test. Nasdaq notified the Company in December 1999 that, based on the
Form 10-QSB filing, it was in compliance with the requirements for continued
listing on the Nasdaq Smallcap Market. If in the future we are unable to satisfy
the continued listing requirements, our stock may be delisted from the Nasdaq
SmallCap Market. If our stock is delisted from the Nasdaq SmallCap Market, the
liquidity of our stock could be further 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 SmallCap Market.
If our stock is delisted from the Nasdaq SmallCap Market, trading, if any, in
our stock would thereafter be conducted:
. in the over-the-counter market in the "pink sheets;" or
. on the National Association of Securities Dealers, Inc.'s "Electronic
Bulletin Board."
Continued inclusion on the Nasdaq SmallCap Market generally requires that we
maintain:
. at least $2,000,000 in "net tangible assets" (total assets less total
liabilities and goodwill);
. a minimum bid price of the Common Stock of $1.00 per share; . at least
500,000 shares in the public float valued at $1,000,000 or
more;
. at least two active market makers for the Common Stock; and . a least 300
holders of the Common Stock.
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 is delisted from the 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:
. delivery, prior to any transaction in a penny stock, of a disclosure
schedule relating to the penny stock market;
. disclosure about commissions payable to both the broker-dealer and the
registered representative and current quotations for the securities; and
. 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:
. that has a market price of less than $5.00 per share; or
15
<PAGE>
. 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.
We Remain 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. We cannot fully assess the likelihood of third parties'
year 2000 compliance or the impact that any noncompliance may have on our
operations at this time, but we have not experienced any significant negative
effects to date regarding year 2000 problems. If there are significant delays or
unremedied year 2000 problems with key business vendors or end users of our
online games, 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 Prospectus 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 Prospectus, the words "believe," "expect,"
"anticipate," "estimate" and similar expressions are intended to identify
forward-looking statements. The accuracy of such forward-looking statements is
subject to certain risks, uncertainties and assumptions, including those
identified above under "Risk Factors." Should one or more of these risks or
uncertainties materialize, or should underlying assumptions prove incorrect,
actual results may vary materially from those anticipated, estimated or
projected.
USE OF PROCEEDS
The Company previously received $4,000,000 in gross proceeds from the
February 1999 sale of the Convertible Note in such original principal amount to
RGC International Investors, LDC, a portion of which note was converted into
3,810.844 shares of Series D Preferred Stock in November 1999 and the remainder
of which was previously converted to common stock. In addition, the Company
received an additional $2.2 million through the sale of 2.2 million shares of
common stock, the resale of which is covered by this prospectus, to RGC,
Vertical Financial Holdings and Value Management & Research AG. All shares
offered by this Prospectus are being resold by the Selling Shareholders and all
proceeds from the sales of such shares will go to the Selling Shareholders. The
Company will receive no proceeds from this offering.
MARKET FOR COMMON STOCK AND
RELATED STOCKHOLDER MATTERS
The Company's common stock began trading July 22, 1998 (the date of its
initial public offering) on the Nasdaq National Market (originally under the
ticker symbol IMGK and now under the ticker symbol "IENT"). The following sets
forth the quarterly high and low bid prices during each of the six quarters
shown as reported on Nasdaq. These prices are based on quotations between
dealers, which do not reflect retail mark-up, markdown or commissions and may
not reflect actual transactions.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------
Price
- ----------------------------------------------------------------------
Quarter Ended High Low
- ----------------------------------------------------------------------
<S> <C> <C>
September 30, 1998 $14.00 $6.50
- ----------------------------------------------------------------------
December 31, 1998 $ 6.50 $4.13
- ----------------------------------------------------------------------
March 31, 1999 $ 7.75 $3.50
- ----------------------------------------------------------------------
June 30, 1999 $ 4.03 $2.06
- ----------------------------------------------------------------------
September 30, 1999 $ 3.25 $0.50
- ----------------------------------------------------------------------
December 31, 1999 $ 2.56 $0.75
- ----------------------------------------------------------------------
</TABLE>
The Company has approximately 175 holders of record of its common stock and
estimates that it has approximately 3,000 beneficial holders. 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.
16
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
iEntertainment Network, Inc. (or the "Company") is a developer and
publisher of Internet and online games and an operator of online game services.
The Company develops and publishes proprietary online multi-player games and has
built the iEntertainment Network ("iEN"), an Internet distribution
infrastructure which offers online gamers a variety of free, subscription and
pay-per-play games and services, including simulation, parlor, strategy, role
playing and action games. The Company historically generated 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 has also historically generated 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.
First Nine Months, 1999 vs. First Nine Months, 1998
RESULTS OF OPERATIONS
OVERVIEW
On June 30,1999 the Company received $2,500,000 from Ubi Soft Entertainment
S.A.for the sale of the rights the Company had for the development of certain
CD-ROM games. The Company retained the online rights for these games. The sale
of the development rights marked the Company's exit from the CD-ROM business.
The three month and nine month financial statement comparisons are therefore
heavily impacted by the disposition of the CD-ROM business.
NET REVENUES
Net revenues decreased by 43% to $ 1.5 million for the three months ended
September 30, 1999 from $2.7 million for the three months ended September 30,
1998. Net revenue decreased from $11.4 million in the first nine months of 1998
to $3.6 million in the first nine months of 1999.
The following table summarizes the changes in revenue from 1998 to 1999:
<TABLE>
<CAPTION>
- -------------------------------------------- ------------------------------------ ------------------------------
- -------------------------------------------- ------------------------------------ ------------------------------
Three Months ended September 30 Nine months ended September 30
($000) ($000)
- -------------------------------------------- ------------------------------------ ------------------------------
<S> <C> <C> <C>
Revenue for the period in 1998 $2,669 $11,404
- -------------------------------------------- ------------------------------------ ------------------------------
Increase/ (Decrease) in CD-ROM revenue (1,530) (7,521)
- -------------------------------------------- ------------------------------------ ------------------------------
Increase/ (Decrease) in Online Revenue (9) 172
- -------------------------------------------- ------------------------------------ ------------------------------
Increase/(Decrease) in Royalty & Licensing (281) (1,673)
- -------------------------------------------- ------------------------------------ ------------------------------
Increase in Advertising & Other 659 1,265
- -------------------------------------------- ------------------------------------ ------------------------------
Revenue for the period in 1999 $1,508 $3,647
- -------------------------------------------- ------------------------------------ ------------------------------
</TABLE>
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 the third quarter of 1999 decreased to $ 0.2 million from $1.7
million in the same period of 1998. The decrease was due to the Company's exit
from the CD-ROM business. For the nine month period, cost of revenue in 1999 is
$1.7 million below the comparable period for 1998. The decrease reflects the
considerably lower level of CD-ROM shipments, offset partially by the expenses
in the second quarter for the establishment of reserves and inventory
write-downs associated with the exit from the CD-ROM business.
18
<PAGE>
OPERATING EXPENSES
Operating expenses decreased $1.4 million or 33% from the third quarter of 1998
to the same period in 1999. On a year-to-date basis, operating expenses were
$0.9 million higher in 1999 than they were in 1998. Included in the 1999 results
was $376,000 and $932,000 for the three and nine month periods, respectively,
due to amortization of goodwill associated with the MPG-Net acquisition. The
following is a summary of major variances:
<TABLE>
<CAPTION>
- ------------------------------------------------ ------------------------------------- -------------------------------
- ------------------------------------------------ ------------------------------------- -------------------------------
Three Months ended September 30 Nine months ended September 30
($000) ($000)
- ------------------------------------------------ ------------------------------------- -------------------------------
<S> <C> <C> <C>
Operating Expenses for the period in 1998 $4,179 $10,874
- ------------------------------------------------ ------------------------------------- -------------------------------
Increase/ (Decrease) Sales and Marketing (1,534) (2,158)
- ------------------------------------------------ ------------------------------------- -------------------------------
Increase/ (Decrease) Product Development (273) 959
- ------------------------------------------------ ------------------------------------- -------------------------------
Increase/ (Decrease) General and Administrative 61 1,164
- ------------------------------------------------ ------------------------------------- -------------------------------
Increase/ (Decrease) Goodwill Amortization 376 932
- ------------------------------------------------ ------------------------------------- -------------------------------
Operating Expenses for the period in 1999 $2,809 $11,771
- ------------------------------------------------ ------------------------------------- -------------------------------
</TABLE>
SALES AND MARKETING. Sales and marketing expenses declined significantly during
the quarter due to the exit from the CD-ROM business, and declined for a similar
reason year-to-date, which was coupled with a significant decrease in market
development funds spending in 1999 compared to 1998.
PRODUCT DEVELOPMENT. Product development expenses decreased in the quarter due
to the exit from the CD-ROM business, but higher year-to-date due to increased
development for on-line games, as well as the write-off of unamortized
development costs associated with the exit from the CD-ROM business.
GENERAL AND ADMINISTRATIVE. General and administrative expenses increased
slightly for the three month period, and were higher on a year-to-date basis due
to the additional expense of being a publicly-held company; relocation expenses
relating to the consolidation of our Florida and Texas operations to North
Carolina; as well as employee severance.
Goodwill Amortization. Goodwill from the MPG-Net acquisition is being amortized
to income over 36 months.
OTHER (INCOME) EXPENSE
For the first nine months of 1999 compared to 1998 there is additional expense
of $2,379,000. The higher expense level is due to the interest expense relating
to the recognition of the beneficial conversion feature of the $ 4,000,000
convertible debenture, and related warrants, which were issued in the first
quarter of 1999; as well as the interest expense on these debentures, which is
partially offset by the gain on the sale of the CD-ROM business in the second
quarter.
INCOME TAX EXPENSE
The Company recorded $53,000 in income tax expense for the first nine months of
1999 compared to $156,000 for the same period in 1998. The entire tax expense in
each period is attributable to earnings in Europe.
19
<PAGE>
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, and its initial
public offering.
The following is a condensed table of cash on hand and major cash flow items
from December 31, 1998 to September 30, 1999:
<TABLE>
<CAPTION>
----------------------------------------------------------------- ------------------
$ Million
----------------------------------------------------------------- ------------------
----------------------------------------------------------------- ------------------
<S> <C> <C> <C>
Cash on hand, December 31, 1998 $2.9
----------------------------------------------------------------- ------------------
----------------------------------------------------------------- ------------------
Net loss for the first nine months (14.0)
----------------------------------------------------------------- ------------------
Add: non-cash charges and expenses 5.0
----------------------------------------------------------------- ------------------
Less: non-cash gain on sale of CD-ROM (.9)
----------------------------------------------------------------- ------------------
Changes in working capital 3.0
----------------------------------------------------------------- ------------------
Net Cash Used in Operations (6.9)
----------------------------------------------------------------- ------------------
Net proceeds from sale of CD-ROM 2.3
----------------------------------------------------------------- ------------------
Net proceeds from issuing convertible debentures 3.7
----------------------------------------------------------------- ------------------
Other investing and financing activities (.4)
----------------------------------------------------------------- ------------------
----------------------------------------------------------------- ------------------
Net change in cash for the nine months ended September 30, 1999 (1.3)
----------------------------------------------------------------- ------------------
----------------------------------------------------------------- ------------------
Cash on hand, September 30, 1999 $1.6
----------------------------------------------------------------- ------------------
</TABLE>
The Company's success 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.
Management expects the disposition of its CD-ROM operations will reduce 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.
Subsequent to the close of the September 30, 1999 quarter, the Company has
completed the following transactions in an effort to improve its financial
position:
A) On November 11, 1999, RGC International Investors, LDC (Rose Glen)
exchanged the remainder of its unconverted debenture, which as of
September 30, 1999 had an outstanding principal balance of
$3,310,844 and a recorded value of $2,156,000 for 3,310.844
shares of the Company's newly created Series D Preferred Stock
with a stated value of $1,000 per share. In addition, Rose Glen
exchanged $500,000 of all other accrued amounts under the
debenture for 500 shares of Series D Preferred Stock, and agreed
to waive all other accrued amounts which totaled $260,000. The
difference between the recorded value of the debt and the
outstanding principal balance along with the $260,000 waived
interest accrual were netted and charged to additional paid-in
capital. Interest expense related to these debentures was
$3,679,000 for the nine months ended September 30, 1999.
B) On November 11, 1999 Rose Glen purchased 1,100 shares of Series D
Preferred Stock for $1,100,000.
C) On November 11, 1999 Vertical Financial Holdings purchased 700,000
shares of common stock for $700,000.
D) On November 11, 1999 - Value Management & Research AG purchased
400,000 shares of common stock for $400,000.
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
F) E) On November 9, 1999, J.W. Stealey, former CEO of the Company,
arranged for the release of the Company from the line of credit
indebtedness to BB&T in the amount of $1,000,000 in exchange for
1,000,000 shares of common stock. The Company also paid $15,000
due on this line. Interest expense on this line of credit was
$78,000 and $158,000 for the nine months ended September 30, 1999
and the year ended December 31, 1998 respectively. In addition, as
part of these transactions, Mr. Stealey's resignation agreement
dated August 16, 1999 has been amended such that his consulting
services are no longer being used and the sole remaining
consideration due him has been reduced to one lump sum payment of
$200,000 (less the value of 12 months health insurance payments
and car lease payments totaling approximately $20,000) and 50,000
shares of the Company's common stock valued at $62,500. This
payment was made November 12, 1999. The Company has agreed to
convey to Mr. Stealey all trademarks and available rights to the
name Interactive Magic, pending shareholder approval of the
Company name change to iEntertainment Network. Mr. Stealey agreed
to waive the interest due him from the Company in the amount of
$183,000 under the terms of the line of credit with BB&T that he
had personally guaranteed; in consideration of which the Company
incurred additional interest expense of $59,000 for the nine
months ended September 30, 1999 and $107,000 for the year ended
December 31, 1998. The amount of waived interest has been
reflected as a credit to additional paid-in capital.
<PAGE>
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 in order to meet our short-term cash
requirements, which could have a material adverse effect on our business,
financial condition and results of operations.
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 paragraphs will impact the Company's
future capital requirements and the adequacy of its available funds.
20
<PAGE>
1998 vs. 1997
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.
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.
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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, and has adopted and implemented a
Year 2000 compliance plan. Under the Company's Year 2000 compliance plan, the
Company inventoried and collected documentation on all of its computers,
computer related equipment, and equipment with embedded processors. In addition,
the Company has contacted critical vendors and suppliers to obtain assurances of
their ability to ensure smooth delivery of products and services after December
1999. The Company has not prepared estimates of or compiled data regarding
actual costs for correction of Year 2000 problems. Based on information
available at this time, the Company does not believe that the cost of remedial
actions has or will have a material adverse effect on the Company's
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results of operations or financial condition. Although the Company has not yet
experienced any significant negative effects following the occurrence of Year
2000, there can be no assurance that there will not be a delay in, or increased
costs associated with, the implementation of corrections, if any, as the Year
2000 compliance plan is performed. Failure to implement such changes 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 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 2000.
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". SFAS 137
defers for one year the effective date of SFAS 133. The rule will now apply to
all fiscal quarters of all fiscal years beginning after June 15, 2000. 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.
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THE COMPANY
Overview
iEntertainment Network, Inc. (the "Company") is a developer and publisher
of Internet and online games and an operator of online game services. The
Company develops and publishes proprietary online multi-player games and has
built the iEntertainment Network ("iEN"), an Internet distribution
infrastructure which offers online gamers a variety of free, subscription and
pay-per-play games and services, including simulation, parlor, strategy, role
playing and action games.
The Company is the exclusive game site operator for AT&T WorldNet, an
Internet service provider ("ISP"), has been contracted to provide online games
for America Online ("AOL"), the world's leading online Internet services
company, operates EarthLink's Games Arena, and provides content for Time Warner,
Inc.'s ENTERTAINDOM site. The Company seeks to establish itself as a major
provider of online gaming services for ISPs, Internet portals and online
services in order to broaden its audience of users. GameHub, AT&T WorldNet's
co-branded online gaming service, was launched in January 1999 and is currently
being marketed by AT&T to new WorldNet subscribers as a premium service included
with their subscription. The GameHub site offers consumers a mix of free and
pay-per-play games in all categories, including strategy, role playing,
simulation, action and parlor games. In addition to games, GameHub will offer
chat rooms, forums and shopping areas. GameHub is expected to generate revenue
from subscriber premiums, e- commerce and advertising. GameHub complements the
Company's online gaming strategy by expanding the Company's network of player
communities.
Historically, the Company has generated revenue primarily from developing,
publishing and distributing simulation and strategy games on CD-ROM for the PC
platform. In June 1999, the Company sold certain assets related to the retail
CD-ROM portion of its business for $2,500,000 in cash to focus its efforts
exclusively on the development of its Internet properties and strategies. By
focusing on delivering realistic games with high quality graphics, the Company
believes it has built strong brand recognition and consumer loyalty among game
enthusiasts.
The Company introduced its first large-scale online multi-player game in
April 1997 following the acquisition of Interactive Creations, Inc. ("ICI").
ICI's WarBirds, an award winning World War II air combat simulation game, has
logged over 2.5 million hours of online game time with players in more than 70
countries.
The Company operates its own Internet-based gaming service, the iEN, where
it currently offers a variety of proprietary large-scale multi-player simulation
games such as WarBirds, Dawn of Aces and Drakkar. The Company currently offers
its online games through monthly subscriptions and hourly fees.
To further expand its customer base and brand recognition, the Company has
entered into a partnership with AOL to provide high-quality, large-scale multi-
player games for AOL's game channel. The Company launched Fighter Ops in
December 1999, a simplified, mass- market version of WarBirds, on AOL's games
channel. Raider Wars, scheduled to be launched in the first quarter of 2000, is
an online space combat simulation game that allows hundreds of players to fly
different types of spaceships against one another.
The Company is a technological leader within the online gaming industry
with a number of leading edge online and multi-player gaming technologies which
enhance the play value of its games and augment its service capabilities. The
Company's MEGAplayer technology enables the implementation of large-scale multi-
player games on the Internet, allowing over 300 players to play simultaneously
in the same game arena by minimizing latency and addressing problems such as
onscreen "warping". The Company's MEGAvoice technology allows groups of up to
four players to engage in real-time voice communication over the Internet while
playing a game together.
Through its acquisition of MPG-Net in February 1999, the Company has
acquired the ICONS gaming services platform, which enables implementation of the
key elements of a fully-integrated online gaming service. These elements include
real-time chat, player tracking, customer e-mail, e-commerce, advertising,
billing, database management and marketing. The Company's ICONS platform allows
the Company to expand its online offerings from multiple individual online games
to a comprehensive online gaming service incorporating a variety of
community-building features.
Online Gaming Industry
The evolution of the Internet into an accessible, easy-to-use, platform-
independent global network capable of supporting multimedia applications, has
led to the development of online gaming. Online gaming is an emerging market
covering several
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gaming paradigms, including: (i) the electronic distribution of pay-for-play or
subscription-based games and (ii) the implementation of multi-player features on
traditional games with the use of the Internet or on-line services as the wide-
area network connecting physically-distant players.
The Internet and online services present a new platform on which
traditional game publishers and distributors can market, advertise and
distribute their products, whether through direct sales from Web sites or
through sponsoring multi-player on-line tournaments featuring their games. The
ability to compete on-line is an additional product feature that may increase
demand for interactive entertainment software products. The development of the
Internet has also led to the emergence of online gaming services that aggregate
numerous licensed and/or proprietary software titles and online developers that
make their server-based titles exclusively available online. As PC and Internet
access prices continue to decline, these gaming services are attracting a
rapidly growing number of users.
Online gaming presents many distinct advantages for game developers and
publishers over traditional CD-ROM publishing. The online gaming model
eliminates traditional cost of sales such as product packaging, warehousing and
physical distribution, and minimizes distribution issues such as return
allowances and rebates. Online gaming can allow for higher margins and
encourages recurring revenues through subscription-based revenue models. Unlike
CD-ROM products which have a limited shelf life, online-only games are often
perpetual products which are continually under development and require
continuous updates and maintenance. Revenue sources in the online gaming model
include pay-for- play fees, subscriptions, e-commerce transaction fees,
advertising and direct merchandising. Online gaming presents more favorable
economics, eliminates distribution channel issues, provides for a larger number
of potential revenue sources and enables the publisher to maintain a more
intimate relationship with its customers.
A 1998 Jupiter Communications report estimates that more than 3.7 million
consumers in the United States are currently playing games over the Internet,
generating revenues of approximately $81 million in 1998, and projects that 26.8
million consumers will generate $1.1 billion in revenues in 2002. These figures
include subscription and pay-for-play revenues generated from online games and
CD-ROM games with an online component, as well as advertising revenues from
online gaming sites. Jupiter expects that by 2002, consumer revenues will
account for $622 million, or 57% of total online gaming revenues. Advertising,
in the form of sponsorships, banners and interstitials, is also expected to
become an important revenue stream for online gaming sites, generating $464
million, or 43% of total online gaming revenues by 2002.
The emerging popularity of online games is evidenced by the increasing
number of industry participants. Two major categories of market participants
have emerged in the online gaming industry: online gaming software developers
and online gaming aggregators.
Online gaming developers offer server-based games directly to consumers
over the Internet or through retail channels involving an upfront charge to the
buyer. These developers also maintain Web sites where they host their games and
match up opponents. Under the online publishing model, game developers publish
server-based titles (typically massively multi-player or "immersive" games)
exclusively for online play and typically sell unlimited usage or time-based
subscriptions to the game, typically ranging from $4.95 to $19.95 a month.
Online gaming aggregators offer a variety of third-party games and related
services and seek to generate revenues through a combination of usage fees
and/or advertising. Online aggregators focus on providing server hosting,
match-making services and tournaments for multi-player games published by third-
parties, as well as community-building services such as chat rooms and bulletin
boards. Typically, these services offer many of the same games on a non-
exclusive basis. Chat accounts for as much as 50 percent of usage on aggregation
sites, as consumers come for games and stay for community. Furthermore,
aggregators seek to enhance their customers' online gaming experience by
minimizing latency for Internet-based games. Latency, or the length of time it
takes to communicate from the host server to the player's computer, is the most
important technical constraint impeding game play on the Internet. The typical
delay on the Internet is of the order of 4/10th of a second, which significantly
affects the quality of multi-player action games. A majority of the competitors
vying for the on-line and Internet gaming market are focused on multi-player
action games which require low latency data links between the players and the
host. Online game networks include Mpath's Mplayer, America Online's WorldPlay,
Microsoft's Internet Gaming Zone, Kesmai's Gamestorm, Total Entertainment
Network ("TEN"), Engage Games Online, SegaSoft's Heat.Net and Dwango.
Traditional publishers of games for the PC platform are also increasingly
including options for online play in their game software.
As the Internet develops into a popular medium for online gaming,
traditional game publishers, which are primarily focused on retail distribution,
are increasingly using the Internet to directly promote traditional retail
titles by providing free online play on
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their Web sites as an added benefit to retail buyers. According to a study
conducted by Jupiter Communications, by offering free online play, publishers
are able to increase retail sales of their products by 10%-15%.
Online Products
The Company acquired ICI in April 1997 as a vehicle to enter the online
gaming market. ICI had developed and launched a pioneer Internet gaming service
with the online-only game WarBirds. WarBirds has been named "Online Only Game of
the Year" every year since 1996 by PC Games magazine and is recognized as one of
the world's leading real-time large-scale online multi-player games.
The acquisition of MPG-Net provides the Company with the ICONS(TM) fully
integrated gaming network platform which is designed to seamlessly control game
play, player tracking, chat, advertising, billing and e-commerce. Using the
ICONS platform, the Company plans to position itself as a leading entertainment
destination on the Web by expanding the scope of its services to include
advertising and e-commerce and enhancing the community-building features of its
gaming networks, such as chat and messaging.
The Company owns and operates AT&T WorldNet's GameHub, EarthLink's Games
Arena, and the iEntertainment Network. The Company also provides Internet
content for America Online and Time Warner, Inc.'s ENTERTAINDOM site. The
acquisition of MPG-Net and its technology portfolio enabled the Company to
accelerate the development of its online game service offerings and its launch
of iEN, its fully integrated online gaming service, in the first quarter of
1999.
iEN
The Company's iEN site currently offers six real-time large-scale online
games. WarBirds is available on a subscription basis with memberships to the
iEntertainment Network site. The Company currently offers players three
subscription options on the iEntertainment Network. Users choose to pay $9.95,
$19.95 or $29.95 for five, thirteen or twenty hours, respectively, of game play
per month. Users pay an additional $1.99 for each hour played beyond this
subscription allocation. The Company believes that this pricing plan caters to
the needs of a variety of players ranging from novices to experts and provides
players with an incentive for added game play.
iEntertainment Network is distinguished by the real-time large-scale nature
of its online games. While a number of multi-player games are available over the
Internet, generally only four, eight or 16 players can play simultaneously with
or against each other. By contrast, large-scale multi- player games permit a
significantly greater number, frequently hundreds, of simultaneous players. The
Company is one of the few online developers that have the knowledge, skill and
experience necessary and are recognized within the industry for their ability to
successfully develop and operate large-scale online multi-player games.
The Company hosts numerous playing arenas for large-scale multi-player
online games on its highly scalable, redundant and secure high performance
client-server network. The Company believes this game server network can be
expanded and distributed as needed to accommodate growth in the Company's
customer base. The Company believes that its massively multi-player online games
create a gaming experience that constantly engage the player, presenting fresh
challenges. Large-scale online games are infinitely expandable and can grow
organically through regular development and modification. As such, unlike the
mission-oriented or level- based CD-ROM games, they have a perpetual shelf life.
These games present ongoing submersive play experiences where players can choose
to reenter the game environment at any time, 24 hours a day, seven days a week.
The Company believes that as its massively multi-player games develop a
loyal following, they become ideal environments around which to form
communities. The Company believes that its customers wish to socialize and form
relationships while competing online against one another. Accordingly, the
Company designs its massively multi-player online games to be inherently
conducive to community building by allowing hundreds of people from around the
world to play simultaneously. WarBirds, for example, allows players to fly in
squadrons, participate in organized special events, gain status and build
careers as pilots for their online personas. In addition to playing games, the
Company's customers are given the opportunity to participate in a rich social
environment, including chat, competitive tournaments and live event broadcasts.
The Company's iEN game site currently includes the following online titles:
WarBirds, an award winning World War II air combat simulation game,
allows hundreds of players from around the world to simultaneously fly air
combat missions in a single campaign. To date, there have been as many as
350 WarBirds
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players online at one time. WarBirds combines strategy, realism and
community building to offer players a unique, compelling and engaging
online gaming experience. Players choose to fly for one of four teams,
select an airplane from an array of 50 historically accurate bombers or
fighters and choose a role as a pilot, gunner or bomber. Individual
combatants then engage in dogfights or fly bombing missions over enemy
territories, with the outcome of each individual mission affecting the
outcome of the overall campaign. The incorporation of 3D rolling terrain
graphics, the Company's MEGAvoice technology, which allows groups of up to
four players to engage in real-time voice communication, and the Company's
MEGAplayer technology, which minimizes latency and onscreen "warping", add
to the realism of the playing experience.
WarBirds is played on a continuous basis, allowing players to enter
the game 24 hours a day, seven days a week. WarBirds also incorporates a
number of features that are conducive to community-building: players can
fly in a squadron, participate in organized special events and advance and
build careers as pilots. To encourage recurring play, the Company promotes
the development of communities of regular WarBirds players that participate
in special promotional events such as squadron conferences, conventions and
competitions around the world. WarBirds has been named "Online Only Game of
the Year" every year since 1996 by PC Games and in 1996 and 1997 by
Computer Games/Strategy Plus.
Dawn of Aces is a WWI air combat simulation game based on the WarBirds
engine. Dawn Of Aces places players in the middle of an ongoing WWI air
battle over Continental Europe and carries a more historic feel than
WarBirds. Dawn of Aces allows players to fly either as Allied (British or
French) or Central (German) pilots, with the goal of helping their side
capture enemy aerodromes and advance front lines. Players can chose their
aircraft from a variety of historically accurate models available to their
team and can change sides in the on-going battle each time they rejoin the
game.
The Company owns and operates the iEntertainment Network
(www.iencentral.com), AT&T WorldNet's GameHub (www.gamehub.net) and
EarthLink's Games Arena (www.thegamesarena.com). iEN has strategic
agreements with AT&T (NYSE:T), America Online (NYSE:AOL), Earthlink
(Nasdaq:ELNK), as well as other content and service providers.
iEntertainment Network, GameHub, and Games Arena are full-featured
entertainment destinations containing software downloads, free and premium
games, news updates for the computer gaming and entertainment industry,
online advertising, personalized portals providing daily interest content,
such as national news, weather, sports and stocks. These destinations
feature:
Premium Games: WarBirds(TM), the award-winning World War II flight
simulation voted "Online Game of the Year" for the third consecutive
year; WarBirds(TM) Air Combat; Dawn of Aces(TM), an exciting World War
I air combat simulation; ShockForce(TM), an action-packed futuristic
hovertank game; and Drakkar II, a medieval role playing game.
Free Games: Bingo, Bingo eXtreme, Wild Card Games (to include Bridge,
Hearts, Pinochle, Rummy and Spades), Video Poker, Checkers, Empire
Builder, Operation Market Garden, Minion Hunter, Backgammon, FiefQuest,
Chess, Wari, Tic Tac Toe, Video Slots, Blackjack, Roulette, Euchre,
Four in a Row, SuperTris, Diceridoo, Shuffle Puzzle, Word Scrambler and
Word Painter.
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iEN
The Company has fully integrated its iEntertainment Network and other
gaming sites into a seamless network of distributed servers and databases which
form the basis for iEN. The Company's branded and private label online gaming
sites serve as gateways to iEN. With the introduction of iEN, the Company
shifted to a three- tier service structure in order to expand its user base and
build a successful mainstream online entertainment service:
The first tier of the Company's services consists of free entertainment in
the form of chat, messaging and online parlor games such as chess, checkers,
Poker, Hearts, Spades, Bingo and backgammon to attract a large user audience to
the Company's site. Following the lead of major Internet portals which have used
free services to aggregate large communities of online users, the Company offers
these online gaming services free of charge in order to build a large and loyal
customer base.
The Company's second tier of services consists of subscription-based access
to more traditional action, simulation and strategy games and related services.
The Company also hosts multi-player arenas for a variety of popular
Internet-enabled CD-ROM titles published by the Company and third-party
publishers. Additional services include tournament play with rankings, contests,
special events and prizes. Players will be charged $9.95 per month for unlimited
usage of these services.
The third-tier of the Company's services target avid gamers. In addition to
all of the services included in the second-tier, the third tier offers the most
sophisticated online only games on a pay-per-play basis, including massively
multi-player games such as WarBirds and Dawn of Aces. These games include titles
that are differentiated enough from generic online gaming offerings to warrant
premium pricing. The Company plans to offer hourly, daily and monthly game time
purchases.
The Company has expanded the community-orientation of its services by
providing feature-rich, easy-to-use chat and messaging services which enhance
the social experience of playing the Company's broad offering of free,
subscription-based and pay-per-play games. The Company believes that these chat
rooms and messaging services encourage player congregation at its sites and
facilitate social interaction and player matching for multi-player games. These
chat and messaging services are being enhanced in 2000 with the introduction of
the Company's new Internet voice technology for chat rooms, messaging and voice-
enabled games. To support these free services, the Company is leveraging its Web
traffic and draw revenue from advertising, sponsorship and e-commerce offerings.
The Company has launched an online store which sells both Company and
third-party products.
CD-ROM Products
In June 1999, the Company sold certain assets related to the retail CD-ROM
portion of its business for $2,500,000 in cash to focus its efforts exclusively
on the development of its Internet properties and strategies.
Marketing
The Company's online marketing focuses on strategies for increasing
recurring revenues from the current customer base while recruiting new
customers. The Company seeks to increase revenues from its current customer base
through community building programs such as regular e-mail information updates,
sponsorship of online events, contests and conventions attended by subscribers.
For example, the Company is promoting the development of "communities" of
regular WarBirds flyers that participate in special promotional events, such as
squadron conferences, conventions and competitions around the world. To date,
over 200 of these informal squadrons or communities exist. In addition, the
Company is committed to providing extensive technical support to its customers.
The Company believes that as a result of these efforts, it has developed
significant customer loyalty, encouraging long term customer game play.
Technology
The Company has developed proprietary technologies that create an enhanced
gaming experience for the user and enable the Company to create highly realistic
games. The Company has filed a patent application on its MEGAplayer technology,
which minimizes latency and addresses problems such as "warping", which is
inherent in high and variable latency networks such as the
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Internet. The Company also has developed its MEGAvoice technology, which allows
groups of up to four players to engage in real-time voice communication over the
Internet while playing the Company's games. This technology utilizes bandwidth
efficiently while limiting any impact on latency and networked game play. In
2000, the Company plans to launch new Internet voice technology which will
further enhance the chat features of its online gaming sites.
As part of the MPG-NET acquisition, the Company obtained the ICONS online
gaming platform which provides features such as player tracking, chat, messaging
and billing and enables advertising and e-commerce. The acquisition of MPG-
Net's ICONS software technology enables the Company to expand its online
offering from multiple individual online games to a comprehensive online gaming
service incorporating a variety of community-building features. The ICONS system
involves the use of trained systems operators available online within the
Company services to offer tours, answer questions and to generally assist both
new visitors and service members with the utilization of services and the
purchase of various products, games and game-related merchandise.
Product Development
The development cycle for new online products is continuous throughout the
life of the product. Generally, each new internally developed product begins as
brief design document proposed by the Company's internal development staff.
Following management approval, the product's designer drafts a detailed product
design specification, programmers develop the software design and create a
schedule based on that design, and artists develop storyboards and the art
production schedule. The Company then develops the overall project schedule and
budget, including a scheduled release date and a marketing and sales plan.
The Company typically reviews externally developed products in various
stages of development, and, once the Company has selected and contracted for a
product, the Company's product development staff then manages the product
development process with the external developer in a manner similar to the
Company's internal development process.
Throughout the development phase of each product, whether internally or
externally developed, the Company implements a number of quality control
procedures. The software is carefully designed, implemented and tested by the
programmers, followed by frequent testing releases. Each product is played and
critiqued by the Company's in-house playtest staff and other Company employees.
Products are then submitted to groups of up to 50 external playtesters. This
product test process reduces implementation defects and provides design and
playability feedback in a timely manner for incorporation in the finished
product.
Properties
The Company leases approximately 15,000 square feet in an office park in
Morrisville, North Carolina. The lease is non-cancelable and expires in May
2001. All of the Company's United States and Corporate operations are conducted
from this facility. The Company also leases space for its offices in the United
Kingdom and Germany, but has plans for closing such offices.
Legal Proceedings
The Company is not currently a party to any material pending legal
proceeding.
Recent Developments
The Company announced, on July 20,1999, it was changing its name to
iEntertainment Network. The name change was approved by our shareholders at the
1999 Annual Shareholder's Meeting held on December 30, 1999. The Company also
changed its "ticker symbol" on the Nasdaq exchange to "IENT" from "IMGK".
In June 1999, the Company was notified by the Nasdaq Stock Market that we
were no longer in compliance with the net tangible asset listing requirement of
$4,000,000 for continued listing on the Nasdaq National Market. On October 14,
1999, following an oral hearing before the Nasdaq Qualifications Panel, the
Company's common stock, which had been listed on The Nasdaq National Market
System under the symbol "IENT," began trading on the Nasdaq SmallCap Market via
a temporary exception from the net tangible assets requirement.
On November 15, 1999, the Company demonstrated compliance with the terms
required by Nasdaq, which included a $3.7 million net tangible assets
requirement. The Company was able to satisfy this requirement because,
subsequent to the close of the third quarter, it consummated the following
reorganization transactions as part of its Nasdaq compliance plan:
A) On November 11, 1999, RGC International Investors, LDC (Rose Glen)
exchanged the remainder of its unconverted debenture, which as of
September 30, 1999 had an outstanding principal balance of
$3,310,844 for 3,310.844 shares of the Company's newly created
Series D Preferred Stock with a stated value of $1,000 per share.
In addition, Rose Glen exchanged $500,000 of all other accrued
amounts under the debenture for 500 shares of Series D Preferred
Stock, and agreed to waive all other accrued amounts which totaled
$260,000.
B) On November 11, 1999 Rose Glen purchased 1,100 shares of Series D
Preferred Stock for $1,100,000.
C) On November 11, 1999 Vertical Financial Holdings purchased 700,000
shares of common stock for $700,000.
D) On November 11, 1999 - Value Management & Research AG purchased
400,000 shares of common stock for $400,000.
E) On November 9, 1999, J.W. Stealey, former CEO of the Company,
arranged for the release of the Company from the line of credit
indebtedness to BB&T in the amount of $1,000,000 in exchange for
1,000,000 shares of common stock. The Company also paid $15,000
due on this line. In addition, as part of these transactions, Mr.
Stealey's resignation agreement dated August 16, 1999 was amended
such that his consulting services are no longer being used and the
sole remaining consideration due him was reduced to one lump sum
payment of $200,000 (less the value of 12 months health insurance
payments and car lease payments totaling approximately $20,000)
and 50,000 shares of the Company's common stock valued at $62,500.
This payment was made November 12, 1999. The Company has agreed to
convey to Mr. Stealey all trademarks and available rights to the
name Interactive Magic. Mr. Stealey agreed to waive the interest
due him from the Company in the amount of $183,000 under the terms
of the line of credit with BB&T that he had personally guaranteed.
Delisting by Nasdaq would have a serious impact on our near- term ability
to raise capital and would limit the liquidity of our capital stock. For a
further explanation of such risks, please refer to the "Risk Factor" section of
this statement.
Effective August 3, 1999, the Company accepted the resignation of Avi
Suriel, a member of the Board of Directors.
On August 16, 1999, the Company and John W. ("Bill") Stealey, the
Company's founder and then Chief Executive Officer, entered into an agreement:
(1) providing for the resignation of Mr. Stealey from his position as Chief
Executive Officer of the Company, (2) appointing Jacob Agam, a designee of
Vertical Financial Holdings, as Chairman of the Board to fill the vacant Board
seat created by Avi Suriel's recent resignation from the Board, (3) designating
management's slate of nominees for election to the Board at the annual meeting
of shareholders; and (4) establishing various other terms relating to Mr.
Stealey's resignation. Vertical Financial Holdings, a large shareholder of the
Company, also executed the agreement for the purpose of agreeing to vote its
shares in accordance with certain terms of the agreement. James F. Hettinger,
the former CEO and founder of Multiplayer Gaming Network and the Company's
Director of Business Development, was named Interim Chief Executive Officer to
replace Mr. Stealey. Michael Pearce was subsequently appointed as the Company's
Chief Executive Officer. Mr. Stealey remains as a member of the Company's Board
of Directors and as a consultant to the Company.
At the Company's annual meeting of shareholders on December 30, 1999, the
Company's shareholders approved the following proposals:
1. the election of Jacob Agam, Marc Goldfarb, Michael Pearce, W. Joseph
McClelland and J.W. Stealey to the Board of Directors of the Company;
2. the amendment of the Company's Articles of Incorporation to change the
Company's name to iEntertainment Network, Inc.;
3. the reservation of an additional 1,000,000 shares of common stock for
issuance under the Company's 1998 Stock Plan;
4. the ratification of the Series D Preferred Stock Financing; and
5. the ratification of the appointment of Ernst & Young LLP as the
independent auditors of the Company for the year ended December 31,
1999.
On January 7, 2000, the Company issued a press release substantially as follows:
iEntertainment Network, a leading provider and operator of worldwide
Internet entertainment communities, announced today it will launch a
co-branded gaming site with Red Hat, Inc.
Red Hat is a leader in open-source operating system software, services
and information and distributes the popular Red Hat Linux OS.
"This groundbreaking agreement provides iEntertainment Network with
the opportunity to access the Red Hat Linux revolution and to provide
our award-winning content to the open-source community," said Dave
Murray, iEN's V.P of Marketing. "Red Hat is the clear leader in the
open-source movement and we are eager to enter this phenomenal
market."
Under the agreement, the Red Hat Homepage will feature the "Geek
Games" (http://www.gamesforgeeks.com) site which contains a wide
variety of computer games as well as Linux gaming news updates.
iEntertainment Network will also begin developing games using Red Hat
Linux.
In recent months, iEntertainment Network has signed contracts to
provide entertainment content for Time Warner Entertainment's
ENTERTAINDOM(R) (www.entertaindom.com) site and Earthlink's Games
Arena (www.thegamesarena.com). In addition, iEntertainment Network has
increased their Internet customer base by releasing new versions of
their award-winning WarBirds and Dawn of Aces Internet flight
simulation games, launching Hearts, Spades, Pinochle, Bridge, Rummy,
Bingo eXtreme, completing their acquisition of the TheGamers.Net
entertainment service, and establishing independent Bingo servers in
both Germany and the UK.
Founded in 1994, Red Hat, Inc. is the market leader in open-source
operating system (OS) software, services and information. Along with
its award-winning open-source Red Hat Linux OS, Red Hat offers a full
line of services, including telephone support, on-site consulting,
developer training, certification programs and priority access
updates, making Red Hat a leading resource for knowledgeable,
innovative, mission-critical open-source solutions. Red Hat shares all
of its software innovations freely with the open-source community
under the GNU General Public License (GPL). The official Red Hat Linux
OS and related services are available directly from Red Hat and
through its partner, distributor and reseller programs. Red Hat is
based in Durham, N.C., and has offices worldwide.
On January 10, 2000, the Company issued the following press release:
iEntertainment Network announced today that company advertising
impressions increased to 135 million in the 4th quarter from 94
million in the 3rd quarter. The company credited new relationships
with EarthLink and Time Warner Entertainment as contributors to
advertising gains.
"During the fourth quarter, we launched EarthLink's Games Arena and we
also began a new partnership providing content for Time Warner
Entertainment's ENTERTAINDOM(R) site," said Dave Murray,
iEntertainment Network's V.P. of Marketing, added "The Internet
advertising numbers generated from new relationships, combined with
the ongoing growth of our existing sites, has resulted in a
significant increase in our overall online advertising impressions.
Consistent with the Company's new Internet-only strategy, in the fourth quarter
of 1999, the Company decided to shut down its overseas offices in Germany and
the United Kingdom effective in early 2000.
29
<PAGE>
DIRECTORS AND EXECUTIVE OFFICERS
Current Directors
The following table sets forth information regarding the Directors of the
Company:
<TABLE>
<CAPTION>
Year First
Elected As
Name of Director Director Age
- ------------------------------------------------------------------------------------
<S> <C> <C>
J.W. Stealey (2) 1995 50
- ------------------------------------------------------------------------------------
W. Joseph McClelland (1) (2) 1997 52
- ------------------------------------------------------------------------------------
Jacob Agam (2) 1999 44
- ------------------------------------------------------------------------------------
Michael Pearce 1999 38
- ------------------------------------------------------------------------------------
Marc Goldfarb (1) 1999 36
- ------------------------------------------------------------------------------------
(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>
Michael Pearce Chief Executive Officer 1999
- -----------------------------------------------------------------------------------------------------
Robert Hart Chief Financial Officer
and Secretary 1999
- -----------------------------------------------------------------------------------------------------
James F. Hettinger Chief Technology Officer 1999
- -----------------------------------------------------------------------------------------------------
</TABLE>
Biographies of the Directors and Executive Officers
Jacob Agam was elected as Chairman of the Board in August 1999. Mr. Agam also
serves as the Chairman of Vertical Financial Holdings, a member of the Vertical
Group. The Vertical Group is an international private equity firm specializing
in providing equity capital to mid-sized growth companies operating in a variety
of industries, including technology. Mr. Agam has also served since October 1996
as the Chairman of the Board and since April 1998 as the Chief Executive Officer
of Spigadoro, Inc. (f/k/a IAT Multimedia, Inc.), a publicly-traded food and
animal feed company. Mr. Agam received his J.D. from Tel Aviv University in 1984
and his L.L.M. in Securities and Corporate Finance from the University of
Pennsylvania in 1986.
J.W. Stealey served as Chairman of the Board of Directors and Chief Executive
Officer of the Company from January 1995 until August 1999. 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. Mr. Stealey remains a director of the Company.
W. Joseph McClelland has served as a Director of the Company since February
1997. Up until December 1999, Mr. McClelland had been Vice
30
<PAGE>
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.
James Hettinger, has been in the gaming business for more than 10 years. In
addition to developing long term strategic partnerships for iEN, Hettinger has
helped manage the company's growth and acquisition strategies in the United
States and Europe. Before joining iEN, Mr. Hettinger was founder and CEO of
MPG-Net, Multi-Player Games Net. Hettinger is a graduate of New York University
with degrees in both History and Psychology.
Robert L. Hart was appointed Chief Financial Officer and Secretary effective
October 27, 1999, after serving the Company as Interim CFO since September 1999.
Prior to joining the Company, Mr. Hart was self-employed as a contract CFO in
the manufacturing and pharmaceutical industries. From November 1997 through
February 1999, he was employed as the V.P. of Finance for Jasco Tools, Inc., a
multi-state metal machining and cutting tool company. From April 1996 through
November 1997, he was employed by J.C. Plastics as Controller and G.M. From
September 1994 through April 1996, Mr. Hart was the Executive V.P. of Pittsford
Capital Finance, Inc., a financial services firm that he started and
subsequently sold. Mr. Hart was employed by Mobil Oil Corp. from July 1983
through September 1994 where he served in various financial positions in both
operational and corporate capacities. Mr. Hart received a B.B.A. in Accounting
from Siena College in 1981, and his M.B.A. from Rennselaer Polytechnic Institute
in 1982.
Mike Pearce has served as a director since December 1999. Mr. Pearce has served
as Chief Executive Officer of the Company since October 1999. Prior to joining
iEntertainment Network, Mr. Pearce held a variety of technology industry
positions, including serving as Senior Vice President of Sales and Marketing at
VocalTec Communications Inc, a public company specializing in Internet
telephony, from 1996-1998. He also provided consulting services to VocalTec
during 1999. Previously, Mr. Pearce served as Senior Vice President of Sales and
Marketing for Ventana Communications Inc, a publisher of software and computer
reference books, from 1995-1996. During 1990-1993, he was Vice President, Sales,
at Librex Computer Systems, a wholly-owned subsidiary of Nippon Steel, Tokyo,
Japan, engaged in the manufacture and marketing of portable computers. From
1987-1990, Mr. Pearce was employed by Hyundai Electronics America, a
wholly-owned subsidiary of Hyundai Group, Seoul, Korea, ultimately in the
capacity of National Sales Manager for this manufacturer of personal computers
and peripherals.
Marc S. Goldfarb has served as a director since December 1999. Mr. Goldfarb has
served as a director of Spigadoro, Inc. (f/k/a IAT Multimedia, Inc.), a public
company, since September 1999. Since August 1998, Mr. Goldfarb has been the
President and Managing Director of Orida Capital USA, Inc., a consulting firm
that is the U.S. representative of the Vertical Group. Prior to joining Orida
Capital, Mr. Goldfarb was a corporate and securities attorney for over 10 years,
most recently as a partner at Bachner, Tally & Polevoy LLP in New York, where he
specialized in corporated finance, venture capital and mergers and acquisitions.
Mr Goldfarb holds a B.S. degree in Management and Industrial Relations from
Cornell University and a J.D. degree from the University of Pennsylvania Law
School.
31
<PAGE>
1999 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 1999 150,000 25,000 263,125(3) (4)
Chairman of the Board and 1998 170,742 - 14,306(3) (4)
Chief Executive Officer (2) 1997 160,000 - 16,832(3) (4)
Joseph Rutledge 1999 115,625 27,905 - (4)
Senior Vice President 1998 125,000 12,508 - (4)
Technology (5)
Raymond Rutledge 1999 106,385 38,555 - (4)
Vice President Licensing (6) 1998 120,000 24,396 - (4)
Michael Pearce 1999 - - -(7) (4)
Chief Executive Officer
</TABLE>
(1) Amount paid during year, earned in prior year
(2) Mr. Stealey resigned as Chairman and CEO in
August 1999. He remains on the Company's Board
of Directors.
(3) Consists of country club expenses in 1997 and 1998 and $200,000 of severance
payments and 50,000 shares of common stock (valued at $1.25 per share) in
1999.
(4) None awarded
(5) Joseph Rutledge left the Company in October 1999.
(6) Raymond Rutledge left the Company in October 1999.
(7) See chart below for stock options granted to Mr. Pearce
upon his appointment as the Company's Chief Executive
Officer in October 1999.
Stock Options Granted During 1999
<TABLE>
<CAPTION>
Number % of Total Potential Realizable Value at
Of Securities Options Assumed Annual Rates of Stock
Underlying Granted to Exercise or Price Appreciation for the
Options Employees in Base Price Expiration Option Term/(2)/
Name Granted Fiscal Year (1) ($ / Share) Date 5% 10%
<S> <C> <C> <C> <C> <C> <C>
Joseph Rutledge 81,663 3% $3.288 12/31/04 $168,877 $ 427,967
Raymond Rutldge 84,206 3% $3.315 12/31/04 $175,575 $ 444,941
J.W. Stealey 25,000 1% $4.250 12/31/04 $ 66,820 $ 169,335
Michael Pearce 800,000 8% $1.093 12/31/04 $549,905 $1,393,568
</TABLE>
(1) Based upon 2,662,580 total options granted.
(2) The compounding assumes a 10-year exercise period for all option grants.
These amounts represent certain assumed rates of appreciation only. Actual
gains, if any, on stock option exercises are dependent on the future
performance of the Common Stock and overall stock market conditions. The
amounts reflected in this table may not be necessarily achieved.
32
<PAGE>
No options were exercised by the Named Officers during 1999. The following table
sets forth certain information concerning the number and value of unexercised
options held by the Named Officers as of December 31, 1999:
<TABLE>
<CAPTION>
Number of Securities Value of Unexercised
Underlying Unexercised Options at In-the-Money Options
December 31, 1999 at December 31, 1999/(1)/
-------------------------------- ----------------------------------
Excercisable Unexercisable Excercisable Unexercisable
Name
<S> <C> <C> <C> <C>
Joseph Rutledge 295,000 0 $214,675 $ 0
Raymond Rutledge 271,000 0 $191,443 $ 0
J.W. Stealey 241,250 65,000 $223,850 $ 0
Michael Pearce 133,333 666,667 $116,666 $583,334
</TABLE>
(1) Options are considered in-the-money if the market value of shares covered
thereby is greater than the option exercise price. Value is calculated
based on the difference between the fair market value of the shares of
Common Stock at December 31, 1999 ($1.968), as quoted on the Nasdaq
SmallCap Market, and the exercise price of the options.
EMPLOYMENT AGREEMENTS
The Company entered into employment agreements with J. W. Stealey and
Robert L. Pickens effective January 1995. Each employment agreement had an
initial term of three years that automatically renewed for an additional
one-year term. During the term of employment, the parties had the right to
terminate the employment for any reason upon notice. If the termination was for
any reason other than voluntary termination by the employee or by the Company
for cause, the Company was obligated to make the following payments to the
employee:
(1) any unpaid base compensation for services performed prior to the
date of termination;
(2) the amount of any accrued annual vacation pay and other accrued
but unpaid benefits; and
(3) an amount as liquidated damages equal to twice the amount of the
employee's (A) annual base salary then in effect, (B) any earned
incentive compensation due but unpaid, and (C) such incentive
compensation as would have been earned from January 1 of the year
of termination through the date of termination pursuant to
performance criteria established by the Board of Directors.
With respect to Mr. Pickens, the Company's failure to extend his employment
agreement for an additional year on an anniversary of the effective date would
have been a termination by the Company without cause. If the termination was
voluntary by the employee or by the Company for cause, the Company would have
had to pay the employee
(1) any unpaid compensation for services performed prior to the date
of termination,
(2) the amount of any accrued annual vacation pay, and
(3) such incentive compensation as would have been earned from January
1 of the year of termination through the date of termination
pursuant to performance criteria established by the Board of
Directors.
Voluntary termination did not include termination by the employee as a result of
(1) a material change in the employee's duties, responsibilities or
authority, including the sale or other disposition of a
substantial part of the business of the Company that would
decrease the scope of the employee's position,
(2) failure to obtain the assumption of the obligation to perform the
agreement by any successor,
(3) breach of the employment agreement by the Company, or
(4) relocation of the employee's office to a location more than 50
miles from the employee's residence or the Company's principal
offices.
The employment agreements each included a non-competition provision, effective
during the term of the employment agreement and for a period of one year (two
years for Mr. Stealey) following termination of employment, pursuant to which
the employee cannot compete with the Company within 250 miles of any location at
which the Company maintains its principal administrative headquarters by
becoming interested, directly or indirectly, as a partner, officer, director,
shareholder, advisor, employee or in any other capacity with any competitive
business engaged in the design, manufacture or sale of games used on personal
computers. The employment agreements each prohibited disclosure of any
confidential information about the Company. The Company and Mr. Pickens
terminated his agreement when he left the Company in October 1998, and the
Company and Mr. Stealey terminated his agreement when he left the Company in
August 1999. The terms of Mr. Stealey's severance are described in "Certain
Transactions".
In November 1998, the Company entered into a severance agreement with Mr.
Pickens, pursuant to which the Company agreed to pay Mr. Pickens severance equal
to 100% of his salary through December 31, 1998 and 50% of his salary thereafter
through March 31, 1999. The Company also agreed to accelerate the vesting of Mr.
Picken's right to purchase 9,750 shares and extended the exercise date on these
options (together with 53,062 existing options that were already vested) until
March 31, 2000.
The Company entered into an employment agreement with Michael Pearce effective
in October 1999. The agreement has an initial term of three years that
automatically renews for additional one-year terms absent notice of non-renewal
by either party at least sixty days prior to expiration of the term. In lieu of
receiving the stated annual salary for his position of $180,000, pursuant to the
agreement Mr. Pearce elected instead to receive options to purchase a total of
800,000 shares of common stock with an exercise price of $1.09 per share. These
options are exercisable as follows: 133,333 are immediately exercisable, 133,333
become exercisable on the first anniversary of the grant date and 266,667 become
exercisable on each of the second and third anniversaries of the grant date. If
Mr. Pearce is terminated because of death, extended illness, disability or
without cause, all of these options that would have vested at any time during
the calendar year of termination become fully exercisable, provided Mr. Pearce,
or his estate, must exercise such options within six months following
termination. Mr. Pearce and his family are entitled to participate in such
employee benefit plans as the Company may offer from time to time to its senior
officers.
33
<PAGE>
CERTAIN TRANSACTIONS
The Company, Mr. Stealey and Robert Pickens, former President of the
Company, are parties to a January 3, 1995 Stock Purchase and Stockholder
Agreement (the "Co-Sale Agreement"). The Co-Sale Agreement grants Mr. Pickens a
co-sale right to participate in any transfer of shares of Common Stock by Mr.
Stealey on the same terms and conditions as offered to the third party by Mr.
Stealey. The co-sale right entitles Mr. Pickens to participate in such transfer
in the same proportion to the number of shares to be sold by Mr. Stealey that
the number of shares of Common Stock owned by Mr. Pickens prior to the transfer
bears to the number of shares of Common Stock owned by Mr. Stealey prior to the
transfer. Mr. Pickens resigned from his position as President of the Company in
October 1998.
The Company has also entered into a marketing agreement, dated January 3,
1995, with Mr. Stealey, pursuant to which Mr. Stealey makes his T-28 Trojan
aircraft and his services as a pilot available to the Company in consideration
for which the Company pays all of the expenses to store, operate and maintain
such aircraft and to maintain Mr. Stealey's pilot license. This marketing
agreement was terminated in November 1999.
On March 6, 1995, the Company issued a demand Promissory Note to Mr.
Pickens in the principal amount of $600,000 at an annual interest rate of 12%,
which increased to 14% on June 30, 1996 because the balance thereunder exceeded
$400,000 on that date. In consideration of this loan, the Company issued
warrants to Mr. Pickens to purchase 13,845 shares of Common Stock at an exercise
price of $1.00 per share. In connection with the Company's Series B Preferred
Stock financing, Mr. Pickens, on February 4, 1998, converted the outstanding
principal of $600,000 into 132,744 shares of Series C Preferred Stock, which
shares will be converted into 132,744 shares of Common Stock in connection with
the Recapitalization. Also in connection with the Recapitalization, Mr. Pickens
has forgiven $50,000 of the accrued interest outstanding in connection with this
loan in payment of the $1.00 per share exercise price of his 50,000
Recapitalization Options. The Company paid Mr. Pickens $111,421 of the remaining
$183,864 in accrued interest due to him under this loan upon the consummation of
the Company's initial public offering in July 1998.
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 $322,500 to NDL for the rights to the technology which includes amounts
paid pursuant to a royalty of 1% of net sales based on products that incorporate
the DEMON technology.
On December 4, 1995, the Company entered into a leasehold agreement with
Southport Business Park Limited Partnership ("Southport") for the Company's
principal executive offices located at 215 Southport Drive in Morrisville, North
Carolina. The term of the lease is for a period of five years commencing April
1, 1996 at a monthly rent of $13,962, subject to adjustment in certain
circumstances. J. W. Stealey has executed a personal guarantee in favor of
Southport in connection with the leasehold agreement.
Since the Company's inception, Mr. Stealey has executed several personal
guaranties and pledges of personal collateral in favor of BB&T, one of the
Company's primary bank creditors, in connection with revolving and term loans
extended by BB&T to the Company. On January 24, 1997, the Company issued a
$2,500,000 Promissory Note to BB&T secured by Mr. Stealey's guarantee and pledge
of collateral. The January 24, 1997 note has been paid in full, and Mr.
Stealey's guarantee and pledge in respect thereof have been extinguished. On
August 25, 1997, the Company issued a $2,750,000 Promissory Note to BB&T secured
by Mr. Stealey's guarantee and pledge of collateral in replacement of the
January 24, 1997 note. On November 25, 1997, the Company issued a $250,000
Promissory Note to BB&T secured by Mr. Stealey's guarantee and pledge of
collateral. The November 25, 1997 note has been paid in full, and Mr. Stealey's
guarantee and pledge in respect thereof have been extinguished. On March 27,
1998, the Company issued a $250,000 Promissory Note to BB&T secured by Mr.
Stealey's guarantee and pledge of collateral. In connection with his guaranties
to BB&T, the Company became obligated to pay Mr. Stealey a fee equal to 6% per
annum of the indebtedness borrowed. All of such indebtedness has been repaid and
Mr. Stealey has waived all payment rights relating to his guaranties.
On May 20, 1996, the Company issued a Promissory Note to Mr. Stealey in the
principal amount of $1,000,000, payable on November 17, 1996, with interest at
the annual rate of 15%, increasing to 17% if the Company did not repay Mr.
Stealey by November 17, 1996. In connection with this loan, the Company issued
warrants to Mr. Stealey to purchase 25,000 shares of Common Stock at a price of
$2.00 per share. Under the original terms of the note, if the note was not
repaid by November 17, 1996, the Company was obligated to issue additional
warrants to Mr. Stealey to purchase 25,000 shares of Common Stock per 180 days
prorated over the time until repayment occurred. On March 20, 1997, in
connection with a loan to the Company made by Petra, Mr. Stealey waived his
right under the note to accrue additional warrants after November 16, 1997. On
February 4, 1998, in connection with the Company's Series B Preferred Stock
financing, Mr. Stealey converted the $1,000,000 principal outstanding under the
May 20, 1996 note into 221,239 shares of Common Stock. In connection with the
recapitalization effected in connection with the Company's initial public
offering in July 1998 (the "Recapitalization"), Mr. Stealey has forgiven
$268,750 of the accrued interest outstanding under this note in payment of the
$1.00 per share exercise price of his 268,750 Recapitalization options.
34
<PAGE>
On July 10, 1996, the Company issued a Promissory Note to Mr. Stealey in
the principal amount of $1,000,000, payable on January 6, 1997, with interest at
the annual rate of 15%, increasing to 17% if the Company did not repay Mr.
Stealey by January 6, 1997. In connection with this loan, the Company issued
warrants to Mr. Stealey to purchase 50,000 shares of Common Stock at a price of
$6.00 per share. Under the original terms of the note, if the note was not
repaid by January 6, 1997, the Company was obligated to issue additional
warrants to Mr. Stealey to purchase 250,000 shares of Common Stock per 180 days
prorated over the time until repayment occurred. On March 20, 1997, in
connection with a loan to the Company by Petra, Mr. Stealey waived his right
under the note to accrue additional warrants after January 6, 1998. On February
4, 1998, in connection with the Company's Series B Preferred Stock financing,
Mr. Stealey converted the $1,000,000 principal outstanding under the July 10,
1996 note into 221,239 shares of Common Stock. The Company paid Mr. Stealey
$234,729 accrued interest due to him in connection with the loan upon
consummation of the Company's initial public offering.
The Company has borrowed approximately $870,000 from Laura M. Stealey, the
former wife of Mr. Stealey, under a $1,000,000 credit line established by Ms.
Stealey in favor of the Company, which is guaranteed by Mr. Stealey, pursuant to
a Letter Agreement dated October 31, 1996. In consideration of the credit line,
the Company granted to Ms. Stealey a warrant exercisable for 14,948 shares of
Common Stock at a purchase price of $5.82 per share. On March 24, 1997, in
connection with a loan to the Company by Petra, Ms. Stealey waived her right to
convert debt under the credit line into shares of the Company's Common Stock.
The Company repaid the entire principal amount, plus the $117,175 in accrued
interest thereon through March 31, 1998, of this credit line upon the
consummation of the Company's initial public offering.
On February 4, 1998, Vertical Financial Holdings, Suriel Financial
Consulting and several other investors purchased an aggregate of 778,746 shares
of the Company's Series B Preferred Stock for $3,500,000. Mr. Suriel, then a
director of the Company, is a Director of Vertical Financial Holdings and
founder and a principal of Suriel Financial Consulting. All of the Series B
Preferred Stock investors have signed a proxy agreement with Vertical Financial
Holdings granting Vertical Financial Holdings voting rights with respect to
their shares. In connection with the Recapitalization, the 778,746 shares of
Series B Preferred Stock converted into 2,045,649 shares of Common Stock.
The Company and General Capital, an affiliate of Vertical Financial
Holdings, have also signed a Marketing Agreement dated February 4, 1998,
pursuant to which the Company is obligated to pay $400,000 to General Capital
for marketing services when the Company's shareholders' equity equals or exceeds
$5,000,000. The Company satisfied such obligation upon the consummation of the
Company's initial public offering.
In August 1999, the Company and Mr. Stealey (the Company's founder and then
Chairman and CEO), entered into an agreement: (1) providing for the resignation
of Mr. Stealey from his position as Chairman and CEO; (2) appointing Jacob Agam,
a designee of Vertical Financial Holdings (a significant shareholder of the
Company), as Chairman of the Board to fill the vacancy created by the departure
of Avi Suriel; and (3) designating management's slate of nominees for election
to the Board at the annual meeting of shareholders (to include a total of three
designees from Vertical, together with Mr. Stealey and one designee of Mr.
Stealey. Vertical also signed the agreement for the purpose of agreeing to vote
its shares in favor of management's slate of nominees. As part of this agreement
the Company also agreed to: (1) retain Mr. Stealey as a consultant through
December 31, 2000 at an annual fee of $180,000 and other benefits identical to
those provided under his employment agreement, which agreement was terminated,
together with Mr. Stealey's severance rights thereunder (this consulting
arrangement was terminated in November 1999 as described below); (2) undertake
best efforts to have Mr. Stealey removed from personal guarantees he made to
secure approximately $1 million of Company indebtedness (Mr. Stealey arranged to
have the Company released from this indebtedness in November 1999 as described
below); (3) grant certain registration rights to Mr. Stealey with respect to his
shares; (4) sell to Mr. Stealey for $1,000 the Company's rights to its old name,
logo and url (imagicgames.com) following the Company's transition to its new
name; and (5) limit Mr. Stealey's noncompetition restrictions to nonsolicitation
of Company employees for the next 17 months.
In November 1999, the Company effected a balance sheet reorganization
involving the following transactions, the following components of which were
consummated with affiliated parties:
A) Vertical Financial Holdings, a significant shareholder of the Company,
purchased 700,000 shares of common stock for $700,000. Jacob Agam, the
Chairman of the Company's Board of Directors, is Chairman of Vertical
Financial Holdings.
B) J. W. Stealey, the Company's founder, former CEO and current director,
arranged for the release of the Company from $1,000,000 of
line-of-credit indebtedness to BB&T in exchange for 1,000,000 shares of
common stock. In addition, Mr. Stealey's resignation agreement dated
August 16, 1999 was amended such that his consulting services are no
longer being used and the sole remaining consideration due him was
reduced to one lump sum payment of $200,000 (less the value of 12 months
of health insurance payments and car lease payments totaling
approximately $20,000) and 50,000 shares of the Company's common stock.
This payment was made on November 12, 1999. The Company also agreed to
convey to Mr. Stealey all trademarks and available rights to the name
Interactive Magic, pending shareholder approval of the name change to
iEntertainment Network. Mr. Stealey agreed to waive the interest due him
from the Company in the amount of $183,000 under the terms of the line
of credit agreement with BB&T that he personally guaranteed.
The Company granted registration rights for the shares of common stock
purchased in connection with the reorganization. In addition, Mr. Stealey and
Vertical Financial Holdings agreed to vote all of their shares at the 1999
annual meeting in favor of the Series D Preferred Stock financing and the
convertibility of such shares into common stock.
35
<PAGE>
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 January 31, 2000, 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 3,974,367 (2) 25.8%
215 Southport Drive
Morrisville, NC 27560
Vertical Financial Holdings 2,745,649 (3) 18.4%
Hambrechtikerstrasse 61
Ch-8640 Rapperswil
Switzerland
Elliot Bossen 1,066,880 7.2%
</TABLE>
(1) Based on 14,891,218 shares outstanding
(2) Includes 248,750 shares subject to options and 236,389 shares subject to
warrants. Excludes 600,000 shares held in trusts for Mr. Stealey's children. 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.
The table below gives the number of shares of Common Stock of the Company
beneficially owned as of January 31, 2000 by persons who are members of the
Board and the named executive officers of the Company.
<TABLE>
<CAPTION>
Name and Position Shares Beneficially Owned Percent of Shares Outstanding (1)
<S> <C> <C>
J.W. Stealey 3,974,367 (2) 25.8%
Director
Jacob Agam -- (3) --
Chairman of the Board
Joseph Rutledge 271,663 (4) 1.8%
Vice President
Raymond Rutledge 270,206 (5) 1.8%
Vice President
Michael Pearce 133,333 (6) *
Chief Executive Officer
Robert Hart 38,250 (6) *
Chief Financial Officer
W. Joseph McClelland 66,000 (6) *
Director
Marc Goldfarb 32,500 (6) *
Director
</TABLE>
36
<PAGE>
All directors and executive officers 4,206,200 26.9%
as a group (5 directors and 2 executive
officers)(7)
* Less than one percent (1) Based on 14,891,218 shares outstanding.
(2) Includes 248,750 shares subject to options and 236,389 shares subject to
warrants. Excludes 600,000 shares held in trusts for Mr. Stealey's
children. 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. Mr. Stealey resigned as Chairman and CEO
in August 1999.
(3) Jacob Agam, the Chairman of the Board of the Company, is the Chairman of
Vertical Financial Holdings, a principal stockholder of the Company. Mr.
Agam disclaims beneficial ownership of the shares held by Vertical.
(4) Includes 265,000 shares subject to options. Mr. Rutledge left the Company
in October 1999.
(5) Includes 261,000 shares subject to options. Mr. Rutledge left the Company
in October 1999.
(6) Consists entirely of shares subject to options or warrants.
(7) Includes the shares discussed in the relevant footnotes above.
37
<PAGE>
SELLING SECURITY HOLDERS
The following table sets forth certain information regarding the beneficial
ownership of common stock by the Selling Shareholders as of January 31, 2000,
and the number of shares of common stock covered by this Prospectus:
<TABLE>
<CAPTION>
Beneficial Ownership Beneficial Ownership
Prior to Offering After Offering(1)
-------------------------- -------------------------
Name and Address Number Number of Shares Number Percent
of Selling Stockholder of Shares Offered Hereby of Shares of Class
- ---------------------- ---------- ----------------- ---------- -------
<S> <C> <C> <C> <C>
RGC International Investors, LDC 5,527,750(2) 6,411,702(3) -- --
J.W. Stealey......................... 3,974,367(4) 1,000,000 2,954,367 19.5%
Director
Vertical Financial Holdings.......... 2,754,649(5) 700,000 2,045,649 13.9%
Value Management & Research AG....... 400,000 400,000 -- --
Multiplayer Games Network, Inc. (6).. 262,500 262,500 -- --
Tantalus, Inc. (6)................... 262,500 262,500 -- --
Approximately 56 transferees of ..... 166,400 166,400 -- --
Bluestone Capital Partners, L.P.(7)
(none of whom own more than 1%)
Virtual Business Designs, Inc. ...... 107,143 53,572 53,571 *
Royce Investment Group, Inc. (7) 193,600 193,600 -- --
Tech Data Product Management, Inc. (8) 77,420 77,420 -- --
High Point Capital, LLC ............. 45,632 45,632 -- --
Ostrander Burch & Company, Inc. ..... 33,366 33,366 -- --
Don A. Clendenon .................... 30,000 30,000 -- --
IFM Venture Group ................... 18,000 18,000 -- --
Andrew G. Burch ..................... 18,000 18,000 -- --
James P. Bailey ..................... 9,000 9,000 -- --
-------- ---------
Total .......................... 9,681,692
</TABLE>
- ---------------------------------------
* Less than one percent
(1) Assumes the sale of all shares offered hereby.
(2) Consists of (a) 616,906 shares of common stock issued upon conversion of the
Convertible Note and which are carried forward from Registration Statement
No. 333-84691 pursuant to Rule 429, and (b) 4,910,844 shares of common stock
issuable upon conversion of Series D Preferred Stock. Pursuant to the terms
of the Series D Preferred Stock, the Series D Preferred Stock is convertible
by any holder only to the extent that the number of shares of Common Stock
thereby issuable, together with the number of shares of common stock owned
by such holder and its affiliates, would not exceed 4.99% of the then
outstanding common stock as determined in accordance with Section 13(d) of
the Exchange Act. Accordingly, the number of shares of common stock set
forth in the table for this Selling Shareholder exceeds the number of shares
of common stock that this Selling Shareholder could own beneficially at any
given time through its ownership of the Series D Preferred Stock. In that
regard, beneficial ownership of this Selling Shareholder set forth in the
table is not determined in accordance with Rule 13d-3 under the Exchange
Act. The actual number of shares of common stock offered in this prospectus
and included in the registration statement of which this prospectus is a
part includes such additional number of shares of common stock as may be
issued or issuable upon conversion of the Series D Preferred Stock by reason
of any stock split, stock dividend or similar transaction involving the
common stock in accordance with Rule 416 under the Securities Act.
(3) Includes 883,952 shares that the Company estimates it will need to satisfy
its obligations relating to a 6% premium on the Series D Preferred shares.
(4) Includes 248,750 shares subject to options and 236,389 shares subject to
warrants.
(5) 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.
See "Certain Transactions" for a description of material relationships
between this shareholder and the Company during the past three years.
(6) James Hettinger, an officer of the Company, is the majority shareholder of
this selling security holder. This selling security holder acquired these
shares upon the Company's acquisition of MPG-Net in February 1999.
(7) Bluestone Capital Partners, L.P. and Royce Investment Group, Inc. served as
the Companys' lead underwriters for its July 1998 initial public offering.
In addition, the Company entered into a consulting agreement in October 1999
with Royce Investment Group, Inc., pursuant to which the Company issued to
Royce a warrant to purchase 100,000 shares of its common stock.
(8) These shares were issued in January 2000 in settlement of an account payable
from the Company to Tech Data.
38
<PAGE>
PLAN OF DISTRIBUTION
The shares of common stock (the "Shares") being offered by the Selling
Shareholders or in some cases their respective pledgees, donees, transferees or
other successors in interest, will be sold from time to time in one or more
transactions (which may involve block transactions) on the Nasdaq SmallCap
Market or on such other market on which the common stock may from time to time
be trading, in privately- negotiated transactions, through the writing of
options on the Shares, short sales or any combination thereof. The sale price to
the public may be the market price prevailing at the time of sale, a price
related to such prevailing market price, at negotiated prices or such other
price as the Selling Shareholders determine from time to time. The Shares may
also be sold pursuant to Rule 144. Any Selling Shareholder shall have the sole
and absolute discretion not to accept any purchase offer or make any sale of
Shares if it deems the purchase price to be unsatisfactory at any particular
time.
The Selling Shareholders or in some cases their respective pledgees,
donees, transferees or other successors in interest, may also sell the Shares
directly to market makers acting as principals and/or broker-dealers acting as
agents for themselves or their customers. Such broker-dealers may receive
compensation in the form of discounts, concessions or commissions from the
Selling Shareholders and/or the purchasers of Shares for whom such
broker-dealers may act as agents or to whom they sell as principal or both
(which compensation as to a particular broker- dealer might be in excess of
customary commissions). Market makers and block purchasers purchasing the Shares
will do so for their own account and at their own risk. It is possible that a
Selling Shareholder will attempt to sell shares of common stock in block
transactions to market makers or other purchasers at a price per share which may
be below the then market price. There can be no assurance that all or any of the
Shares offered hereby will be issued to, or sold by, the Selling Shareholders.
The Selling Shareholder and any brokers, dealers or agents, upon effecting the
sale of any of the Shares offered hereby, may be deemed "underwriters" as that
term is defined under the Securities Act or the Exchange Act, or the rules and
regulations thereunder.
The Selling Shareholders, alternatively, may sell all or any part of the
Shares offered hereby through an underwriter. The Selling Shareholders have not
entered into any agreement with a prospective underwriter and there is no
assurance that any such agreement will be entered into. If the Selling
Shareholders enter into such an agreement or agreements, the relevant details
will be set forth in a supplement or revisions to this Prospectus.
The Selling Shareholders and any other persons participating in the sale or
distribution of the Shares will be subject to applicable provisions of the
Exchange Act and the rules and regulations thereunder, including, without
limitation, Regulation M, which provisions may restrict certain activities of,
and limit the timing of purchases and sales of any of the Shares by the Selling
Shareholders or any other such person. Furthermore, under Regulation M, persons
engaged in a distribution of securities are prohibited from simultaneously
engaging in market making and certain other activities with respect to such
securities for a specified period of time prior to the commencement of such
distributions, subject to specified exceptions or exemptions. The foregoing may
affect the marketability of the Shares.
The Company has agreed to indemnify the Selling Shareholders, or their
transferees or assignees, against certain liabilities, including liabilities
under the Securities Act, or to contribute to payments the Selling Shareholders
or their respective pledgees, donees, transferees or other successors in
interest, may be required to make in respect thereof.
DESCRIPTION OF SECURITIES
Common Stock
As of the date of this Prospectus, the Company has authorized 50,000,000
shares of Common Stock, $.10 par value per share. As of the date of this
Prospectus, 14,963,174 shares of Common Stock were issued and outstanding and
held of record by approximately 175 shareholders. The Company estimates that it
has approximately 3,000 beneficial shareholders. Holders of Common Stock are
entitled to one vote for each share held on matters which are submitted to a
vote of shareholders and are not entitled to cumulative voting in the election
of directors. Subject to any preferential rights of holders of Preferred Stock,
holders of Common Stock are entitled to receive dividends, if any, as declared
from time to time by the Board of Directors out of assets legally available for
such purpose. On liquidation, holders of Common Stock are entitled to a pro rata
portion of all assets available for distribution after payment of creditors and
the liquidation preference of any outstanding shares of Preferred Stock. Holders
of Common Stock have no preemptive rights or other rights to subscribe for
additional shares. All outstanding shares of Common Stock are, and the shares
offered hereby will be, upon issuance, validly issued, fully paid and non-
assessable.
Preferred Stock
39
<PAGE>
As of the date of this Prospectus, the Company has authorized 25,000,000
shares of Preferred Stock, $.10 par value per share. There are 4,910.844 shares
of Series D Convertible Preferred Stock authorized and outstanding. The
following is a summary of the terms of the Series D Preferred Stock:
Dividends
There are no dividends automatically payable on the Series D preferred
stock. No dividends may be paid upon the common stock while any Series D
preferred stock is outstanding.
Liquidation Preferences
Upon any liquidation, dissolution or winding up of the Company, before
anything can be paid to the holders of common stock, the holders of the Series D
Preferred Stock will be entitled to receive $1,000 per share, plus an amount
equal to a 6% annual return on that amount since November 1999 and any penalty
amounts due thereunder, if any.
Redemption
The Series D Preferred Stock must be redeemed by the Company if it is
requested to do so by the holders of a majority of the outstanding Series D
Preferred Stock upon:
(1) failure by the Company to comply with certain terms of the Articles,
the Securities Purchase and Exchange Agreement or the related
Registration Rights Agreement with respect to the Series D Preferred
Stock;
(2) bankruptcy of the Company; or
(3) certain changes in control of the Company.
In any such event, the redemption price per share would be equal to the greater
of (1) $1,200 per share, plus an amount equal to a 6% annual return since
November 1999 on the $1,000 paid for each share and any penalty amounts due
under the terms of the Series D preferred stock (including, but not limited to,
as a result of the failure to convert or deliver shares on a timely basis), and
(2) the "Parity Value" of the shares, which equals the product of (a) the number
of shares of common stocks into which the Series D Preferred Stock could have
been converted multiplied by (b) the highest reported closing price per share of
the common stock between the event triggering the right to request redemption
and the payment of the redemption price.
Conversion
Following shareholder approval of the Series D Preferred Stock financing in
December 1999, the Series D Preferred Stock became convertible into 4,910,844
shares of common stock. At any time, a holder of Series D Preferred Stock may
convert all of those shares into common stock. Each share of Series D Preferred
Stock was initially convertible into 1,000 shares of common stock. The number of
shares of common stock issuable upon conversion of a share of Series D Preferred
Stock increases over time to provide the holder additional common stock equal to
a 6% annual return since November 1999 and any penalty amounts otherwise due
thereunder. Subject to certain conditions, the Series D Preferred Stock will
automatically convert into common stock in November 2002.
Voting
The Series D Preferred Stock has no voting rights other than as provided by law
and except that the approval of the holders of a majority of the outstanding
Series D Preferred Stock is required for:
(1) any adverse change to the rights of the Series D Preferred Stock;
(2) the creation of securities having senior or equal rights;
(3) an increase in the authorized number of shares of Series D Preferred
Stock;
(4) an increase in the par value of the common stock; or
(5) any action that would result in certain taxes being imposed on the
Series D Preferred Stock.
The Company may issue additional shares of Preferred Stock in one or more
series as may be determined by the Company's Board of Directors, who may
establish, from time to time, the number of shares to be included in each
series, may fix the designation, powers, preferences and rights of the shares of
each such series and any qualifications, limitations or restrictions thereof,
and may increase or decrease the number of shares of any such series without any
further vote or action by the shareholders. Any Preferred Stock so issued by the
Board of Directors may rank senior to the Common Stock with respect to the
payment of dividends or upon liquidation, dissolution or winding up of the
Company, or both. In addition, any such shares of Preferred Stock may have class
or series voting rights. Under certain circumstances, the issuance of Preferred
Stock or the existence of the unissued Preferred Stock may tend to discourage or
render more difficult a merger or other change in control of the Company.
Warrants
As of December 31, 1999, the Company had the following warrants
outstanding:
<TABLE>
<CAPTION>
Number of Shares Exercise Price
Underlying Warrants
<S> <C> <C>
190,421 $1.000- $2.000
327,300 $2.406- $5.280
178,952 $6.000- $6.000
200,000 $7.000- $7.000
33,774 $8.000- $8.271
259,998 $9.600- $9.600
Total 1,190,445
</TABLE>
Certain Articles of Incorporation and Bylaws Provisions Having Potential Anti-
Takeover Effects
General
A number of provisions of the Company's Articles of Incorporation and
Bylaws address matters of corporate governance and the rights of shareholders.
The following summary of such provisions is not intended to be complete and is
qualified in all respects by the Company's Articles of Incorporation and Bylaws.
Certain of these provisions, as well as the ability of the Board of Directors to
issue shares of Preferred Stock and to set the voting rights, preferences and
other terms thereof, may delay or prevent takeover attempts not first approved
by the Board of Directors (including takeovers which certain shareholders may
deem to be in their best interests). These provisions also could delay or
frustrate the removal of incumbent directors or the assumption of control by
shareholders.
Classification of Board of Directors
The Board of Directors currently consists of five members. The Articles of
Incorporation provide that if the size of the Board increases to nine or more
members, the Board of Directors of the Company will be divided into three
classes as nearly equal in number as possible. The directors of each class will
serve a term of three years. As a result of a classification of the Board of
Directors, approximately one-third of the members of the Board of Directors will
be elected each year, and two annual meetings will be required for the Company's
shareholders to change a majority of the members constituting the Board of
Directors.
Nomination and Removal of Directors; Filling Vacancies
The Company's Bylaws provide that nominations to the Board of Directors may
only be made by the Board of Directors, a nominating committee of the Board or
by any shareholder entitled to vote in elections of directors who complies with
certain notice procedures. In addition, the Articles of Incorporation and Bylaws
provide that a director may be removed by the shareholders only upon the
affirmative vote of the holders of two-thirds of the voting power of all shares
of capital stock entitled to vote generally in the election of directors, and
the Bylaws specify that vacancies on the Board of Directors may be filled only
by the Board of Directors. The purpose of these provisions is to prevent a
majority shareholder from circumventing the classified board system by removing
directors and filling the vacancies with new individuals selected by that
shareholder. Accordingly, these provisions may have the effect of impeding
efforts to gain control of the Board by anyone who obtains a controlling
interest in the Company's Common Stock.
40
<PAGE>
Amendment of Articles of Incorporation
The Articles of Incorporation of the Company provide that amendments to the
Articles of Incorporation may be adopted only upon the affirmative vote of the
holders of at least two-thirds of the voting power of all shares of capital
stock of the Company entitled to vote thereon. However, if such amendment has
received the prior approval by an affirmative vote of a majority of
Disinterested Directors, as defined below, then the affirmative vote of the
holders of at least a majority of the voting power of all shares of capital
stock of the Company entitled to vote thereon, or such greater percentage
approval as required by North Carolina law, is sufficient to adopt such
amendment. A Disinterested Director is defined as any member of the Board of
Directors who is unaffiliated with, and not a nominee of, a Control Person, as
defined below, and was a member of the Board of Directors prior to the time a
Control Person became such, and any successor of a Disinterested Director who is
unaffiliated with, and not a nominee of, a Control Person, who is recommended to
succeed a Disinterested Director by a majority of Disinterested Directors then
on the Board of Directors. A Control Person is defined as any corporation,
person, group, or other entity, which together with its affiliates, prior to a
Business Combination, as defined below, beneficially owns 10% or more of the
shares of any class of equity or convertible securities of the Company, and any
affiliate of any such corporation, person, group, or other entity; provided,
however, any corporation, person, group or other entity which, together with its
affiliates, prior to July 2, 1998 beneficially owned 10% or more of the shares
of any class of equity or convertible securities of the Company, and any
affiliate of any such party is not considered to be a Control Person.
Amendment of Bylaws
Subject to certain restrictions described below, either the Board of
Directors or the shareholders of the Company may amend the Company's Bylaws. The
Board of Directors may amend the Bylaws and adopt new Bylaws except that: (i) a
bylaw adopted or amended by the shareholders may not be readopted, amended, or
repealed by the Board of Directors if neither the Articles of Incorporation nor
a bylaw adopted by the shareholders authorizes the Board of Directors to adopt,
amend, or repeal that particular bylaw or the Bylaws generally; (ii) a bylaw
that fixes a greater quorum or voting requirement for the Board of Directors may
not be adopted by the Board of Directors by a vote of less than a majority of
the directors then in office and may not itself be amended by a quorum or vote
of directors less than the quorum or vote therein prescribed or prescribed by a
bylaw adopted or amended by the shareholders; and (iii) if a bylaw fixing a
greater quorum or voting requirement for the Board of Directors is originally
adopted by the shareholders, it may be amended or repealed only by the
shareholders, unless the Bylaws permit amendment or repeal by the Board of
Directors. The shareholders of the Company generally may adopt, amend, or repeal
the Bylaws upon the affirmative vote of the holders of two-thirds of the voting
power of all shares of capital stock entitled to vote thereon.
Supermajority Vote Requirement
The Articles of Incorporation of the Company provide that, unless otherwise
more restrictively required by applicable law, any Business Combination, as
defined below, must be approved by a majority of a quorum of the Board of
Directors and must receive the level of shareholder approval, if any, as
follows: (i) to the extent shareholder approval is otherwise required by law, by
an affirmative vote of the shareholders holding at least a majority of the
shares of capital stock of the Company entitled to vote thereon, provided that
such Business Combination has been approved by an affirmative vote of at least
two-thirds of the full Board of Directors before such Business Combination is
submitted for approval to the shareholders or (ii) by an affirmative vote of the
shareholders holding at least two-thirds of the shares of capital stock of the
Company entitled to vote thereon provided that such Business Combination has
been approved by an affirmative vote of at least a majority of a quorum of the
Board of Directors (but less than two-thirds of the full Board of Directors). In
addition, if the Business Combination is approved by the affirmative vote of the
shareholders holding at least two-thirds of the shares of Common Stock entitled
to vote and by a majority of a quorum of the Board of Directors but less than
two-thirds of the full Board of Directors, the Business Combination must grant
to shareholders not voting to approve the Business Combination certain "fair
price" rights.
The Company's Articles of Incorporation define a Business Combination as
(i) any merger or consolidation of the Company into any other corporation,
person, group, or other entity where the Company is not the surviving or
resulting entity; (ii) any merger or consolidation of the Company with or into
any Control Person or with any corporation, person, group or other entity where
the merger or consolidation is proposed by or on behalf of a Control Person;
(iii) any sale, lease, exchange, or other disposition of all or substantially
all of the assets of the Company; (iv) any sale, lease, exchange, or other
disposition of more than 10% of the total assets of the Company to a Control
Person; (v) the issuance of any securities of the Company to a Control Person;
(vi) the acquisition by the Company of any securities of a Control Person unless
such acquisition begins prior to the person becoming a Control Person or is an
attempt to prevent the Control Person from obtaining greater control of the
Company; (vii) the acquisition by the Company of all or substantially all of the
assets of any Control Person or any entity where the acquisition is proposed by
or on behalf of a Control Person; (viii) the adoption of any plan or proposal
for the liquidation or dissolution of the Company which is proposed by or on
behalf
41
<PAGE>
of a Control Person; (ix) any reclassification of securities or recapitalization
of the Company which has the effect of increasing the proportionate share of the
outstanding shares of any class of equity or convertible securities of the
Company which is beneficially owned or controlled by a Control Person; (x) any
of the above transactions which are between the Company and any of its
subsidiaries and which are proposed by or on behalf of any Control Person; or
(xi) any agreement, plan, contract, or other arrangement providing for any of
the above transactions.
The requirement of a supermajority vote of shareholders to approve certain
business transactions, as described above, may discourage a change in control of
the Company by allowing shareholders holding less than a majority of the shares
of Common Stock to prevent a transaction favored by shareholders holding a
majority of such shares. Also, in some circumstances, the Board of Directors
could cause a two-thirds vote to be required to approve a transaction thereby
enabling management to retain control over the affairs of the Company and their
positions with the Company.
Fair Price Provision
The "fair price" provision of the Company's Articles of Incorporation
applies to Business Combinations that have not received the approval of two-
thirds of the full Board of Directors and only to shareholders who vote against
such Business Combinations and who elect to sell their shares to the Company for
cash at their fair price. This "fair price" provision requires that the
consideration for such shares be paid in cash by the Company and that the price
per share be at least equal to the greater of the following:
(i) The highest price per share paid for the Company's Common Stock during
the four years immediately preceding the Business Combination vote by any
shareholder who beneficially owned five percent or more of the Company's
Common Stock and who votes in favor of the Business Combination;
(ii) The cash value of the highest price per share previously offered
pursuant to a tender offer to the shareholders of the Company within the four
years immediately preceding the Business Combination vote; or
(iii) The highest price per share, including commissions and fees, paid by
a Control Person in acquiring any of its holdings of the Company's Common
Stock.
The fair price provision is intended to prevent some of the potential
inequities of two-step takeover attempts by encouraging negotiations with the
Company. However, some shareholders may find the fair price provision
disadvantageous to the extent it discourages changes in control in which
shareholders might receive for at least some of their shares a substantial
premium above the market price at the time an acquisition transaction is made.
The Company is not aware of any pending or threatened effort to acquire
control of the Company or to change management. The Board of Directors does not
presently intend to propose any additional anti-takeover provisions.
Constituencies
The Company's Articles of Incorporation expressly authorize the Board of
Directors of the Company, any committee of the Board of Directors, or any
individual director in determining what is in the best interest of the Company
and its shareholders, to consider, in addition to the long-term and short-term
interests of the shareholders, the social and economic effects of the matter to
be considered on the Company and its subsidiaries, their employees, clients,
creditors, and the communities in which the Company and its subsidiaries operate
or are located. When evaluating a business combination or a proposal by another
person to make a business combination or a tender offer or any other proposal
relating to a potential change in control of the Company, the Board of Directors
may consider such matters as (i) the business and financial condition and
earnings prospects of the acquiring person, and the possible effect of such
condition upon the Company and its subsidiaries and the communities in which the
Company and its subsidiaries operate, (ii) the competence, experience, and
integrity of the acquiring person and its management and (iii) the prospects for
successful conclusion of the business combination, offer or proposal. The
consideration of any of the above factors is completely discretionary with the
Company's Board of Directors. The constituency provision of the Company's
Articles of Incorporation may discourage or make more difficult certain
acquisition proposals or business combinations and therefore, may adversely
affect the ability of shareholders to benefit from certain transactions opposed
by the Company's Board of Directors.
Special Meetings of Shareholders
The Company's Bylaws provide that special meetings of shareholders may be
called only by the Board of Directors, the Chairman of the Board, the President
or holders of 20% or more of the voting power of the outstanding shares of the
Company. As a result, this provision would prevent shareholders owning less than
20% of the voting power of the outstanding Common Stock from
42
<PAGE>
compelling shareholder consideration of any proposal (such as a proposal for a
Business Combination) over the opposition of the Company's Board of Directors.
Shareholder Proposals
The Company's Bylaws provide that shareholders who desire to bring any
business before a meeting of shareholders must follow specified procedures,
including advance written notice to the Company. The shareholder proposal
provision may make it more difficult for shareholder proposals to be considered
at shareholder meetings.
43
<PAGE>
DISCLOSURE OF COMMISSION POSITION
ON INDEMNIFICATION FOR SECURITIES ACT LIABILITIES
As permitted by North Carolina law, Article IX of the Company's Articles of
Incorporation provides for the limitation of the personal liability of directors
for monetary damages for breach of duty as a director provided that the
limitation of liability does not apply to (i) acts or omissions not made in good
faith that the director at the time of such breach knew or believed were in
conflict with the best interests of the corporation; (ii) any liability under
the North Carolina Business Corporation Act for unlawful distributions; (iii)
any transaction from which the director derived an improper personal benefit or
(iv) acts or omissions occurring prior to the date the provision became
effective.
The North Carolina Business Corporation Act also contains provisions
prescribing the extent to which present or former directors, officers, or
employees of a corporation shall or may be indemnified against liabilities which
they may incur in those capacities. Under those provisions, the availability or
requirement of indemnification or reimbursement of expenses is dependent upon
numerous factors, including whether the action is brought by the corporation or
by outsiders and the extent to which the potential indemnitee is successful in
his defense. The statute also permits a corporation to purchase and maintain
insurance on behalf of its directors and officers against liabilities which they
may incur in their capacities as such, whether or not the corporation would have
the power to indemnify them under other provisions of the statute.
As permitted by North Carolina law, Article IX of the Bylaws of the Company
provides for the indemnification of directors and officers, employees or agents
of the Company within the limitations permitted by North Carolina law.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and persons controlling the
Company pursuant to the foregoing provision, or otherwise, the Company has been
advised that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in the Securities Act of
1933 and is, therefore, unenforceable.
LEGAL MATTERS
The validity of the common stock offered under this Prospectus will be
passed upon for us by our counsel, Wyrick Robbins Yates & Ponton LLP, Raleigh,
North Carolina.
EXPERTS
The consolidated financial statements of the Company at December 31, 1998
and 1997, and for the years then ended and the combined financial statements of
Multiplayer Games Network, Inc., Tantalus, Inc. and MPG-Net, Inc. as of October
31, 1998 and December 31, 1997 and for the ten months ended October 31, 1998 and
for the year ended December 31, 1997 appearing in this Prospectus and the
Registration Statement have been audited by Ernst & Young LLP, independent
auditors, as set forth in their reports thereon appearing elsewhere herein and
in the Registration Statement, and are included in reliance upon such reports
given upon the authority of such firm as experts in accounting and auditing.
WHERE YOU CAN FIND MORE INFORMATION
We file annual, quarterly and special reports, proxy statements and other
information with the Commission. You may read and copy any document we file at
the Commission's public reference rooms in Washington, D.C., New York, New York
and Chicago, Illinois. Please call the Commission at 1-800-SEC 0330 for further
information on the public reference rooms. Our Commission filings are also
available to the public from the SEC's website at http://www.sec.gov.
------------------
This prospectus is part of a registration statement we filed with the
Commission. As such, it does not contain all of the information set forth in the
registration statement and the exhibits and schedules filed with the
registration statement. For further information about us and the common stock
described by this prospectus, please see the registration statement and the
exhibits and schedules filed with it, copies of which can be inspected at, or
obtained from, the Commission's public reference rooms.
We have authorized no one to provide you with different information. We are
not making an offer of these securities in any state where the offer is not
permitted. You should not assume that the information in this prospectus is
accurate as of any date other than the date on the front of this document.
44
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
iENTERTAINMENT NETWORK, INC.
(f/k/a as INTERACTIVE MAGIC, INC.)
Report of Independent Auditors............................ F-1
Consolidated Balance Sheets............................... F-2
Consolidated Statements of Operations..................... F-4
Consolidated Statements of Stockholder's Equity (Deficit). F-5
Consolidated Statements of Cash Flows..................... F-7
Notes to Consolidated Financial Statements................ F-9
Unaudited Pro Forma Financial Statements and
Notes Thereto........................................ F-31
Unaudited Interim Financial Statements and Notes Thereto.. F-35
MPG-NET
Report of Independent Auditors............................ F-52
Combined Balance Sheets................................... F-53
Combined Statements of Operations......................... F-55
Combined Statements of Stockholder's Deficit.............. F-56
Combined Statements of Cash Flows......................... F-57
Notes to Combined Financial Statements.................... F-58
</TABLE>
<PAGE>
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 auditing standards generally accepted
in the United States. 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 accounting principles generally accepted in the United States.
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
F-1
<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
============================
</TABLE>
F-2
<PAGE>
<TABLE>
<CAPTION>
December 31
1998 1997
----------------------------
<S> <C> <C>
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>
F-3
<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>
F-4
<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> <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 9) (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>
F-5
<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.
F-6
<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>
F-7
<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.
F-8
<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.
F-9
<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, iMagic Online 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):
<TABLE>
<CAPTION>
December 31
1998 1997
-------------------------
<S> <C> <C>
Finished goods $ 1,065 $ 645
Components 117 79
-------------------------
1,182 724
Inventory valuation reserve (290) (87)
-------------------------
$ 892 $ 637
=========================
</TABLE>
F-10
<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>
F-11
<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):
<TABLE>
<CAPTION>
1998 1997
----------------
<S> <C> <C>
Balance at beginning of year $ 425 $ 152
Capitalized 1,450 849
Amortized (963) (576)
---------------
Balance at end of year $ 912 $ 425
===============
</TABLE>
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.
F-12
<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.
F-13
<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.
F-14
<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, 2000. 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.
F-15
<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.
F-16
<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.
F-17
<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.
F-18
<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>
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.
F-19
<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.
F-20
<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.
F-21
<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.
F-22
<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 1,004,882 - 1,863,368 $1.44 589,206
Options authorized for grant - - - - -
Options granted (232,095) - 232,095 6.00 -
Options exercised - - (1,125) 1.00 -
Options canceled 101,294 - (101,294) 4.19 -
-----------------------------------------------------------------------------------
Balances at December 31, 1997 874,081 - 1,993,044 1.83 977,433
Options authorized for grant - 1,800,000 - - -
Options granted (254,684) (586,417) 841,101 4.84 -
Options exercised - - (420,088) 1.19 -
Options canceled 392,438 4,800 (397,238) 3.43 -
-----------------------------------------------------------------------------------
Balances at December 31, 1998 1,011,835 1,218,383 2,016,819 $2.91 896,806
===================================================================================
</TABLE>
F-23
<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>
$1.000 931,063 3.51 $1.00 529,350 $1.00
$2.000 - $4.125 483,388 4.49 3.45 68,811 2.07
$4.250 - $5.375 251,667 4.60 4.63 101,667 5.19
$6.000 350,701 4.93 6.00 195,978 6.00
------------------------------------------------------------------------------------------
2,016,819 4.13 $2.91 896,806 $2.66
==========================================================================================
</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:
<TABLE>
<CAPTION>
Year ended December 31
1998 1997
--------------------------
<S> <C> <C>
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
</TABLE>
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.
F-24
<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:
<TABLE>
<CAPTION>
Warrants
Outstanding
--------------------
<S> <C>
Balance at December 31, 1996 261,156
Issued 488,126
--------------------
Balance at December 31, 1997 749,282
Issued 413,327
Exercised (535,104)
--------------------
Balance at December 31, 1998 627,505
====================
</TABLE>
F-25
<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:
<TABLE>
<S> <C>
Outstanding incentive stock options 1,409,319
Outstanding performance based stock options 607,500
Possible future issuance under stock option plan 2,230,218
Stock purchase warrants 627,505
----------------------
4,874,542
======================
</TABLE>
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.
F-26
<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>
Deferred tax assets: <C>
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>
F-27
<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.
F-28
<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>
F-29
<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.
16. Disposition of Assets (Unaudited)
On May 25, 1999, the Company executed an Agreement Regarding Assignment of
Contracts (the "Agreement") to sell its rights under certain development
contracts for CD-ROM products between the Company and third party developers
(and assume certain liabilities thereto) for $2.5 million. The Agreement
provides the Company a license to use these products on the Internet. The
transaction was consummated on June 30, 1999. Cash proceeds to the Company, net
of related expenses, were $2.3 million. The carrying value of net assets sold
(primarily CD-ROM advance royalties) was $1.6 million. The Company recognized a
gain of $855,000 related to the sale.
F-30
<PAGE>
The following unaudited pro forma consolidated financial data present the
unaudited pro forma condensed consolidated balance sheet of Interactive Magic,
Inc. as of September 30, 1999 and the unaudited pro forma consolidated
statements of operations of Interactive Magic, Inc. for the nine months ended
September 30, 1999 and the year ended December 31, 1998. The unaudited pro forma
condensed consolidated balance sheet data reflects the following adjustments, as
described above, as if they had occurred on September 30, 1999:
o Conversion of Rose Glen indebtedness o All issuances of preferred and
common stock o Severance accrual for CEO o Release of BB&T line of credit
indebtedness
The unaudited pro forma consolidated statements of operations data reflect the
disposition of assets, release of the BB&T line of credit indebtedness and the
CEO's personal guarantee and the acquisition of MPG-Net as if they had occurred
on January 1, 1998.
A) On November 11, 1999, RGC International Investors, LDC (Rose Glen) converted
the remainder of its unconverted debenture, which as of September 30, 1999
had an outstanding principal balance of $3,310,844 and a recorded value of
$2,156,000 into 3,310.844 shares of the Company's newly created Series D
Preferred Stock with a stated value of $1,000 per share. In addition, Rose
Glen converted $500,000 of all other accrued amounts under the debenture into
500 shares of Series D Preferred Stock, and agreed to waive all other accrued
amounts which totaled $260,000. The difference between the recorded value of
the debt and the outstanding principal balance along with the $260,000 waived
interest accrual were netted and charged to additional paid-in capital.
Interest expense related to these debentures was $3,679,000 for the nine
months ended September 30, 1999.
B) On November 11, 1999 Rose Glen purchased 1,100 shares of Series D Preferred
Stock for $1,100,000.
C) On November 11, 1999 Vertical Financial Holdings purchased 700,000 shares of
common stock for $700,000.
D) On November 11, 1999 - Value Management & Research AG purchased 400,000
shares of common stock for $400,000.
E) November 9, 1999 J.W. Stealey, former CEO of the Company, released the
Company from the line of credit indebtedness to BB&T in the amount of
$1,000,000 in exchange for 1,000,000 shares of common stock. The Company also
paid $15,000 due on this line. Interest expense on this line of credit was
$78,000 and $158,000 for the nine months ended September 30, 1999 and the
year ended December 31, 1998, respectively. In addition, as part of these
transactions, Mr. Stealey's resignation agreement dated August 16, 1999 has
been amended such that his consulting services are no longer being used and
the sole remaining consideration due him has been reduced to one lump sum
payment of $200,000 (less the value of 12 months health insurance payments
and car lease payments totaling approximately $20,000) and 50,000 shares of
the Company's common stock valued at $62,500. This payment was made November
12, 1999. The Company has agreed to convey to Mr. Stealey all trademarks and
available rights to the name Interactive Magic, pending shareholder approval
of the Company name change to iEntertainment Network. Mr. Stealey agreed to
waive the interest due him from the Company in the amount of $183,000 under
the terms of the line of credit with BB&T that he had personally guaranteed;
in consideration of which the Company incurred additional interest expense of
$59,000 for the nine months ended September 30, 1999 and $107,000 for the
year ended December 31, 1998. The amount of waived interest has been
reflected as a credit to additional paid-in capital.
Disposition of Assets
F) Effective on June 30, 1999 and pursuant to an Agreement Regarding Assignment
of Contracts ("Assignment Agreement") dated as of May 25, 1999, between then
Interactive Magic, Inc., and Ubi Soft Entertainment S.A., Interactive Magic sold
to Ubi Soft substantially all of the assets of its CD-ROM business operation,
less certain online rights retained by Interactive Magic, for $2.5 million in
cash resulting in a $855,000 gain on disposition of assets. Operating expenses
related to titles under contracts which were sold per the Assignment Agreement
were $981,000 for the nine months ended September 30, 1999 and $354,000 for the
year ended December 31, 1998.
Acquisition of MPG-Net:
G) Reflects the acquisition of MPG-Net, Inc., Multiplayer Games Network, Inc.
and Tantalus, Inc. (collectively referred to as "MPG-Net") as if it had occurred
on January 1, 1998. Adjustments include the operations of MPG-Net from January
1, 1998 excluding interest expense to related parties on debt that was settled
during the acquisition and amortization of goodwill related to the acquisition.
The unaudited pro forma consolidated financial data are based on historical
financial statements of Interactive Magic and the aforementioned adjustments.
The unaudited pro forma financial data do not purport to represent what
Interactive Magic's financial position or result's of operations would actually
have been if the transactions had in fact occurred on the dates indicated and
are not necessarily representative of Interactive Magic's financial position or
results of operations at any future date or for any future period.
F-31
<PAGE>
Interactive Magic, Inc
Unaudited Pro Forma Condensed Consolidated Balance Sheet
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
PRO FORMA
SEPTEMBER 30 PRO FORMA SEPTEMBER 30
1999 ADJUSTMENTS 1999
--------------------------------------------------------
ASSETS
Current assets:
<S> <C> <C> <C>
Cash and cash equivalents $ 1,570 B 1,100 $ 3,575
C 700
D 400
E (15)
E (180)
Other current assets 895 895
--------------------------------------------------------
Total current assets 2,465 2,005 4,470
Property and equipment, net 1,110 1,110
Goodwill and intangible assets 3,750 3,750
Other 73 73
========================================================
Total assets $ 7,398 $ 2,005 $ 9,403
========================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 2,241 A (760) $ 1,501
E 20
Lines of credit 1,023 E (1,015) 8
Royalties and other current liabilities 289 289
--------------------------------------------------------
Total current liabilities 3,553 (1,755) 1,798
Long-term debt 2,156 A (2,156) -
Other noncurrent liabilities 196 E (183) 13
Stockholders' equity:
Preferred Stock, $.10 par value; 25,000,000 shares
authorized; of Series D Preferred Stock, stated
value $1,000 per share. 4,910.844 shares
authorized, issued and outstanding - A,B 1 1
Common stock, $.10 par value; 50,000,000 shares
authorized; 12,505,337 and 14,655,337 shares issued and
outstanding at September 30, 1999 and pro forma
September 30, 1999, respectively 1,250 C 70 1,465
D 40
E 105
Additional paid-in capital 40,239 A 2,915 46,385
B 1,100
C 630
D 360
E 1,141
Accumulated deficit (39,861) E (263) (40,124)
Accumulated other comprehensive loss (135) (135)
-----------------------------------------------------------
Total stockholders' equity 1,493 6,099 7,592
==========================================================
Total liabilities and stockholders' equity $ 7,398 $ 2,005 $ 9,403
==========================================================
</TABLE>
F-32
<PAGE>
Interactive Magic, Inc
Unaudited Pro Forma Consolidated Statements of Operations (In
thousands, except share and per share data)
<TABLE>
<CAPTION>
Pro forma
Nine months Nine months
September 30, Pro forma ended
1999 Adjustments September 30, 1999
---------------------------------------------
<S> <C> <C>
Net revenues:
CD-ROM product sales $ 934 - $ 934
Online sales 1,429 G 17 1,446
Royalties and licenses 19 - 19
Advertising and other 1,265 G 77 1,342
----------------------------------------
Total net revenues 3,647 94 3,741
Cost of revenues:
Cost of products and services 2,620 G 12 2,632
Royalties and amortized software costs 279 G 3 282
----------------------------------------
Total cost of revenues 2,899 15 2,914
----------------------------------------
Gross profit 748 79 827
Operating expenses:
Sales and marketing 4,003 F (560) 3,487
G 44
Product development 4,193 F (421) 3,907
G 135
General and administrative 2,643 G 187 2,830
Goodwill 932 G 173 1,105
----------------------------------------
Total operating expenses 11,771 (442) 11,329
----------------------------------------
Operating loss (11,023) 521 (10,502)
Other (income) expense:
Net Interest expense/(income) - third parties 3,771 A (3,679) 14
E (78)
Interest expense - related parties 59 E (59) -
Other (906) F 855 (51)
----------------------------------------
Total other (income) expense 2,924 (2,961) (37)
----------------------------------------
Loss before income taxes (13,947) 3,482 (10,465)
Income tax expense 52 52
---------------------------------------
Net loss $ (13,999) 3,482 $ (10,517)
=======================================
Basic loss per share:
Net loss per share $ (1.31) $ (0.82)
========================================
Weighted average shares used in computing
basic loss per share 10,674,069 12,886,706
========================================
</TABLE>
F-33
<PAGE>
Interactive Magic, Inc
Unaudited Pro Forma Consolidated Statements of Operations (In
thousands, except share and per share data)
<TABLE>
<CAPTION>
Unaudited
Pro forma
Year ended Year ended
December 31, Pro forma December 31,
1998 ITEM Adjustments 1998
------------------------------------------------------
<S> <C> <C> <C>
Net revenues:
CD-ROM product sales $ 9,177 $ 9,177
Online sales 1,773 G 107 1,880
Royalties and licenses 1,616 G 122 1,738
Advertising and other - G 94 94
------------------------------------------------------
Total net revenues 12,566 323 12,889
Cost of revenues:
Cost of products and services 3,157 G 72 3,229
Royalties and amortized software costs 2,942 G 10 2,952
------------------------------------------------------
Total cost of revenues 6,099 82 6,181
------------------------------------------------------
Gross profit 6,467 241 6,708
Operating expenses:
Sales and marketing 8,490 F (293) 8,345
G 148
Product development 5,983 F (61) 6,757
G 835
General and administrative 2,684 F 755 3,439
Amortization of goodwill - G 1,458 1,458
------------------------------------------------------
Total operating expenses 17,157 2,842 19,999
------------------------------------------------------
Operating loss (10,690) (2,601) (13,291)
Other (income) expense:
Net Interest expense/(income) -
third parties 554 E (158) 396
Interest expense - related parties 134 E (107) 37
G 10
Other (161) (161)
------------------------------------------------------
Total other (income) expense 527 (255) 272
------------------------------------------------------
Loss before income taxes
and extraordinary item (11,217) (2,346) (13,563)
Income tax expense 28 28
------------------------------------------------------
Loss before extraordinary item $(11,245) (2,346) $(13,591)
======================================================
Basic loss per share:
Loss before extraordinary item $ (1.73) $ (1.45)
======================================================
Weighted average shares used in
computing basic loss per share 6,515,213 9,365,213
======================================================
</TABLE>
F-34
<PAGE>
Unaudited Interim Financial Statements
and Notes Thereto
Interactive Magic, Inc
Consolidated Balance Sheets
(IN THOUSANDS, EXCEPT SHARE DATA)
SEPTEMBER 30 DECEMBER 31
1999 1998
(UNAUDITED) (AUDITED)
------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 1,570 $ 2,943
Trade receivables, net of allowances of $713
and $2,871, respectively 475 2,109
Inventories 61 892
Advance royalties, net 231 1,586
Software development costs, net - 912
Prepaid expenses and other 128 252
------------------------------
Total current assets 2,465 8,694
Property and equipment, net 1,110 1,082
Noncurrent assets:
Royalties receivable 73 726
Goodwill, net 3,750 0
Other - 18
------------------------------
Total noncurrent assets 4,933 744
------------------------------
Total assets $ 7,398 $10,520
==============================
F-35
<PAGE>
Interactive Magic, Inc
Consolidated Balance Sheets (continued)
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
SEPTEMBER 30 DECEMBER 31
1999 1998
(UNAUDITED) (AUDITED)
------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
<S> <C> <C>
Accounts payable and accrued expenses $ 2,241 $ 1,698
Royalties and commissions payable 239 768
Lines of credit 1,023 1,348
Current portion of capital lease obligations 50 23
------------------------------------
Total current liabilities 3,553 3,837
Noncurrent liabilities:
Accrued interest payable to related parties 183 117
Long-term debt 2,156 -
Capital lease obligations, less current portion 13 15
------------------------------------
Total noncurrent liabilities 2,352 132
Stockholders' equity (deficit):
Preferred Stock, $.01 par value; 25,000,000 shares authorized; none
issued and outstanding - -
Common stock, $.10 par value; 50,000,000 shares authorized; 12,505,337
and 9,850,867 shares issued and outstanding at September 30, 1999 and
December 31, 1998, respectively 1,250 985
Additional paid-in capital 40,239 31,522
Accumulated deficit (39,861) (25,862)
Accumulated other comprehensive loss (135) (94)
-------------------------------------
Total stockholders' equity (deficit) 1,493 (6,551)
-------------------------------------
Total liabilities and stockholders' equity (deficit) $ 7,398 $ 10,520
=====================================
</TABLE>
SEE ACCOMPANYING NOTES.
F-36
<PAGE>
Interactive Magic, Inc
Consolidated Statements of Operations
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
1999 1998 1999 1998
-----------------------------------------------------------
NET REVENUES:
<S> <C> <C> <C> <C>
CD-ROM PRODUCT SALES $ 373 $ 1,903 $ 934 $ 8,455
ONLINE SALES 464 473 1,429 1,257
ROYALTIES AND LICENSES 12 293 19 1,692
ADVERTISING AND CONTRACT REVENUE 659 -- 1,265 --
------------------------------------------------------------------
TOTAL NET REVENUES 1,508 2,669 3,647 11,404
COST OF REVENUES:
COST OF PRODUCTS AND SERVICES 238 957 2,588 2,529
ROYALTIES AND AMORTIZED SOFTWARE COSTS -- 709 311 2,079
-----------------------------------------------------------------
TOTAL COST OF REVENUES 238 1,666 2,899 4,608
-----------------------------------------------------------------
GROSS PROFIT 1,270 1,003 748 6,796
OPERATING EXPENSES:
SALES AND MARKETING 912 2,446 4,003 6,161
PRODUCT DEVELOPMENT 1,000 1,273 4,193 3,234
GENERAL AND ADMINISTRATIVE 521 460 2,643 1,479
GOODWILL AMORTIZATION 376 -- 932 --
------------------------------------------------------------------
TOTAL OPERATING EXPENSES 2,809 4,179 11,771 10,874
-----------------------------------------------------------------
OPERATING LOSS (1,539) (3,176) (11,023) (4,078)
OTHER (INCOME) EXPENSE:
INTEREST EXPENSE - THIRD PARTIES 1,198 78 3,771 593
INTEREST EXPENSE - RELATED PARTIES 21 22 59 114
OTHER 16 (179) (906) (160)
-----------------------------------------------------------------
TOTAL OTHER (INCOME) EXPENSE 1,235 (79) 2,924 547
-----------------------------------------------------------------
LOSS BEFORE INCOME TAXES (2,774) (3,097) (13,947) (4,625)
INCOME TAX EXPENSE 10 28 52 156
-----------------------------------------------------------------
LOSS BEFORE EXTRAORDINARY ITEM $ (2,784) $ (3,125) $ (13,999) $ (4,781)
EXTRAORDINARY LOSS ON EARLY EXTINGUISHMENT OF DEBT -- (387) -- (387)
-----------------------------------------------------------------
NET LOSS $ (2,784) $ (3,512) $ (13,999) $ (5,168)
=================================================================
BASIC LOSS PER SHARE:
LOSS BEFORE EXTRAORDINARY ITEM $ (0.25) $ (0.35) $ (1.31) $ (0.88)
=================================================================
EXTRAORDINARY ITEM $ (0.00) $ (0.04) $ (0.00) $ (0.07)
=================================================================
NET LOSS PER SHARE $ (0.25) $ (0.39) $ (1.31) $ (0.95)
=================================================================
WEIGHTED AVERAGE SHARES USED IN COMPUTING BASIC
LOSS PER SHARE 11,013,733 8,992,650 10,674,069 5,420,773
=================================================================
</TABLE>
SEE ACCOMPANYING NOTES.
F-37
<PAGE>
Interactive Magic, Inc
Consolidated Statements of Cash Flows
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30
1999 1998
-----------------------------------
OPERATING ACTIVITIES
<S> <C> <C>
Net loss $ (13,999) $ (5,168)
Adjustments to reconcile net loss to net cash used in operating
activities:
Issuance of warrants 172 -
Depreciation and amortization 1,116 305
Extraordinary Loss - 387
Gain on the sale of advance royalties (NOTE 3) (855) -
Amortization of capitalized software development costs 329 745
Noncash interest expense 2,775 59
Write-off of capitalized software development costs 611 -
Changes in operating assets and liabilities net of effects of purchase of
MPG-Net (NOTE 4)
Trade and royalties receivables 2,402 (1,855)
Inventories 831 (96)
Advance royalties 5 (446)
Prepaid expenses and other (89) 48
Accounts payable and accrued expenses 251 (520)
Royalties and commissions payable (529) 92
Accrued interest to related party 66 (485)
-----------------------------------
Net cash used in operating activities (6,914) (6,934)
INVESTING ACTIVITIES
Acquisition of MPG-Net (NOTE 4) (15) -
Proceeds from the sale of advance royalties (NOTE 3) 2,315 -
Purchase of property and equipment (31) (208)
Increase in notes receivable (200) -
Software development costs (37) (1,423)
----------------------------------
Net cash provided by (used in) investing activities 2,032 (1,631)
FINANCING ACTIVITIES
Proceeds from issuance of common and preferred stock 245 23,760
Proceeds (Repayments) on long-term debt 3,660 (4,950)
Repayments on notes payable to related parties - (870)
F-38
<PAGE>
Interactive Magic, Inc
Consolidated Statements of Cash Flows (continued)
(IN THOUSANDS)
(UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30
1999 1998
-----------------------------------
Net repayments from lines-of-credit (325) (3,342)
Payments on capital lease obligations (30) (38)
-----------------------------------
Net cash provided by financing activities 3,550 14,560
Effect of currency exchange rate changes on cash and cash equivalents (41) (25)
-----------------------------------
Net (decrease) increase in cash and cash equivalents (1,373) 5,970
Cash and cash equivalents at beginning of period 2,943 384
-----------------------------------
Cash and cash equivalents at end of period $ 1,570 $ 6,354
===================================
NONCASH INVESTING AND FINANCING ACTIVITIES
Conversion of notes payable into common and preferred stock $ 831 $ 2,600
===================================
Issuance of common stock in settlement of accrued interest payable to
related parties $ - $ 319
===================================
Conversion of preferred stock into common stock $ - $ 3,169
===================================
Issuance of common stock in connection with acquisition of MPG-Net (NOTE 4) $ 3,858 $ -
===================================
Issuance of common stock in connection with acquisition of Virtual Business
Designs, Inc. (NOTE 4) $ 288 $ -
===================================
Contingently issuable warrants provided to holder of convertible debenture
(NOTE 6) $ 1,067 $ -
===================================
Issuance of warrants to broker in connection with convertible debenture
(NOTE 6) $ 390 $ -
===================================
</TABLE>
SEE ACCOMPANYING NOTES.
F-39
<PAGE>
Interactive Magic, Inc
Notes to Consolidated Financial Statements
(INFORMATION AS OF SEPTEMBER 30, 1999 AND FOR THE THREE AND NINE MONTHS ENDED
SEPTEMBER 30, 1999 AND 1998 IS UNAUDITED)
1. DESCRIPTION OF BUSINESS
Interactive Magic, Inc. (or the "Company") is a developer and publisher of
Internet and online games and an operator of online game services. The Company
develops and publishes proprietary online multi-player games and is building the
Company Entertainment Network ("iEN"), an Internet distribution infrastructure
which will offer online gamers a variety of free, subscription and pay-per-play
games and services, including simulation, parlor, strategy, role playing and
action games.
The Company is the exclusive game site operator for AT&T WorldNet, an
Internet service provider ("ISP"), and has been contracted to provide online
games for America Online, the world's leading online Internet services company.
The Company seeks to establish itself as a major provider of online gaming
services for ISPs, Internet portals and online services in order to broaden its
audience of users. GameHub, AT&T WorldNet's co-branded online gaming service,
was launched in January 1999 and is currently being marketed by AT&T to new
WorldNet subscribers as a premium service included with their subscription. The
GameHub site offers consumers a mix of free and pay-per-play games in all
categories, including strategy, role playing, simulation, action and parlor
games. In addition to games, GameHub will offer chat rooms, forums and shopping
areas. GameHub is expected to generate revenue from subscriber premiums,
e-commerce and advertising. GameHub complements the Company's online gaming
strategy by expanding the Company's network of player communities.
2. BASIS OF PRESENTATION
The condensed consolidated financial statements include the accounts of
Interactive Magic, Inc. (the "Company"), a North Carolina corporation, and its
wholly owned subsidiaries, iMagicOnline Corporation, Interactive Magic Ltd. And
Interactive Magic GmbH. All significant intercompany accounts and transactions
have been eliminated.
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 nine months ended September 30, 1999 the Company
incurred a loss of $13,999,000 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.
F-40
<PAGE>
Interactive Magic, Inc
Notes to Consolidated Financial Statements (continued)
2. BASIS OF PRESENTATION (CONTINUED)
While the financial information furnished is unaudited, the condensed
consolidated financial statements included in this report reflect all
adjustments (consisting only of normal recurring adjustments) which the Company
considers necessary for the fair presentation of the results of operations for
the interim periods covered and of the financial condition of the Company at the
date of the interim balance sheet. The results for interim periods are not
necessarily indicative of the results for the entire year. The condensed
consolidated financial statements should be read in conjunction with the
Company's consolidated financial statements and the notes thereto, included in
the Company's Annual Report on Form 10-KSB, as amended, for the year ended
December 31, 1998.
3. DISPOSITION OF ASSETS
On May 25, 1999, the Company executed an Agreement Regarding Assignment of
Contracts (the "Agreement") to sell its rights under certain development
contracts for CD-ROM products between the Company and third party developers
(and assume certain liabilities thereto) for $2.5 million. The Agreement
provides the Company a license to use these products on the Internet. The
transaction was consummated on June 30, 1999. Cash proceeds to the Company, net
of related expenses, were $2.3 million. The carrying value of net assets sold
(primarily CD-ROM advance royalties) was $ 1.6 million. The Company recognized a
gain of $855,000 related to the sale, which is included in other (income)
expense in the consolidated statements of operations.
4. BUSINESS COMBINATION
On August 27, 1999 the Company purchased all right, title and interest in and to
all of the tangible and intangible assets of Virtual Business Designs, Inc.,
doing business as The Gamers Net ("The Gamers Net"), for 107,143 shares of its
common stock valued at approximately $288,000. The merger was accounted for as a
purchase in accordance with Accounting Principles Board Opinion No. 16 and,
accordingly, the operating results of The Gamers Net have been included in the
Company's consolidated financial statements since the date of acquisition. The
related goodwill is being amortized over 2 years.
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 $0.8
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 accounted for as a purchase in
accordance with Accounting Principles Board Opinion No. 16 and, accordingly, the
operating results of MPG-Net have been included in the Company's consolidated
financial statements since the date of acquisition. The excess of the aggregate
purchase price over the fair market value of the net assets acquired of
approximately $4.3 million is being amortized over 3 years.
F-41
<PAGE>
Interactive Magic, Inc
Notes to Consolidated Financial Statements (continued)
4. BUSINESS COMBINATION (CONTINUED)
The following unaudited consolidated pro forma data summarizes the combined
operating results of the Company and MPG-Net as if the acquisition had occurred
at January 1, 1998:
<TABLE>
<CAPTION>
--------------------------- --------------------------
NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 1999 SEPTEMBER 30, 1998
--------------------------- --------------------------
<S> <C> <C>
Net revenues $3,741 $ 11,588
Net loss before extraordinary item (14,459) (6,988)
Net loss (14,459) (7,375)
Loss per share $(1.34) $(1.20)
</TABLE>
5. SIGNIFICANT ACCOUNTING POLICIES AND OTHER MATTERS
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.
<TABLE>
<CAPTION>
Inventories consist of the following (IN THOUSANDS):
SEPTEMBER 30, 1999 DECEMBER 31, 1998
-------------------------------------------------
<S> <C> <C>
Finished goods $ 243 $ 1,065
Components 93 117
-------------------------------------------------
336 1,182
Inventory valuation reserve (275) (290)
-------------------------------------------------
$ 61 $ 892
=================================================
</TABLE>
ADVANCE ROYALTIES
Advance royalties represent prepayments made to independent software developers
under development agreements. Advance royalties are expensed as part of
royalties and amortized software costs at the contractual royalty rate based on
actual net product sales. Management continuously evaluates the future
realization of advance royalties, and charges to cost of revenues any amount
that management deems unlikely to be amortized at the contractual royalty rate
through product sales. At September 30, 1999 and December 31, 1998, the reserve
for advance royalties was $36,000 and $1,654,000, respectively.
F-42
<PAGE>
Interactive Magic, Inc
Notes to Consolidated Financial Statements (continued)
5. 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):
<TABLE>
<CAPTION>
SEPTEMBER 30, 1999 DECEMBER 31, 1998
-------------------------------------------------
<S> <C> <C>
Balance at beginning of period $ 912 $ 425
Capitalized 37 1,450
Written off (620) -
Amortized (329) (963)
-------------------------------------------------
Balance at end of period $ - $ 912
=================================================
</TABLE>
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying value of cash and cash equivalents, trade receivables, accounts
payable and other liabilities approximates fair value at September 30, 1999 and
December 31, 1998.
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.
F-43
<PAGE>
Interactive Magic, Inc
Notes to Consolidated Financial Statements (continued)
5. SIGNIFICANT ACCOUNTING POLICIES AND OTHER MATTERS (CONTINUED)
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
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.
Revenue from certain software development contracts with fixed price components
is recognized on the percentage of completion basis in accordance with the
American Institute of Certified Public Accountants' SOP 81-1, "Accounting for
Performance of Construction-Type and Certain Production-Type Contracts." In
accordance with SOP 81-1, the Company recognizes percentage of completion
revenue based upon the ratio of accumulated incurred costs to the total
estimated costs to complete each contract.
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.
F-44
<PAGE>
Interactive Magic, Inc
Notes to Consolidated Financial Statements (continued)
5. SIGNIFICANT ACCOUNTING POLICIES AND OTHER MATTERS (CONTINUED)
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.
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.
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 loss.
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.
COMPREHENSIVE LOSS
The following chart details the Company's comprehensive loss for the periods
presented:
<TABLE>
<CAPTION>
-------------------------------------------- ---------------------------------------
THREE MONTHS ENDED SEPTEMBER 30 NINE MONTHS ENDED SEPTEMBER 30
------------------- ------------------------ --------------------- -----------------
1999 1998 1999 1998
------------------- ------------------------ --------------------- -----------------
<S> <C> <C> <C> <C>
Net Loss $ (2,784) $ (3,512) $ (13,999) $ (5,168)
Other comprehensive (loss) - (foreign
currency translation adjustment) (84) (4) (41) (25)
Comprehensive loss $ (2,868) $ (3,516) $ (14,040) $ (5,193)
</TABLE>
F-45
<PAGE>
Interactive Magic, Inc
Notes to Consolidated Financial Statements (continued)
5. SIGNIFICANT ACCOUNTING POLICIES AND OTHER MATTERS (CONTINUED)
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.
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.
6. LONG-TERM DEBT
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 broker of the debenture, 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. For the three and nine months ended September 30,
1999, amortization of the debt issuance costs was approximately $159,000 and
$259,000, respectively.
The debenture accrues interest at an annual interest rate of 6% and is due with
principal 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").
Subsequent to May 11, 1999 the debenture accrues additional interest at a
monthly rate of 4% of the outstanding principal balance until such time as the
Company's registration statement effecting the shares issuable under the
debenture becomes, and remains effective. For the nine months ended September
30, 1999, the Company recorded approximately $743,000 of interest expense
related to this provision.
F-46
<PAGE>
Interactive Magic, Inc
Notes to Consolidated Financial Statements (continued)
6. LONG-TERM DEBT (CONTINUED)
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. However, the debenture was convertible at the date of issuance and
therefore the value of the conversion feature was 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. For the three and
nine months ended September 30, 1999, the Company recorded approximately
$232,000 and $380,000 in interest expense related to such accretion,
respectively.
For the three and nine months ended September 30, 1999, interest expense related
to this debenture totaled $1.2 million and $3.7 million, respectively.
On or about September 15, 1999 the holder of the debenture elected to convert
$830,611 of principal and the related accrued interest into 1,683,786 shares of
the Company's common stock.
7. STOCK OPTIONS, STOCK PLANS AND WARRANTS
The following table summarizes the activity under the Company's Stock Option
Plans for the nine months ended September 30, 1999:
<TABLE>
<CAPTION>
OPTIONS WEIGHTED-AVERAGE EXERCISE PRICE
OUTSTANDING PER SHARE
-------------------------------------------------------
<S> <C> <C> <C> <C>
Balances at December 31, 1998 2,016,819 2.91
Options granted 1,336,830 3.17
Options exercised (113,541) 2.26
Options canceled (702,528) 4.37
-------------------------------------------------------
Balances at September 30, 1999 2,537,580 $2.67
=======================================================
</TABLE>
At September 30, 1999 the Company had 1,677,398 options exercisable at exercise
prices ranging from $1.00 - $6.00 per share.
F-47
<PAGE>
Interactive Magic, Inc
Notes to Consolidated Financial Statements (continued)
7. STOCK OPTIONS, STOCK PLANS AND WARRANTS (CONTINUED)
STOCK WARRANTS
The following summarizes the activity of warrants for the nine months ended
September 30, 1999:
WARRANTS
OUTSTANDING
------------
Balance at December 31, 1998 627,505
Issued 474,998
Cancelled (27,058)
Exercised -
------------
Balance at September 30, 1999 1,075,445
============
All of the Company's outstanding warrants at September 30, 1999 were exercisable
at prices ranging from $1.00 to $9.60 per share.
8. SUBSEQUENT EVENTS
Subsequent to the close of the September 30, 1999 quarter, the Company has
completed the following transactions in an effort to improve its financial
position:
A) On November 11, 1999, RGC International Investors, LDC (Rose Glen)
converted the remainder of its unconverted debenture, which as of
September 30, 1999 had an outstanding principal balance of
$3,310,844 and a recorded value of $2,156,000 into 3,310.844
shares of the Company's newly created Series D Preferred Stock
with a stated value of $1,000 per share. In addition, Rose Glen
converted $500,000 of all other accrued amounts under the
debenture into 500 shares of Series D Preferred Stock, and agreed
to waive all other accrued amounts which totaled $260,000. The
difference between the recorded value of the debt and the
outstanding principal balance along with the $260,000 waived
interest accrual were netted and charged to additional paid-in
capital. Interest expense related to these debentures was
$3,679,000 for the nine months ended September 30, 1999.
B) On November 11, 1999 Rose Glen purchased 1,100 shares of Series D
Preferred Stock for $1,100,000.
C) On November 11, 1999 Vertical Financial Holdings purchased 700,000
shares of common stock for $700,000.
D) On November 11, 1999 - Value Management & Research AG purchased
400,000 shares of common stock for $400,000.
F-48
<PAGE>
Interactive Magic, Inc
Notes to Consolidated Financial Statements (continued)
8. SUBSEQUENT EVENTS (CONTINUED)
E) On November 9, 1999, J.W. Stealey, former CEO of the Company,
released the Company from the line of credit indebtedness to BB&T
in the amount of $1,000,000 in exchange for 1,000,000 shares of
common stock. The Company also paid $15,000 due on this line.
Interest expense on this line of credit was $78,000 and $158,000
for the nine months ended September 30, 1999 and the year ended
December 31, 1998 respectively. In addition, as part of these
transactions, Mr. Stealey's resignation agreement dated August 16,
1999 has been amended such that his consulting services are no
longer being used and the sole remaining consideration due him has
been reduced to one lump sum payment of $200,000 (less the value
of 12 months health insurance payments and car lease payments
totaling approximately $20,000) and 50,000 shares of the Company's
common stock valued at $62,500. This payment was made November 12,
1999. The Company has agreed to convey to Mr. Stealey all
trademarks and available rights to the name Interactive Magic,
pending shareholder approval of the Company name change to
iEntertainment Network. Mr. Stealey agreed to waive the interest
due him from the Company in the amount of $183,000 under the terms
of the line of credit with BB&T that he had personally guaranteed;
in consideration of which the Company incurred additional interest
expense of $59,000 for the nine months ended September 30, 1999
and $107,000 for the year ended December 31, 1998. The amount of
waived interest has been reflected as a credit to additional
paid-in capital.
The following unaudited pro forma consolidated financial data present the
unaudited pro forma consolidated balance sheet of Interactive Magic as of
September 30, 1999 and the unaudited pro forma consolidated statements of
operations of Interactive Magic for the nine months ended September 30, 1999 and
the year ended December 31, 1998. The unaudited pro forma consolidated balance
sheet data reflects the following adjustments, as described above, as if they
had occurred on September 30, 1999:
o Conversion of Rose Glen indebtedness
o All issuances of preferred and common stock
o Severance accrual for former CEO
o Release of the Company from the BB&T line of credit indebtedness
The unaudited consolidated statements of operations data reflect the release of
the BB&T line of credit indebtedness and the former CEO's personal guarantee as
if they had occurred on January 1, 1998.
The unaudited pro forma consolidated financial data are based on historical
financial statements of Interactive Magic and the aforementioned adjustments.
The unaudited pro forma financial data do not purport to represent what
Interactive Magic's financial position or result's of operations would actually
have been if the transactions had in fact occurred on the dates indicated and
are not necessarily representative of Interactive Magic's financial position or
results of operations at any future date or for any future period.
F-49
<PAGE>
Interactive Magic, Inc
Unaudited Pro Forma Consolidated Statements of Operations
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
PRO FORMA
NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 1999 SEPTEMBER 30, 1999
---------------------
PRO FORMA
ADJUSTMENTS
------------------------------------------------------------------------
NET REVENUES:
<S> <C> <C>
CD-ROM PRODUCT SALES $ 934 $ 934
ONLINE SALES 1,429 1,429
ROYALTIES AND LICENSES 19 19
ADVERTISING AND OTHER 1,265 1,265
------------------------------------------------------------------------
TOTAL NET REVENUES 3,647 3,647
COST OF REVENUES:
COST OF PRODUCTS AND SERVICES 2,620 2,620
ROYALTIES AND AMORTIZED SOFTWARE COSTS 279 279
------------------------------------------------------------------------
TOTAL COST OF REVENUES 2,899 2,899
------------------------------------------------------------------------
GROSS PROFIT 748 748
OPERATING EXPENSES:
SALES AND MARKETING 4,003 4,003
PRODUCT DEVELOPMENT 4,193 4,193
GENERAL AND ADMINISTRATIVE 2,643 2,643
GOODWILL 932 932
------------------------------------------------------------------------
TOTAL OPERATING EXPENSES 11,771 11,771
------------------------------------------------------------------------
OPERATING LOSS (11,023) (11,023)
OTHER (INCOME) EXPENSE:
NET INTEREST EXPENSE/(INCOME) - THIRD PARTIES 3,771 A (3,679) 14
E (78)
INTEREST EXPENSE - RELATED PARTIES 59 E (59) -
OTHER (906) (906)
------------------------------------------------------------------------
TOTAL OTHER (INCOME) EXPENSE 2,924 (3,816) (892)
------------------------------------------------------------------------
LOSS BEFORE INCOME TAXES (13,947) (3,816) (10,131)
INCOME TAX EXPENSE 52 52
------------------------ -------------------------------------
NET LOSS $ (13,999) (3,816) $ (10,057)
========================================================================
BASIC LOSS PER SHARE:
NET LOSS PER SHARE $ (1.31) $ (0.80)
========================================================================
WEIGHTED AVERAGE SHARES USED IN COMPUTING BASIC
LOSS PER SHARE 10,674,069 12,774,069
========================================================================
</TABLE>
F-50
<PAGE>
V
Unaudited Pro Forma Consolidated Statements of Operations
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
UNAUDITED
PRO FORMA PRO FORMA
YEAR ENDED DECEMBER ADJUSTMENTS YEAR ENDED DECEMBER
31, 1998 ITEM 31, 1998
-------------------------------------------------------------
NET REVENUES:
<S> <C> <C>
CD-ROM PRODUCT SALES $ 9,177 $ 9,177
ONLINE SALES 1,773 1,773
ROYALTIES AND LICENSES 1,616 1,616
----------------------------
---------------------------------
TOTAL NET REVENUES 12,566 12,566
COST OF REVENUES:
COST OF PRODUCTS AND SERVICES 3,157 3,157
ROYALTIES AND AMORTIZED SOFTWARE COSTS 2,942 2,942
---------------------------- ---------------------------------
TOTAL COST OF REVENUES 6,099 6,099
---------------------------- ---------------------------------
GROSS PROFIT 6,467 6,467
OPERATING EXPENSES:
SALES AND MARKETING 8,490 8,490
PRODUCT DEVELOPMENT 5,983 5,983
GENERAL AND ADMINISTRATIVE 2,684 2,684
---------------------------- ---------------------------------
TOTAL OPERATING EXPENSES 17,157 17,157
---------------------------- ---------------------------------
OPERATING LOSS (10,690) (354) (10,690)
OTHER (INCOME) EXPENSE:
NET INTEREST EXPENSE/(INCOME) - THIRD PARTIES 554 E (158) 396
INTEREST EXPENSE - RELATED PARTIES 134 E (107) 27
OTHER (161) (161)
---------------------------- ---------------------------------
TOTAL OTHER (INCOME) EXPENSE 527 (265) 262
---------------------------- ---------------------------------
LOSS BEFORE INCOME TAXES AND EXTRAORDINARY ITEM (11,217) (265) (11,952)
INCOME TAX EXPENSE 28 28
---------------------------- ---------------------------------
LOSS BEFORE EXTRAORDINARY ITEM $ (11,245) (265) $ (10,980)
============================ =================================
BASIC LOSS PER SHARE:
LOSS BEFORE EXTRAORDINARY ITEM $ (1.73) $ (1.27)
============================ =================================
WEIGHTED AVERAGE SHARES USED IN COMPUTING BASIC
LOSS PER SHARE 6,515,213 8,615,213
============================ =================================
</TABLE>
F-51
<PAGE>
Report of Independent Auditors
The Stockholder and Board of Directors
MPG-Net
We have audited the accompanying combined balance sheets as of October 31, 1998
and December 31, 1997, of the corporations listed in Note 1, and the related
combined statements of operations, stockholder's deficit, and cash flows for the
ten months ended October 31, 1998 and for the year ended December 31, 1997.
These financial statements are the responsibility of the companies' management.
Our responsibility is to express an opinion on these combined financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the combined 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 financial statements referred to above present fairly, in
all material respects, the combined financial position at October 31, 1998 and
December 31, 1997, of the corporations listed in Note 1, and the combined
results of their operations and their cash flows for the ten months ended
October 31, 1998 and for the year ended December 31, 1997, in conformity with
accounting principles generally accepted in the United States.
December 3, 1998,
except for Note 10, as to which the date is
February 12, 1999
F-52
<PAGE>
MPG-Net
Combined Balance Sheets
<TABLE>
<CAPTION>
OCTOBER 31 DECEMBER 31
1998 1997
-----------------------------------
(IN THOUSANDS)
ASSETS
Current assets:
<S> <C> <C>
Cash $ 25 $ 19
Accounts receivable 30 14
Prepaid expenses and other current assets 32 16
-----------------------------------
Total current assets 87 49
Property and equipment:
Computer hardware and other equipment 822 786
Furniture and fixtures 193 192
Software 49 27
Leasehold improvements 18 18
-----------------------------------
-----------------------------------
1,082 1,023
Accumulated depreciation (880) (796)
-----------------------------------
202 227
Other noncurrent assets 32 43
-----------------------------------
Total assets $ 321 $ 319
===================================
</TABLE>
F-53
<PAGE>
<TABLE>
<CAPTION>
OCTOBER 31 DECEMBER 31
1998 1997
--------------------------------
(IN THOUSANDS)
LIABILITIES AND STOCKHOLDER'S DEFICIT
Current liabilities:
<S> <C> <C>
Trade accounts payable $ 64 $ 91
Accrued expenses and other current liabilities 227 149
Deferred income 150 -
Accrued interest payable to related parties 4,142 3,313
Rent payable to stockholder 481 386
Notes payable to related parties 12,496 11,519
Current portion of capital lease obligations 33 19
--------------------------------
Total current liabilities 17,593 15,477
Capital lease obligations, less current portion 33 28
Stockholder's deficit:
Common stock 6 6
Additional paid-in capital 48 -
Deferred compensation (31) -
Accumulated deficit (17,328) (15,192)
--------------------------------
Total stockholder's deficit (17,305) (15,186)
================================
Total liabilities and stockholder's deficit $ 321 $ 319
================================
</TABLE>
SEE ACCOMPANYING NOTES.
F-54
<PAGE>
MPG-Net
Combined Statements of Operations
<TABLE>
<CAPTION>
TEN MONTHS
ENDED YEAR ENDED
OCTOBER 31 DECEMBER 31
1998 1997
----------------------------------
(IN THOUSANDS)
Revenues:
<S> <C> <C>
Online sales $ 88 $ 130
Contract royalties and licenses 107 6
Advertising and other 40 -
----------------------------------
Total revenues 235 136
Cost of revenues:
Cost of products and services 64 115
Royalties and amortized costs 2 95
----------------------------------
Total cost of revenues 66 210
----------------------------------
Gross profit (loss) 169 (74)
Operating expenses:
Product development 693 1,449
Sales and marketing 109 51
General and administrative 655 835
----------------------------------
Total operating expenses 1,457 2,335
----------------------------------
Operating loss (1,288) (2,409)
Other expense:
Interest expense - related parties 830 903
Other 18 21
----------------------------------
Total other expense 848 924
==================================
Net loss $ (2,136) $ (3,333)
==================================
</TABLE>
SEE ACCOMPANYING NOTES.
F-55
<PAGE>
MPG-Net
Combined Statements of Stockholder's Deficit
<TABLE>
<CAPTION>
ADDITIONAL
COMMON PAID-IN DEFERRED ACCUMULATED
STOCK CAPITAL COMPENSATION DEFICIT TOTAL
---------- ------------ --------------- ------------- --------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1996 6 $ - $ - $ (11,859) $ (11,853)
Net loss - - - (3,333) (3,333)
--------------------------------------------------------------------
Balance at December 31, 1997 6 - - (15,192) (15,186)
Deferred compensation related to grant
of stock option - 48 (48) - -
Amortization of deferred compensation - - 17 - 17
Net loss - - - (2,136) (2,136)
--------------------------------------------------------------------
Balance at October 31, 1998 6 $ 48 $ (31) $ (17,328) $ (17,305)
====================================================================
</TABLE>
SEE ACCOMPANYING NOTES.
F-56
<PAGE>
MPG-Net
Combined Statements of Cash Flows
<TABLE>
<CAPTION>
TEN MONTHS
ENDED OCTOBER 31 YEAR ENDED
DECEMBER 31
1998 1997
---------------------------------
(IN THOUSANDS)
OPERATING ACTIVITIES
<S> <C> <C>
Net loss $ (2,136) $ (3,333)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 94 157
Amortization of deferred compensation 17 -
Write-off of advanced royalties - 392
Loss on sale of assets 10 -
Amortization of capitalized software development costs - 86
Changes in operating assets and liabilities:
Accounts receivable (16) (3)
Prepaid expenses and other current assets (16) 156
Other noncurrent assets (6) (5)
Trade accounts payable (27) (122)
Accrued expenses and other current liabilities 78 18
Deferred income 150 -
Accrued interest payable to related parties 832 903
Rent payable to stockholder 84 113
---------------------------------
Net cash used in operating activities (936) (1,638)
INVESTING ACTIVITIES
Purchase of property and equipment (24) (17)
---------------------------------
Net cash used in investing activities (24) (17)
FINANCING ACTIVITIES
Proceeds from notes payable to related parties 985 1,674
Payments on capital lease obligations (19) (17)
---------------------------------
Net cash provided by financing activities 966 1,657
---------------------------------
Net increase in cash 6 2
Cash at beginning of period 19 17
=================================
Cash at end of period $ 25 $ 19
=================================
NONCASH INVESTING AND FINANCING ACTIVITIES
Acquisition of equipment under capital leases $ 38 $ 6
=================================
</TABLE>
SEE ACCOMPANYING NOTES.
F-57
<PAGE>
MPG-Net
Notes to Combined Financial Statements
October 31, 1998
1. DESCRIPTION OF BUSINESS
Multiplayer Games Network, Inc. (a New York Subchapter S Corporation), Tantalus,
Inc. (a New York Subchapter S Corporation), and MPG-Net, Inc. (a Delaware
Subchapter C Corporation), (collectively the "Company" or "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 interactive entertainment platforms on the Internet, such as
online game channels, game hubs and websites.
2. PRINCIPLES OF COMBINATION/CONSOLIDATION
The accompanying 1997 combined financial statements represent the combined
operations of Multiplayer Games Network, Inc. and Tantalus, Inc., both of which
are owned by the same sole stockholder. The accompanying 1998 financial
statements represent the consolidated and combined operations of Multiplayer
Games Network, Inc., Tantalus, Inc., and MPG-Net, Inc. MPG-Net, Inc. was formed
on October 1, 1998 through a contribution of the combined net assets, excluding
certain liabilities of Multiplayer Games Network, Inc. and Tantalus, Inc., in
exchange for all of MPG-Net, Inc.'s outstanding common stock, 5,000,000 shares
at $.001 par value. Therefore, Multiplayer Games Network, Inc. and Tantalus,
Inc. each own 50% of the outstanding common stock of MGP-Net, Inc.
The combined entities are effectively owned by one stockholder whom primarily
has funded the operations of MPG-Net since inception. All significant
intercompany accounts and transactions have been eliminated in combination and
consolidation. The 5,000,000 issued and outstanding shares of MPG-Net, Inc. have
been eliminated in consolidation.
The Company's stockholder's deficit at October 31, 1998 is as follows (IN
THOUSANDS, EXCEPT SHARE DATA):
<TABLE>
<CAPTION>
SHARES
------------------------------
ADDITIONAL
PAR COMMON PAID-IN DEFERRED ACCUMULATED
COMPANY VALUE AUTHORIZED OUTSTANDING STOCK CAPITAL COMPENSATION DEFICIT TOTAL
- ----------------- -------- ---------- ---------- --------- --------- ----------- --------- ---------
Multiplayer
<S> <C> <C> <C> <C> <C> <C> <C>
Games Network, No par 200 100 $ 5 $ 48 $(31) $(6,327) $ (6,305)
Inc.
Tantalus, Inc. No par 200 10 1 - - (10,909) (10,908)
MPG-Net, Inc. $.001 30,000,000 - - - - (92) (92)
========== ========== ========= ========= =========== ========= =========
30,000,400 110 $ 6 $ 48 $(31) $(17,328) $(17,305)
========== ========== ========= ========= =========== ========= =========
</TABLE>
F-58
<PAGE>
MPG-Net
Notes to Combined Financial Statements (continued)
2. PRINCIPLES OF COMBINATION/CONSOLIDATION (CONTINUED)
The Company's stockholder's deficit at December 31, 1997 is as follows (IN
THOUSANDS, EXCEPT SHARE DATA):
<TABLE>
<CAPTION>
SHARES
-------------------------------------
PAR VALUE COMMON ACCUMULATED
COMPANY AUTHORIZED OUTSTANDING STOCK DEFICIT TOTAL
- -------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Multiplayer Games
Network, Inc. No par 200 100 $5 $ (5,713) $ (5,708)
Tantalus, Inc. No par 200 10 1 (9,479) (9,478)
-------------------------------------------------------------
400 110 $6 $(15,192) $(15,186)
=============================================================
</TABLE>
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
CASH
The Company includes amounts in demand deposit accounts in cash.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. Depreciation for computer hardware
and other equipment, furniture and fixtures and software is computed using the
straight-line method over the estimated useful lives of the assets, ranging from
five to seven years. Leasehold improvements are amortized on a straight-line
basis over the term of the estimated useful life of the asset or the remaining
lease term, whichever is less. Depreciation expense, including amortization of
equipment under capital leases was $77,000 and $130,000 for the ten months ended
October 31, 1998 and for the year ended December 31, 1997, respectively.
F-59
<PAGE>
MPG-Net
Notes to Combined Financial Statements (continued)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CAPITALIZED SOFTWARE DEVELOPMENT COSTS AND PRODUCT DEVELOPMENT COSTS
Costs incurred in the development of software for sale to customers are
capitalized after a product's technological feasibility has been established.
Capitalization of such costs is discontinued when a product is available for
general release to customers. Capitalized software development costs are
capitalized at the lower of cost or net realizable value and amortized using the
greater of the revenue curve method or the straight-line method over the
estimated economic life of the related product. Amortization begins when a
product is ready for general release to customers. Amortization of capitalized
software development costs is included in royalties and amortized costs in the
combined statements of operations and was $0 and $86,000 for the ten months
ended October 31, 1998 and for the year ended December 31, 1997, respectively.
Information related to net capitalized software development costs is as follows
(IN THOUSANDS):
<TABLE>
<CAPTION>
OCTOBER 31 DECEMBER 31
1998 1997
--------------------------------
<S> <C> <C>
Balance at beginning of period $ - $ 86
Capitalized - -
Amortized - (86)
--------------------------------
Balance at end of period $ - $ -
================================
</TABLE>
Product development expenses (excluding capitalized software development costs)
are charged to operations in the period incurred. These expenses consist
primarily of payroll and payroll related costs incurred in connection with the
development of computer games and the development and enhancement of online
entertainment platforms and websites.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying value of cash, accounts receivable and accounts payable
approximates fair value at October 31, 1998 and December 31, 1997, respectively.
At October 31, 1998 and December 31, 1997, the notes payable to related parties,
accrued interest payable to related parties and rent payable to stockholder were
reflected at historical values. In connection with the February 1999 merger
transaction (see Note 10), the note payable to stockholder, accrued interest
payable to stockholder and rent payable to stockholder were canceled by the
stockholder and recorded as contributed capital at historical values. Also, in
conjunction with the merger transaction, the $1.2 million note payable and
accrued interest payable to the other related party (see note 4) were settled
for approximately $778,000.
F-60
<PAGE>
MPG-Net
Notes to Combined Financial Statements (continued)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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.
Revenue from online sales is recognized based upon the Company's monthly usage
fee and the actual number of network subscribers utilizing the Company's gaming
services. Revenue from contract royalties and licenses is recognized when earned
under the terms of the relevant agreements with third parties. Revenue from
certain software development contracts with fixed price components is recognized
on the percentage of completion basis in accordance with the American Institute
of Certified Public Accountants' Statement of Position 81-1 ("SOP 81-1"),
"Accounting for Performance of Construction-Type and Certain Production-Type
Contracts". In accordance with SOP 81-1, the Company recognizes percentage of
completion revenue based upon the ratio of accumulated incurred costs to total
estimated costs to complete each contract.
ADVERTISING EXPENSE
The cost of advertising is expensed as incurred, and amounted to $60,000 and
$4,000 for the ten months ended October 31, 1998 and for the year ended December
31, 1997, respectively.
F-61
<PAGE>
MPG-Net
Notes to Combined Financial Statements (continued)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INCOME TAXES
MPG-Net, Inc. accounts for income taxes using the liability method. The
liability method accounts for income taxes and deferred tax assets and
liabilities based on differences between the financial reporting and tax basis
of those assets and liabilities. Multiplayer Games Network, Inc. and Tantalus,
Inc. elected to be taxed, for federal and state income tax purposes, as
S-Corporations under applicable provisions of the Internal Revenue Code.
Accordingly, income, losses and credits for those companies are passed directly
to the stockholder rather than being taxed at the corporate level.
IMPACT OF RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In 1998, the Company adopted Statement of Financial Accounting Standards No.
130, Reporting Comprehensive Income, ("SFAS 130"), which establishes standards
for reporting and display of comprehensive income and its components in a full
set of general-purpose financial statements. SFAS 130 only impacts financial
statement presentation as opposed to actual amounts recorded. Other
comprehensive income includes all nonowner changes in equity that are excluded
from net income. This Statement has no financial statement impact for an
enterprise that has no items of other comprehensive income in any period
presented. During the ten months ended October 31, 1998 and the year ended
December 31, 1997, the Company had no items of other comprehensive income.
Effective January 1, 1998, the Company adopted SFAS 131, Disclosures about
Segments of an Enterprise and Related Information, which superseded 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
net earnings or financial position.
In June 1998, the Financial Accounting Standards Board issued SFAS 133,
Accounting for Derivative Instruments and Hedging Activities. SFAS 133
establishes new accounting and reporting requirements for derivative
instruments, including certain derivative instruments embedded in other
contracts and hedging activities. The standard requires all derivatives to be
measured at fair value and recognized as either assets or liabilities in the
balance sheet. Under certain conditions, a derivative may be specifically
designated as a hedge. Accounting for the
F-62
<PAGE>
MPG-Net
Notes to Combined Financial Statements (continued)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
changes in the fair value of a derivative depends on the intended use of the
derivative and the resulting designation. Adoption of the standard is required
for the Company's December 31, 2000 financial statements with early adoption
allowed as of the beginning of any quarter after June 30, 1998. The Company had
no derivative instruments at December 31, 1998.
4. NOTES PAYABLE TO RELATED PARTIES
Notes payable to related parties consist of the following (IN THOUSANDS):
<TABLE>
<CAPTION>
OCTOBER 31 DECEMBER 31
1998 1997
-------------------------------
<S> <C> <C>
Note payable to stockholder, unsecured, interest at
8% per annum $ 11,296 $ 11,314
Note payable to related party, unsecured, interest at
8% per annum 1,200 205
-------------------------------
$ 12,496 $ 11,519
===============================
</TABLE>
The Company incurred interest expense related to these notes totaling $830,000
and $903,000 during the ten months ended October 31, 1998 and the year ended
December 31, 1997, respectively. Accrued interest due to the stockholder was
$4,100,000 and $3,312,000 at October 31, 1998 and December 31, 1997,
respectively. Accrued interest due to the related party was $42,000 and $1,000
at October 31, 1998 and December 31, 1997, respectively. Subsequent to October
31, 1998, the notes payable to stockholder and to the related party and the
related accrued interest were satisfied as described in Note 10. The stockholder
and the related party entered into an agreement providing for the note payable
to related party to have a senior preference over the stockholder's note in the
event of bankruptcy, reorganization, sale or divestiture of the Company.
5. EMPLOYEE STOCK OPTION
In January 1998, the Company entered into an employment and option grant
agreement with a key employee. In accordance with the terms of the agreement,
the Company granted an option to the employee to purchase 5% of the Company's
outstanding common stock at an exercise price of $.01 per share. The option
agreement provides for 20% vesting immediately and the remaining 80% vesting
over four years with accelerated vesting upon a change in control of the
Company.
F-63
<PAGE>
MPG-Net
Notes to Combined Financial Statements (continued)
5. EMPLOYEE STOCK OPTION (CONTINUED)
The Company has elected to follow Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25") and related
interpretations in accounting for the employee stock option.
The Company recorded deferred compensation of $47,500 at the date of the option
grant representing the difference between the grant price and the estimated fair
value of the Company's common stock. This amount is being amortized over the
vesting period of the option and totaled $17,000 during the ten-month period
ended October 31, 1998. In connection with the sale of the Company in February
1999, the option became fully vested and the remaining unamortized deferred
compensation was fully expensed (See Note 10).
The Company has adopted the disclosure-only provisions of SFAS 123. In
accordance with SFAS 123, the fair value of the option grant was determined by
using the minimum value option-pricing model with the following weighted average
assumptions for the ten-month period ended October 31, 1998, dividend yield of
0.0%, risk-free interest rate of 5.30%, and an expected option life of 2 years.
The weighted average grant date fair value of the option was $.19 per share. Had
compensation cost for the Company's stock option been determined based on the
fair value at the date of grant consistent with the provisions of SFAS 123, the
Company's net loss would have increased to $2,138,000 for the ten months ended
October 31, 1998.
6. LEASES
The Company has non-cancelable operating leases in effect for the rental of its
office facilities from the stockholder, as well as certain computer and office
equipment leases with third parties through 2003. The monthly rent under the
Company's facilities lease is periodically adjusted based on changes in the
consumer price index.
Rent expense was $153,000 and $174,000 for the ten-month period ended October
31, 1998 and for the year ended December 31, 1997, respectively.
F-64
<PAGE>
MPG-Net
Notes to Combined Financial Statements (continued)
6. LEASES (CONTINUED)
Property and equipment includes the following amounts for capital leases (IN
THOUSANDS):
<TABLE>
<CAPTION>
OCTOBER 31 DECEMBER 31
1998 1997
--------------------------------
<S> <C> <C>
Computer and office equipment $ 111 $ 73
Less accumulated amortization (30) (17)
-----------------
================================
$ 81 $ 56
================================
The following is a schedule of future minimum lease payments for capital and
operating leases for the years ending October 31 (IN THOUSANDS):
CAPITAL LEASES OPERATING
LEASES
------------------------------
1999 $ 39 $ 260
2000 26 260
2001 11 260
2002 - 260
2003 - 238
------------------------------
76 $ 1,278
===============
Less amounts representing interest (10)
---------------
Present value of future minimum lease payments 66
Less current portion (33)
---------------
Non-current portion of future minimum lease payments $ 33
===============
</TABLE>
7. OTHER RELATED PARTY TRANSACTIONS
For the ten months ended October 31, 1998 and the year ended December 31, 1997,
advances from the stockholder and other related party totaled $985,000 and
$1,674,000, respectively. These advances represent draws on the notes payable to
related parties.
For the ten months ended October 31, 1998 and the year ended December 31, 1997,
the Company incurred rent expense from office leases with a company owned by the
stockholder totaling $139,000 and $156,000, respectively.
F-65
<PAGE>
MPG-Net
Notes to Combined Financial Statements (continued)
8. INCOME TAXES
Tantalus, Inc. and Multiplayer Games Network, Inc. have both elected to be taxed
under Subchapter S of the Internal Revenue Code. Consequently, those companies
have not been subject to federal or state income taxes and the income, losses
and credits of each Company are passed directly to the stockholder. MPG-Net,
Inc. elected to be taxed under Subchapter C of the Internal Revenue Code and
began operations in October 1998.
At October 31, 1998, MPG-Net has federal net operating loss carryforwards
available to offset future taxable income of approximately $90,000 which expire
in 2018. State net operating loss carryforwards are approximately $90,000 and
will expire in 5 to 15 years.
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
MPG-Net's deferred income tax assets consisted of the following at October 31,
1998:
Deferred tax assets - net operating loss carryforward $ 31,500
Less valuation allowance (31,500)
=================
$ -
=================
The deferred tax asset is fully offset by a valuation allowance based on
management's evaluation of the criteria set forth in SFAS 109.
9. SIGNIFICANT CUSTOMERS
Revenues from significant customers representing 10% or more of revenues for the
ten months ended October 31, 1998, are summarized as follows:
Customer 1 29%
Customer 2 16%
There were no customers representing greater than 10% of revenues during the
year ended December 31, 1997.
F-66
<PAGE>
MPG-Net
Notes to Combined Financial Statements (continued)
10. SUBSEQUENT EVENTS
On January 25, 1999, the Company entered into an Agreement and Plan of Merger
("Merger Agreement") with Interactive Magic, Inc. ("Interactive Magic") whereby
the Company exchanged all of its outstanding common stock for common stock of
Interactive Magic. Contemporaneously with the closing of the merger on February
12, 1999, Interactive Magic issued 150,000 shares of its common stock valued at
$778,000 in full settlement of the note payable to related party plus unpaid
interest totaling $1,261,000. The difference in these amounts has been
recognized by the Company in 1999 as an extraordinary gain on the early
extinguishment of the debt.
Immediately prior to the closing of the merger in 1999, all amounts owed to the
stockholder were forgiven and were recorded as contributed capital to the
Company.
During February 1999, prior to the merger with Interactive Magic, the Company's
stockholder assumed the Company's obligation for unpaid professional fees
totaling $212,000 and in exchange received a $212,000 note from the Company.
Immediately prior to the merger, the stockholder forgave the note and the
$212,000 has been recorded as contributed capital to the Company.
During November 1998, the Company and Interactive Magic entered into a loan
agreement which provided $300,000 in working capital advances to the Company
through the closing of the merger on February 12, 1999. Interest on these
advances will accrue at an annual rate of 18%.
In connection with the merger, the outstanding employee stock option (see Note
5) became fully vested and was exercised by the employee. The remaining
unamortized deferred compensation was fully expensed at the time of the merger.
F-67
<PAGE>
MPG-Net
Notes to Combined Financial Statements (continued)
11. YEAR 2000 ISSUE (UNAUDITED)
Many existing computer systems and applications, and other control devices, use
only two digits to identify a year in the date field, without considering the
impact of the upcoming changes in the century. As a result, such systems and
applications could fail or create erroneous results unless corrected so that
they can process data related to the year 2000. The Company relies on its
systems, applications and devices in operating and monitoring all major aspects
of its business, including financial systems (such as general ledger, accounts
payable and payroll modules), customer services, infrastructure, embedded
computer chips, networks and telecommunications equipment. The Company also
relies, directly and indirectly, on external systems of business enterprises
such as customers, suppliers, creditors, financial organizations, and of
governmental entities, for accurate exchange of data. The Company's current
estimate is that the costs associated with the year 2000 issue, and the
consequences of incomplete or untimely resolution of the year 2000 issue, will
not have a material adverse effect on the combined result of operations or
combined financial position of the Company in any given year. However, despite
the Company's efforts to address the year 2000 impact on its internal systems,
the Company has not fully identified such impact or whether it can resolve it
without disruption of its business and without incurring significant expense. In
addition, even if the internal systems of the Company are not materially
affected by the year 2000 issue, the Company could be affected through
disruption in the operation of the enterprises with which the Company interacts.
F-68
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 24. Indemnification of Directors and Officers
Sections 55-8-50 through 55-8-58 of the North Carolina Business Corporation
Act permit a corporation to indemnify its directors, officers, employees or
agents under either or both a statutory or non-statutory scheme of
indemnification. Under the statutory scheme, a corporation may, with certain
exceptions, indemnify a director, officer, employee or agent of the corporation
who was, is, or is threatened to be made, a party to any threatened, pending or
completed legal action, suit or proceeding, whether civil, criminal,
administrative, or investigative, because of the fact that such person was a
director, officer, agent or employee of the corporation, or is or was serving at
the request of such corporation as a director, officer, employee or agent of
another corporation or enterprise. This indemnity may include the obligation to
pay any judgment, settlement, penalty, fine (including an excise tax assessed
with respect to an employee benefit plan) and reasonable expenses incurred in
connection with a proceeding (including counsel fees), but no such
indemnification may be granted unless such director, officer, agent or employee
(i) conducted himself in good faith, (ii) reasonably believed (1) that any
action taken in his official capacity with the corporation was in the best
interest of the corporation or (2) that in all other cases his conduct at least
was not opposed to the corporation's best interest, and (iii) in the case of any
criminal proceeding, had no reasonable cause to believe his conduct was
unlawful. Whether a director has met the requisite standard of conduct for the
type of indemnification set forth above is determined by the board of directors,
a committee of directors, special legal counsel or the shareholders in
accordance with Section 55-8-55. A corporation may not indemnify a director
under the statutory scheme in connection with a proceeding by or in the right of
the corporation in which the director was adjudged liable to the corporation or
in connection with a proceeding in which a director was adjudged liable on the
basis of having received an improper personal benefit.
In addition to, and separate and apart from the indemnification described
above under the statutory scheme, Section 55-8-57 of the North Carolina Business
Corporation Act permits a corporation to indemnify or agree to indemnify any of
its directors, officers, employees or agents against liability and expenses
(including attorney's fees) in any proceeding (including proceedings brought by
or on behalf of the corporation) arising out of their status as such or their
activities in such capacities, except for any liabilities or expenses incurred
on account of activities that were, at the time taken, known or believed by the
person to be clearly in conflict with the best interests of the corporation. The
Company's Bylaws provide for indemnification to the fullest extent permitted
under the North Carolina Business Corporation Act, provided, however, that the
Company will indemnify any person seeking indemnification in connection with a
proceeding initiated by such person only if such proceeding was authorized by
the Board of Directors of the Company. Accordingly, the Company may indemnify
its directors, officers and employees in accordance with either the statutory or
the non-statutory standard.
Sections 55-8-52 and 55-8-56 of the North Carolina Business Corporation Act
require a corporation, unless its articles of incorporation provide otherwise,
to indemnify a director or officer who has been wholly successful, on the merits
or otherwise, in the defense of any proceeding to which such director or officer
was a party. Unless prohibited by the articles of incorporation, a director or
officer also may make application and obtain court-ordered indemnification if
the court determines that such director or officer is fairly and reasonably
entitled to such indemnification as provided in Sections 55-8-54 and 55-8-56.
Finally, Section 55-8-57 of the North Carolina Business Corporation Act
provides that a corporation may purchase and maintain insurance on behalf of an
individual who is or was a director, officer, employee or agent of the
corporation against certain liabilities incurred by such persons, whether or not
the corporation is otherwise authorized by the North Carolina Business
Corporation Act to indemnify such party. It is anticipated that the Company's
directors and officers will be covered under directors' and officers' insurance
policies maintained by the Company prior to this offering.
As permitted by North Carolina law, Article IX of the Company's Articles of
Incorporation limits the personal liability of directors for monetary damages
for breaches of duty as a director, provided that such limitation will not apply
to (i) acts or omissions that the director at the time of the breach knew or
believed were clearly in conflict with the best interests of the Company, (ii)
any liability for unlawful distributions under Section 55-8-33, (iii) any
transaction from which the director derived an improper personal benefit, or
(iv) acts or omissions occurring prior to the date the provision became
effective.
The Registration Rights Agreement also contains certain provisions pursuant
to which certain officers, directors and controlling persons of the Company may
be entitled to be indemnified by the Selling Stockholder.
II-1
<PAGE>
Item 25. Other Expenses of Issuance and Distribution.
The estimated expenses of the Company payable in connection with the
issuance and distribution of the Common Stock being registered hereby are as
follows:
<TABLE>
<S> <C>
SEC Registration Fee................................................. $ 7,828
Printing Expenses.................................................... 10,000
Legal Fees and Expenses.............................................. 25,000
Accounting Fees and Expenses......................................... 10,000
Transfer Agent Fees and Expenses..................................... 1,500
-------
Total $ 54,328
=======
</TABLE>
Item 26. Recent Sales of Unregistered Securities
In the three years preceding the filing of this Registration Statement, the
Company issued the following securities, which were not registered pursuant to
the Securities Act:
From May 1, 1995 to May 21, 1998, the Company issued an aggregate of
2,026,795 incentive and performance incentive stock options to purchase Common
Stock pursuant to the 1995 Plans to officers and employees of the Company, as
described in the Prospectus, at a weighted average exercise price of $2.30 per
share. (1)
II-2
<PAGE>
On February 11, 1997, the Company issued warrants to purchase 13,500 shares
of Common Stock to each of J. Nicholas England, David H. Kestel and W. Joseph
McClelland. (2)
On March 24, 1997, the Company issued a warrant that was exercised for
307,823 shares of Common Stock upon the consummation of the Company's initial
public offering in July, 1998 to Petra in consideration of a $3,000,000 loan
made by Petra. (2)
On April 23, 1997, in connection with the Company's acquisition of
Interactive Creations Incorporated, the Company issued an aggregate of 655,696
shares of Common Stock to former shareholders of Interactive Creations
Incorporated and options exercisable for 98,218 shares of Common Stock. (1)(2)
On April 23, 1997, the Company issued warrants to purchase 15,000 shares of
Common Stock to Oppenheimer & Co., Inc. (2)
On September 29, 1997, the Company issued a warrant that will be
exercisable for 208,946 shares of Common Stock upon the consummation of this
offering to Oberlin in consideration of a $1,200,000 loan made by Oberlin. (2)
Between December 1, 1997 and January 30, 1998, the Company sold 8,625
shares of Common Stock pursuant to the exercise of employee stock options for
$10,125. (3)
On December 31, 1997, the Company issued a warrant to purchase 8,591 shares
of Common Stock to Laura M. Stealey in consideration of amounts outstanding
under the $1,000,000 credit line established by Ms. Stealey in favor of the
Company. (2)
On February 4, 1998, the Company issued warrants to purchase 16,667 shares
of Common Stock to Marion Bass, Inc. (2)
On February 4, 1998, the Company issued 778,746 shares of Series B
Preferred Stock to several investors for $3,500,000, which shares of Series B
Preferred Stock were converted into 2,045,649 shares of Common Stock upon the
closing of the Company's initial public offering in July, 1998. (2)
On February 4, 1998, the Company issued 132,744 shares of Series C
Preferred Stock to Robert L. Pickens upon the conversion of $600,000 of the
Company's debt held by Mr. Pickens, which shares will be converted into 132,744
shares of Common Stock upon the closing of the Company's initial public offering
in July, 1998. (2)
On February 4, 1998, the Company issued 442,478 shares of Common Stock to
J. W. Stealey upon the conversion of $2,000,000 of the Company's debt held by
Mr. Stealey. (2)
On February 4, 1998, the Company issued warrants to purchase 12,500 shares
of Common Stock to Avi Suriel. (2)
On March 12, 1998, the Company issued options to purchase 12,500 shares of
Common Stock to Jeff Stealey, an employee of the Company. (1)
On April 30, 1998, the Company issued 45,000 shares of Common Stock to
William Kaluza upon the exercise of outstanding options held by Mr. Kaluza. (3)
On May 12, 1998, the Company issued 48,604 shares of Common Stock to
Southeast Interactive Technology Fund I, L.L.C. pursuant to certain anti-
dilution rights contained in an agreement between the Company and Southeast
Interactive Technology Fund I, L.L.C. (2)
On May 21, 1998, the Company issued 268,750 shares of Common Stock to J.W.
Stealey upon the exercise of outstanding options held by Mr. Stealey. (2)
On May 21, 1998, the Company issued 50,000 shares of Common Stock to Robert
L. Pickens upon the exercise of outstanding options held by Mr. Pickens. (2)
II-3
<PAGE>
In connection with the Company's acquisition of MPG-Net, Inc. on February
12, 1999, the Company issued an aggregate of 675,000 shares of Common Stock and
options to purchase 30,000 shares of Common Stock.
From July 22, 1998 to June 4, 1999, the Company issued an aggregate of
168,154 shares of Common Stock to employees upon exercises of options. (3)
From July 22, 1998 to June 4, 1999, the Company issued an aggregate of
515,999 shares of Common Stock to two accredited venture capital firms upon
exercise of warrants. (2)
In July 1999, the Company issued options to purchase an aggregate of 75,000
shares of common stock to three Board Members. (3)
In October 1999, the Company issued warrants to purchase 100,000 shares of
common stock to Royce Investment Group. (2)
In November 1999, the Company issued 4,910.844 shares of Series D Preferred
Stock to RGC International Investors, LDC, 1,050,000 shares of Common Stock to
J.W. Stealey, 700,000 shares of Common Stock to Vertical Financial Holdings and
400,000 shares of Common Stock to Value Management & Research AG, all of which
investors are accredited.
In August 1999, the Company issued an aggregate of 107,143 shares of Common
Stock to Virtual Business Designs, Inc. in connection with the Company's
acquisition of the assets of such company.
In January 2000, the Company issued an aggregate of 77,420 shares of common
stock to Tech Data, an accredited investor.
No underwriter was engaged in connection with the foregoing sales of
securities.
- ------------------------
(1) In the view of the Company, the options granted pursuant to the 1995 Plans
and the options exchanged in the ICI transaction were issued but not sold
and, therefore, registration thereof was not required.
(2) Sales of Common Stock and the issuance of warrants were made in reliance
upon Section 4(2) of the Securities Act or Regulation D promulgated
thereunder as transactions not involving any public offering. Each of the
purchasers were sophisticated investors.
(3) Sales of Common Stock were made in reliance upon Rule 701 promulgated under
the Securities Act as transactions not involving a public offering.
Item 27. Exhibits
The following documents (unless indicated) are filed herewith and made a
part of this Registration Statement.
Exhibit
Number Description of Exhibit
- ------ ----------------------
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.
3.04* -Articles of Amendment establishing the Series D Preferred Stock of
Interactive Magic, Inc., filed with the North Carolina Secretary
of State on November 10, 1999.
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
4.05* -Registration Rights Agreement dated August 16, 1999 between the Company
and John W. ("Bill") Stealey.
5.1 -Opinion of Wyrick Robbins Yates & Ponton LLP.
10.01* -Stock Purchase Agreement, dated February 4, 1998, by and between the
Company and Vertical Financial Holdings
10.02* -Investor's Rights Agreement, dated February 4, 1998, by and between the
Company and Vertical Financial Holdings
10.03* -Marketing Agreement, dated February 4, 1998, between the Company and
General Capital
10.04* -Merger Agreement, dated as of March 24, 1997, as amended April 2, 1997,
by and among the Company, Interactive Creations Acquisition
Corp., certain shareholders of Interactive Creations Incorporated
and Interactive Creations Incorporated
10.05* -Form of Shareholder Agreement between the Company and each shareholder
of Interactive Creations Incorporated
10.06* -Form of Stock Purchase Warrant issued to each of J.W. Stealey, Robert
L. Pickens, Laura Stealey, David H. Kestel, J. Nicholas England,
W. Joseph McClelland, Avi Suriel, Marion Bass and Oppenheimer
10.07* -Corporate Airplane Agreement, dated January 3, 1995, between J.W.
Stealey and the Company
10.08* -Loan and Security Agreement, dated March 24, 1997, as amended
April 1, 1997 (See Exhibit 10.10 below), by and between the
Company and Petra Capital LLC
10.09* -Stock Purchase Warrant, dated March 24, 1997, as amended April
1, 1997 (See Exhibit 10.10 below), and January 31, 1998, as
amended, issued by the Company to Petra Capital LLC
10.10* -First Amendment to Loan and Security Agreement and Stock
Purchase Warrant dated April 1, 1997 by and between the Company
and Petra Capital LLC
10.11* -Promissory Note, dated August 25, 1997, issued by the Company to Branch
Banking & Trust Company
II-4
<PAGE>
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 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
10.36* -Agreement Regarding Assignment of Contracts Relating to Sale of the
Company's CD-ROM Operations to Ubi Soft Entertainment S.A.
10.37* -Securities Purchase and Exchange Agreement dated November 8,
1999 between Interactive Magic, Inc. and RGC International
Investors, LDC
10.38* -Registration Rights Agreement dated November 11, 1999 by and
among Interactive Magic, Inc., RGC International Investors, LDC,
Vertical Financial Holdings, J.W. Stealey and Value Management &
Research AG.
10.39* -Asset Purchase Agreement dated August 27, 1999 by and among
Interactive Magic, Inc., Virtual Business Designs, Inc., d/b/a
The Gamers Net, and David Heath.
17.1* -Copy of letter from Avi Suriel tendering his resignation from
the Registrant's Board of Directors effective August 3, 1999.
23.1 -Consent of Ernst & Young LLP.
99.1* -Agreement dated August 16, 1999, among the Company, John W. ("Bill")
Stealey and Vertical Financial Holdings.
- --------------------------------------------------------------------------------
*Previously filed
II-5
<PAGE>
Item 28. Undertakings
The small business issuer hereby undertakes:
1. To file, during any period in which offers or sales of the securities
are being made, a post-effective amendment to this registration statement to:
(i) Include any prospectus required by Section 10(a)(3) of the
Securities Act;
(ii) Reflect in the prospectus any facts or events which,
individually or together, represent a fundamental change in the information
in the registration statement. Notwithstanding the foregoing, any increase
or decrease in volume of securities offered may be reflected in the form of
prospectus filed with the Commission under Rule 424(b) if, in aggregate,
the changes in the volume and price represent no more than a 20% change in
the maximum aggregate offering price set forth in the "Calculation of
Registration Fee" table in the effective registration statement;
(iii) include any additional or changed material information on the
plan of distribution.
2. That, for the purpose of determining liability under the Securities Act
, it shall treat each post-effective amendment as a new registration statement
of the securities offered, and treat the offering of the securities at that time
as an initial bona fide offering.
3. To remove from registration by means of a post-effective amendment any
of the securities being registered which remains unsold at the termination of
the offering.
To the extent that indemnification for liabilities arising under the
Securities Act may be permitted to directors, officers and controlling persons
of the Company pursuant to the provisions described in Item 15, or otherwise,
the Company has been advised that, in the opinion of the Securities and Exchange
Commission, such indemnification is against public policy as expressed in the
Securities Act of 1933 and is, therefore, unenforceable.
In the event a claim for indemnification against such liabilities, other
than the payment by the Company of expenses incurred or paid by a director,
officer of controlling person of the Company in the successful defense of any
action, suit or proceeding, is asserted by such director, officer or controlling
person in connection with the shares being registered hereby, the company will,
unless, in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question as to
whether such indemnification by the Company is against public policy as
expressed in the Securities Act of 1933 and will be governed by the final
adjudication of such issue.
II-6
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the registrant
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form SB-2 and has duly caused this registration
statement on its behalf by the undersigned, thereunto duly authorized, in the
City of Morrisville, State of North Carolina, on the 14th day of February 2000.
iENTERTAINMENT NETWORK, INC.
By: /s/ Michael Pearce
---------------------------------------
Name: Michael Pearce
Title: Chief Executive Officer
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Michael Pearce and Robert Hart, and each
of them, as his true and lawful attorney-in-fact and agent, with full power of
substitution and resubstitution, from him and in his name, place and stead, in
any and all capacities to sign any and all amendments, including post-effective
amendments and related registration statements, to this registration statement,
and to file same, with exhibits thereto and other documents in connection
therewith, with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agent, full power and authority to do separately and
perform each and every act and thing requisite and necessary to be done, as
fully to all intents and purposes as he might or could so in person, hereby
ratifying and confirming all that said attorneys-in-fact and agent, or their
substitutes may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Act of 1933, this
registration statement has been signed by the following persons in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
- --------- ----- ----
<S> <C> <C>
/s/ Michael Pearce Chief Executive Officer, Director February 14, 2000
- ----------------------------------
Michael Pearce (Principal Executive Officer)
/s/ Robert Hart Chief Financial Officer February 14, 2000
- ---------------------------------- (Principal Financial and Accounting Officer)
Robert Hart
/s/ Marc Goldfarb Director February 14, 2000
- ----------------------------------
Marc Goldfarb
/s/ W. Joseph McClelland Director February 14, 2000
- ----------------------------------
W. Joseph McClelland
/s/ J.W. Stealey Director February 14, 2000
- ----------------------------------
J. W. Stealey
</TABLE>
<TABLE>
<CAPTION>
<S> <C> <C>
/s/ Jacob Agam Director February 14, 2000
- ----------------------------------
Jacob Agam
</TABLE>
II-7
<PAGE>
Exhibits
The following exhibits are filed as part of this registration statement:
Exhibit
Number Description of Exhibit
- ------ ----------------------
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.
3.04* -Articles of Amendment establishing the Series D Preferred
Stock of Interactive Magic, Inc., filed with the North
Carolina Secretary of State on November 10, 1999.
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
4.05* -Registration Rights Agreement dated August 16, 1999 between the Company
and John W. ("Bill") Stealey.
5.01 -Opinion of Wyrick Robbins Yates & Ponton LLP.
10.01* -Stock Purchase Agreement, dated February 4, 1998, by and between the
Company and Vertical Financial Holdings
10.02* -Investor's Rights Agreement, dated February 4, 1998, by and between the
Company and Vertical Financial Holdings
10.03* -Marketing Agreement, dated February 4, 1998, between the Company and
General Capital
10.04* -Merger Agreement, dated as of March 24, 1997, as amended April 2, 1997,
by and among the Company, Interactive Creations Acquisition
Corp., certain shareholders of Interactive Creations Incorporated
and Interactive Creations Incorporated
10.05* -Form of Shareholder Agreement between the Company and each shareholder
of Interactive Creations Incorporated
10.06* -Form of Stock Purchase Warrant issued to each of J.W. Stealey, Robert
L. Pickens, Laura Stealey, David H. Kestel, J. Nicholas England,
W. Joseph McClelland, Avi Suriel, Marion Bass and Oppenheimer
10.07* -Corporate Airplane Agreement, dated January 3, 1995, between J.W.
Stealey and the Company
10.08* -Loan and Security Agreement, dated March 24, 1997, as amended
April 1, 1997 (See Exhibit 10.10 below), by and between the
Company and Petra Capital LLC
10.09* -Stock Purchase Warrant, dated March 24, 1997, as amended April
1, 1997 (See Exhibit 10.10 below), and January 31, 1998, as
amended, issued by the Company to Petra Capital LLC
10.10* -First Amendment to Loan and Security Agreement and Stock
Purchase Warrant dated April 1, 1997 by and between the Company
and Petra Capital LLC
10.11* -Promissory Note, dated August 25, 1997, issued by the Company to Branch
Banking & Trust Company
10.12* -Guaranty Agreement, dated August 25, 1997, between J.W. Stealey and
Branch Banking & Trust Company
10.13* -Loan and Security Agreement, dated September 29, 1997, among the
Company, iMagic Online Corporation and Oberlin Capital, L.P.
10.14* -Loan and Security Agreement, dated April 30, 1997, between
Greyrock Business Credit, a Division of NationsCredit Commercial
Corporation, and the Company
10.15* -Lease Agreement, dated December 4, 1995, as amended February 7,
1996, by and between Southport Business Park Limited Partnership
and the Company
10.16* -Employment Agreement, dated January 3, 1995, between the Company and
J.W. Stealey, as amended
10.17* -Employment Agreement, dated January 3, 1995, between the Company and
Robert L. Pickens, as amended
10.18* -Employment Agreement, dated March 25, 1996 between the Company and
William J. Kaluza
10.19* -Employment Agreement, dated January 3, 1995, between the Company
and Joseph Rutledge, and form of amendment thereto
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
II-8
<PAGE>
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 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
10.36* -Agreement Regarding Assignment of Contracts Relating to Sale of the
Company's CD-ROM Operations to Ubi Soft Entertainment S.A.
10.37* -Securities Purchase and Exchange Agreement dated November 8,
1999 between Interactive Magic, Inc. and RGC International
Investors, LDC
10.38* -Registration Rights Agreement dated November 11, 1999 by and
among Interactive Magic, Inc., RGC International Investors, LDC,
Vertical Financial Holdings, J.W. Stealey and Value Management &
Research AG.
10.39* -Asset Purchase Agreement dated August 27, 1999 by and among
Interactive Magic, Inc., Virtual Business Designs, Inc., d/b/a
The Gamers Net, and David Heath.
17.1* -Copy of letter from Avi Suriel tendering his resignation from
the Registrant's Board of Directors effective August 3, 1999.
23.1 -Consent of Ernst & Young LLP.
99.1* -Agreement dated August 16, 1999, among the Company, John W. ("Bill")
Stealey and Vertical Financial Holdings.
- --------------------------------------------------------------------------------
*Previously filed
II-9
Exhibit 5.1
February 15, 2000
iEntertainment Network, Inc.
215 Southport Drive, Suite 1000
Morrisville, North Carolina 27560
RE: Registration Statement on Form SB-2
Ladies and Gentlemen:
We have examined the Registration Statement on Form SB-2 to be filed by
iEntertainment Network, Inc., a North Carolina corporation (the "Company"), with
the Securities and Exchange Commission on or about the date hereof (the
"Registration Statement"), in connection with the registration under the
Securities Act of 1933 of up to 9,681,692 shares of the Company's Common Stock,
$0.10 par value per share (the "Shares"). In our examination, we have assumed
the genuineness of all signatures, the authenticity of all documents submitted
to us as originals and the conformity with the original of all documents
submitted to us as copies thereof.
As your legal counsel, we have examined the proceedings taken, and are
familiar with the proceedings proposed to be taken, in connection with the sale
and issuance of the Shares.
It is our opinion that, upon completion of the proceedings being taken or
contemplated by us, as your counsel, to be taken prior to the issuance of the
Shares, including the proceedings being taken in order to permit such
transaction to be carried out in accordance with applicable state securities
laws, the Shares when issued and sold in the manner referred to in the
Registration Statement and in accordance with the resolutions adopted by the
Board of Directors of the Company, will be legally and validly issued, fully
paid and nonassessable.
We consent to the use of this opinion as an exhibit to the Registration
Statement and further consent to the use of our name wherever appearing in the
Registration Statement, including the Prospectus constituting a part thereof,
and any amendments thereto.
Very truly yours,
/s/ Wyrick Robbins Yates & Ponton LLP
EXHIBIT 23.1
Consent of Independent Auditors
We consent to the reference to our firm under the caption "Experts" in the
Registration Statement (Form SB-2) and related Prospectus of iEntertainment
Network, Inc. (f/k/a Interactive Magic, Inc.) for the registration of 9,681,692
shares of its common stock and to the use of (i) our report dated February 19,
1999, with respect to the consolidated financial statements of Interactive
Magic, Inc. as of December 31, 1998 and 1997 and for the years ended December
31, 1998 and 1997 and (ii) our report dated December 3, 1998, except for Note
10, as to which the date is February 12, 1999, with respect to the combined
financial statements of Multiplayer Games Network, Inc., Tantalus, Inc. and
MPG-Net, Inc. as of October 31, 1998 and December 31, 1997 and for the ten
months ended October 31, 1998 and for the year ended December 31, 1997, included
therein.
/s/ Ernst & Young LLP
Raleigh, North Carolina
February 10, 2000
