SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K/A
AMENDMENT NO. 1
CURRENT REPORT
Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
Date of Report (Date of earliest event reported) February 12, 1999
IENTERTAINMENT NETWORK, INC.
--------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
North Carolina
- --------------------------------------------------------------------------------
(State or other jurisdiction of incorporation)
0-29750 56-2092059
- ------------------------------------ ----------------------------------
(Commission file Number) (IRS Employer ID Number)
215 Southport Drive, Suite 1000, Morrisville, North Carolina 27560
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (919) 461-0722
------------------------
Interactive Magic, Inc.
- --------------------------------------------------------------------------------
(Former name or former address, if changed since last report)
<PAGE>
iEntertainment Network, Inc. (formerly Interactive Magic, Inc.) hereby files
Amendment No. 1 to its Report on Form 8-K filed on February 22, 1999 for the
purpose of filing the financial statements and pro forma financial information
required by Item 7 of Form 8-K.
Item 7. Financial Statements and Exhibits.
(a) Financial Statements of Business Acquired. The financial
statements for the acquired business required by Item 7 of
Form 8-K promulgated by the Commission under the Securities
Exchange Act of 1934, as amended (the "Exchange Act") are
filed herewith as Exhibit 99.2.
(b) Pro Forma Financial Information. The following pro forma
financial information required by Item 7 of Form 8-K
promulgated by the Commission under the Exchange Act is filed
with this report.
<PAGE>
IENTERTAINMENT NETWORK, INC.
(F/K/A INTERACTIVE MAGIC, INC.)
UNAUDITED PRO FORMA FINANCIAL DATA
On February 12, 1999, Interactive Magic, Inc. ("Interactive Magic" or the
"Company") consummated the acquisition of MPG-Net, Inc. ("MPG-Net") 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, BUSINESS COMBINATIONS. 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
of 1999, 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 $4.4
million is being amortized over 3 years.
The following unaudited pro forma condensed financial statements have been
prepared to give effect to the MPG-Net acquisition, using the purchase method of
accounting.
The unaudited pro forma condensed financial information has been presented for
illustrative purposes only and is not necessarily indicative of the financial
position or results of operations that would have actually been reported had the
acquisition occurred at the beginning of the periods presented, nor is it
necessarily indicative of future financial position or results of operations.
These unaudited pro forma condensed combined financial statements including the
notes thereto are qualified in their entirety by reference to and should be read
in conjunction with, the respective historical consolidated financial statements
and notes thereto of Interactive Magic, Inc. incorporated by reference in this
Form 8-K/A and the historical combined financial statements and notes thereto of
MPG-Net included herein. The unaudited pro forma information neither includes
nor assumes any benefits from cost or operational savings resulting from the
acquisition.
The unaudited pro forma condensed balance sheet as of December 31, 1998 gives
effect to the acquisition as if it had occurred on December 31, 1998, as well as
gives effect to the pro forma adjustments described in the accompanying notes.
The unaudited pro forma condensed statements of operations for all periods
presented give effect to the acquisition as if it had occurred on January 1,
1997, as well as gives effect to the pro forma adjustments described in the
accompanying notes.
<TABLE>
<CAPTION>
HISTORICAL PRO FORMA
-------------------------------------------
INTERACTIVE MAGIC (A) MPG-NET (B) ADJUSTMENTS PRO FORMA
----------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 2,943 $ 82 $ - $ 3,025
Trade receivables, net of allowances 2,109 59 - 2,168
Prepaid expenses and other 3,642 61 (200) (c) 3,503
----------------------------------------------------------------------------------
Total current assets 8,694 202 (200) 8,696
Property and equipment, net 1,082 192 - 1,274
Noncurrent royalties receivable 726 - - 726
Excess of purchase price over fair value of
net assets acquired - - 4,374 (h) 4,374
Other noncurrent assets 18 11 - 29
==================================================================================
Total assets $10,520 $405 $4,174 $15,099
==================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable and accrued expenses 2,466 551 (212) (d) 2,805
Lines of credit 1,348 - - 1,348
Accrued interest payable to related parties - 4,320 (4,320) (e),(f) -
Rent payable to stockholder - 481 (481) (f) -
Note payable to related party - 1,200 (1,200) (e) -
Note payable to stockholder - 11,290 (11,290) (f ) -
Current portion of notes payable and
capital lease obligations 23 233 (200) (c) 56
----------------------------------------------------------------------------------
Total current liabilities 3,837 18,075 (17,703) 4,209
Noncurrent liabilities 132 28 - 160
Common Stock 985 6 15 (e) 1,054
3 (g)
4 (i)
41 (j)
Additional paid-in capital 31,522 48 212 (d) 53,134
763 (e)
16,030 (f)
3 (g)
4,374 (h)
229 (i)
(47) (j)
Deferred compensation - (29) 29 (g) -
Accumulated deficit (25,862) (17,723) 483 (e) (43,364)
(29) (g)
(233) (i)
Accumulated other comprehensive loss (94) - - (94)
----------------------------------------------------------------------------------
Total stockholders' equity (deficit) 6,551 (17,698) 21,877 10,730
==================================================================================
Total liabilities and stockholders' equity
(deficit) $10,520 $ 405 $ 4,174 $ 15,099
==================================================================================
</TABLE>
<PAGE>
iEntertainment Network, Inc.
(f/k/a Interactive Magic, Inc.)
Notes to Unaudited Pro Forma Condensed Balance Sheet
(a) Reflects the historical consolidated balance sheet of Interactive
Magic, Inc. as of December 31, 1998.
(b) Reflects the historical combined balance sheet of Multiplayer Games
Network, Inc., Tantalus, Inc. and MPG-Net, Inc. (collectively "MPG-Net") as
of December 31, 1998.
(c) Reflects the elimination of a $200,000 note payable from MPG-Net to
Interactive Magic.
(d) Reflects the assumption by the primary stockholder of MPG-Net of MPG-Net's
obligation for unpaid professional fees totaling $212,000 in exchange for a
$212,000 note payable to MPG-Net from the stockholder. This note was
subsequently canceled by the stockholder and is reflected as additional
paid-in capital.
(e) Reflects the cancellation of MPG-Net's note payable to related party of
$1,200,000 and related accrued interest of $61,000 through the issuance of
150,000 shares of Interactive Magic common stock valued at $778,000 as full
settlement. This transaction resulted in a $483,000 extraordinary gain on
extinguishment of the debt.
(f) Reflects the cancellation of the note payable to stockholder of MPG-Net of
$11,290,000, related accrued interest of $4,259,000 and rent payable to the
primary stockholder of MPG-Net of $481,000. The cancellation of these
amounts due to the stockholder are reflected as additional paid-in capital.
(g) Reflects the expensing of the remaining $29,000 of unamortized deferred
compensation as a result of an automatic acceleration of vesting provision
of an MPG-Net employee stock option agreement triggered by the merger, as
well as the issuance of 30,000 shares of Interactive Magic common stock in
exchange for the MPG-Net common stock issued upon exercise of such option.
(h) Reflects the recording of the $4,374,000 excess of the aggregate purchase
price over the fair value of net assets acquired from MPG-Net.
(i) Reflects the issuance of 45,000 shares of Interactive Magic common stock
valued at $233,000 in consideration for financial advisory services
incurred by MPG-Net in connection with the acquisition.
(j) Reflects the issuance of an additional 525,000 shares of Interactive Magic,
Inc. common stock in exchange for the remaining net assets of MPG-Net, less
the $6,000 book value of the outstanding common stock of MPG-Net.
<PAGE>
Interactive Magic, Inc.
Unaudited Pro Forma Condensed Statement of Operations
Year ended December 31, 1998
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
HISTORICAL PRO FORMA
-----------------------------------------
INTERACTIVE MAGIC (A) MPG-NET (B) ADJUSTMENTS PRO FORMA
------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net revenues:
CD-ROM product sales 9,177 - - 9,177
Online sales 1,773 107 - 1,880
Contract royalties and licenses 1,616 122 - 1,738
Advertising and other - 94 - 94
------------------------------------------------------------------------------------
Total net revenues 12,566 323 - 12,889
Cost of revenues:
Cost of products and services 3,157 72 - 3,229
Royalties and amortized costs 2,942 10 - 2,952
------------------------------------------------------------------------------------
Total cost of revenues 6,099 82 - 6,181
Gross profit 6,467 241 - 6,708
Operating expenses:
Sales and marketing 8,490 148 - 8,638
Product development 5,983 835 - 6,818
General and administrative 2,684 755 - 3,439
Goodwill amortization - - 1,458 (d) 1,458
------------------------------------------------------------------------------------
Total operating expenses 17,157 1,738 1,458 20,353
------------------------------------------------------------------------------------
Operating loss (10,690) (1,497) (1,458) (13,645)
Total other expense 527 1,034 (1,024) (e) 537
------------------------------------------------------------------------------------
Loss before income taxes (11,217) (2,531) (14,182)
(434)
Income tax expense 28 - - 28
====================================================================================
Loss before extraordinary item (11,245) (2,531) (434) (14,210)
====================================================================================
Pro forma loss per share:
Loss per share before
extraordinary item $ (1.73) $(1.96)
Weighted average shares used in
computing pro forma loss per
share (C) 6,515,213 7,265,213
</TABLE>
<PAGE>
Interactive Magic, Inc.
Unaudited Pro Forma Condensed Statement of Operations
Year ended December 31, 1997
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
HISTORICAL PRO FORMA
----------------------------------------
INTERACTIVE MAGIC (A) MPG-NET (B) ADJUSTMENTS PRO FORMA
-----------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net revenues:
CD-ROM product sales 14,067 - - 14,067
Online sales 1,615 130 - 1,745
Contract royalties and licenses 820 6 - 826
Advertising and other - - - -
-----------------------------------------------------------------------------------
Total net revenues 16,502 136 - 16,638
Cost of revenues:
Cost of products and services 3,715 115 - 3,830
Royalties and amortized costs 2,634 95 - 2,729
-----------------------------------------------------------------------------------
Total cost of revenues 6,349 210 - 6,559
Gross profit (loss) 10,153 (74) - 10,079
Operating expenses:
Sales and marketing 6,760 51 - 6,811
Product development 3,878 1,449 - 5,327
General and administrative 1,941 835 2,776
Goodwill amortization - - 1,458 (d) 1,458
-----------------------------------------------------------------------------------
Total operating expenses 12,579 2,335 1,458 16,372
-----------------------------------------------------------------------------------
Operating loss (2,426) (2,409) (1,458) (6,293)
Total other expense 1,905 924 (903) (e) 1,926
-----------------------------------------------------------------------------------
Loss before income taxes (4,331) (3,333) (555) (8,219)
Income tax expense (benefit) (33) - - (33)
-----------------------------------------------------------------------------------
Loss before extraordinary item (4,298) (3,333) (555) (8,186)
Pro forma loss per share:
Loss per share before $ (1.36) $ (2.10)
extraordinary item (C)
Weighted average shares used in
computing pro forma loss per
share (C) 3,152,930 3,902,930
</TABLE>
<PAGE>
Interactive Magic, Inc.
Notes to Unaudited Pro Forma Condensed Statements of Operations
For the years ended December 31, 1998 an 1997
(a) Reflects the historical consolidated statement of operations of
Interactive Magic, Inc. for the respective period.
(b) Reflects the historical combined results of operations of Multiplayer Games
Network Inc. and Tantalus, Inc. for the year ended December 31, 1997 and
historical combined results of operations of Multiplayer Games Network
Inc., Tantalus, Inc. and MPG-Net, Inc. (collectively "MPG-Net") for the
year ended December 31, 1998.
(c) The pro forma loss per share before extraordinary item reflects the pro
forma loss before the extraordinary items divided by historical weighted
average shares outstanding of Interactive Magic plus the 750,000 shares of
common stock issued in connection with the acquisition.
(d) Reflects one year in amortization of the excess of purchase price over fair
value of net assets acquired.
(e) Reflects the elimination of MPG-Net related party interest incurred by
MPG-Net in connection with notes payable and other obligations to related
parties which were canceled or settled as a result of the acquisition.
<PAGE>
(c) Exhibits.
<TABLE>
<CAPTION>
<S> <C>
10.27* Agreement and Plan of Merger ("Merger Agreement") by and among the Company, iMagicOnline
Corporation, MPG-Net, Inc., Multiplayer Games Network, Inc., Tantalus, Inc., James
Hettinger and Donn A. Clendenon dated as of January 25, 1999
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.
23.1 Consent of Ernst & Young LLP
99.2 Financial Statements of MPG-Net
</TABLE>
* Previously filed
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
iENTERTAINMENT NETWORK, INC.
/s/Robert Hart
Date: February 15, 2000 ----------------------------
Robert Hart
Chief Financial Officer
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement (Form
S-8333-91875) pertaining to the 1998 Employee Stock Purchase Plan, The 1998
Stock Plan and in the 1995 Employees' Class B Common Stock Incentive Stock
Option Plan of Interactive Magic, Inc. of 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 in iEntertainment Network, Inc.'s (f/k/a Interactive Magic, Inc.)
Current Report (Form 8-K/A) filed with the Securities and Exchange Commission.
/s/Ernst & Young LLP
Raleigh, North Carolina
February 10, 2000
Exhibit 99.2
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-1
<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-2
<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-3
<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-4
<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-5
<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-6
<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-7
<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-8
<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-9
<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-10
<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-11
<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-12
<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-13
<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-14
<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-15
<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-16
<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-17
