<PAGE>
PROSPECTUS
ACCLAIM ENTERTAINMENT, INC.
$50,000,000
10% CONVERTIBLE SUBORDINATED
NOTES DUE 2002
------------------------
The Notes are being offered and sold by the selling securityholders (the
'Selling Securityholders') named herein. The Notes were originally issued by
Acclaim Entertainment Inc. (the 'Company') in a privately-negotiated transaction
(the 'Initial Offering') pursuant to the exemption from registration provided
under Section 4(2) of the Securities Act of 1933, as amended (the 'Securities
Act') and Regulation D promulgated thereunder. See 'Selling Securityholders.'
The Notes are convertible into shares of Common Stock, $.02 par value per
share (the 'Common Stock'), of the Company at any time until maturity, unless
previously redeemed, at a conversion price of $5.18 per share, subject to
adjustment under certain conditions. See 'Description of Notes--Conversion
Rights' for a description of events which may cause an adjustment to the
conversion price. The Notes will trade in the over-the-counter market.
This Prospectus also covers (i) the issuance by the Company to the Holders
(as defined in the indenture governing the Notes) of the Notes of such
indeterminate number of shares of Common Stock (the 'Shares') as shall be
required to be issued upon conversion of the Notes and (ii) the resale of such
Shares by the holders thereof. The Common Stock is traded on the NASDAQ National
Market System ('NASDAQ') under the symbol 'AKLM.' On September 19, 1997, the
last reported sale price of the Common Stock on NASDAQ was $4.0625 per share.
See 'Price Range of Common Stock and Dividend Policy.'
Interest on the Notes is payable on March 1 and September 1 of each year,
commencing September 1, 1997. The Notes are redeemable, in whole or in part, at
the option of the Company at any time on or after March 1, 2000, at the
redemption prices set forth herein, plus accrued interest, if any, to the
redemption date. If a Repurchase Event (as defined herein) occurs, each Holder
of the Notes will have the right, subject to certain conditions and
restrictions, to require the Company to repurchase all outstanding Notes, in
whole or in part, owned by such Holder at 100% of their principal amount plus
accrued interest, if any, to the date of repurchase. The Notes are subordinated
to all existing and future Senior Indebtedness (as defined herein) of the
Company and are effectively subordinated to all indebtedness and other
liabilities of the Company's subsidiaries. At May 31, 1997, the Company had
outstanding approximately $13.0 million of Senior Indebtedness which included
$3.7 million of letters of credit and $4.4 million of obligations under capital
leases. In addition, a significant portion of the Company's trade payables and
other liabilities are liabilities of subsidiaries of the Company and, therefore,
the Notes are effectively subordinated to all such liabilities. The Notes are
governed by the Indenture (the 'Indenture'), dated as of February 26, 1997,
between the Company and IBJ Schroder Bank & Trust Company, as trustee, which
permits the Company to incur certain additional indebtedness, including Senior
Indebtedness. See 'Description of Notes.'
The Company will not receive any proceeds from the sale of the Notes (or
the Shares issuable upon conversion thereof) by the Selling Securityholders. The
Company has been advised by the Selling Securityholders that they intend that
the Notes and Shares to be offered hereby be offered for sale and sold and
distributed, from time to time, by the Selling Securityholders, or by the
pledgees, donees, transferees or other successors in interest in one or more
exchanges or in the over-the-counter market, or otherwise at prices and at terms
then prevailing or at prices related to the then current market price, or in
negotiated transactions. The Notes and Shares may be sold or distributed through
(i) a block
(Continued on next page)
SEE 'RISK FACTORS' BEGINNING ON PAGE 9 FOR A DISCUSSION OF CERTAIN RISK
FACTORS THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE NOTES OFFERED
HEREBY.
THE NOTES (AND THE SHARES ISSUABLE UPON CONVERSION THEREOF) HAVE NOT BEEN
APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION (THE
'COMMISSION') OR ANY STATE SECURITIES COMMISSION, NOR HAS THE COMMISSION OR ANY
STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS
PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
THE OFFERING IS SUBJECT TO WITHDRAWAL AND CANCELLATION AT ANY TIME, WITHOUT
NOTICE.
------------------------
The date of this Prospectus is September 22, 1997
<PAGE>
(Continued from previous page)
trade in which the broker or dealer so engaged will attempt to sell the Notes
and Shares as agent but may position and resell a portion of the block as
principal to facilitate the transaction, (ii) purchases by a broker or dealer as
principal and resale by such broker or dealer for its own account pursuant to
this Prospectus, (iii) an exchange distribution in accordance with the rules of
such exchange, (iv) ordinary brokerage transactions and transactions in which
the broker solicits purchasers, (v) in negotiated transactions or (vi) through
other means. No sales and distributions of Notes or Shares hereunder, other than
those transactions described in (i) through (v) above, shall be effected until
after this Prospectus shall have been appropriately amended or supplemented, if
required, to set forth the terms thereof. In effecting sales, brokers or dealers
engaged by the Selling Securityholders may arrange for other brokers or dealers
to participate in such sales. In addition, any securities covered by this
Prospectus which qualify for sale pursuant to Rule 144 promulgated under the
Securities Act may be sold under such Rule 144 rather than pursuant to this
Prospectus.
Brokers or dealers will receive commissions or discounts from the Selling
Securityholders in amounts to be negotiated immediately prior to the sale.
In certain cases, the Selling Securityholders and any brokers, dealers or
agents who participate with the Selling Securityholders in the distribution of
the Notes and the Shares may be deemed to be 'underwriters' as such term is
defined under the Securities Act and any discount or commission received by them
and any profit on the sale of Notes or the Shares purchased by them may be
deemed to be underwriting commissions or discounts under the Securities Act.
The Selling Securityholders have agreed to indemnify the Company, and the
Company has agreed to indemnify the Selling Securityholders, against certain
liabilities, including liabilities under the Securities Act. See 'Plan of
Distribution' for a description of this agreement and other arrangements between
the Company and the Selling Securityholders. Expenses of this offering
(including legal fees (which shall be limited to the fees and expenses of one
firm with respect to all Selling Securityholders), if any, incurred by the
Selling Securityholders), estimated at $200,000, will be paid by the Company.
2
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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Prospectus, including certain statements in 'THE COMPANY',
'MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS' and 'BUSINESS' sections, contains certain forward-looking statements
within the meaning of Section 27A of the Securities Act and Section 21E of the
Securities Exchange Act of 1934 (the 'Exchange Act'). When used in this
Prospectus, the words 'believe,' 'anticipate,' 'think,' 'intend,' 'plan,' 'will
be,' 'strategy' and similar expressions identify such forward-looking
statements. Such statements regarding future events and/or the future financial
performance of the Company are subject to certain risks and uncertainties,
including those discussed in 'RISK FACTORS' on pages 9 to 20, which could cause
actual events or the actual future results of the Company to differ materially
from any forward-looking statement. In light of the significant risks and
uncertainties inherent in the forward-looking statements included herein, the
inclusions of such statements should not be regarded as a representation by the
Company or any other person that the objectives and plans of the Company will be
achieved.
AVAILABLE INFORMATION
The Company is subject to the informational requirements of the Exchange
Act and in accordance therewith files reports and other information with the
Securities and Exchange Commission (the 'Commission'). Such reports and other
information can be inspected and copied at the public reference facilities
maintained by the Commission at Room 1024, Judiciary Plaza, 450 Fifth Street,
N.W., Washington, D.C. 20549 and at the Commission's regional offices at 7 World
Trade Center, 13th floor, New York, New York 10048 and 500 West Madison Street,
Suite 1400, Chicago, Illinois 60661-2511. Copies of such material can be
obtained from the Public Reference Section of the Commission, 40 Fifth Street,
N.W., Washington, D.C. 20549, at prescribed rates. The Commission also maintains
a Web site at 'http://www.sec.gov' that contains reports, proxy and information
statements and other information regarding issuers that file electronically with
the Commission.
The Company has filed with the Commission a registration statement on Form
S-1 (herein, together with all amendments and exhibits, referred to as the
'Registration Statement') under the Securities Act with respect to the
registration of the securities offered hereby. This Prospectus does not contain
all the information set forth in the Registration Statement, certain parts of
which are omitted in accordance with the rules and regulations of the
Commission. Statements contained herein concerning the contents of any documents
are not necessarily complete and, in each instance, reference is made to the
copy of such document filed as an exhibit to the Registration Statement. Each
such statement is qualified in its entirety by such reference. The Registration
Statement, as well as items of information omitted from this Prospectus but
contained in the Registration Statement and reports and other information filed
by the Company, may be inspected without charge at the public reference
facilities referred to above and copies of all or any part thereof may be
obtained from the Commission upon request and payment of the prescribed fee.
3
<PAGE>
SUMMARY
The following summary is qualified in its entirety by, and should be read
in conjunction with, the more detailed information and financial data, including
the Consolidated Financial Statements and notes thereto, appearing elsewhere in
this Prospectus. Unless otherwise specified, the information presented herein
does not give effect to the sale or conversion of the Notes. All references to a
fiscal year are to the Company's fiscal year which ends August 31.
THE COMPANY
The Company is a developer, publisher and mass marketer of interactive
entertainment software products ('Software') for use with dedicated interactive
entertainment hardware platforms ('Entertainment Platforms') and multimedia
personal computer systems ('PCs'). The Company operates its own Software design
studios and a motion capture studio, and markets and distributes its products in
the major territories throughout the world. The Company's operating strategy is
to develop Software for the Entertainment Platforms and PCs that dominate the
interactive entertainment market at a given time or which the Company perceives
as having the potential for achieving mass market acceptance. The Company's
strategy is to emphasize sports simulation and arcade style titles for
Entertainment Platforms and fantasy/role-playing, adventure and sports
simulation titles for PCs. The Company intends to continue to support its
existing key brands with the introduction of new titles supporting those brands
and to develop one additional key brand each year based on its original and
licensed properties, which may then be featured on an annual basis in successive
titles.
The Company also engages in: (i) the development and publication of comic
books, which commenced in July 1994 through the acquisition of Acclaim Comics,
Inc. ('Acclaim Comics'); (ii) the distribution of Software titles developed by
other software publishers ('Affiliated Labels'), which commenced in the first
quarter of fiscal 1995; (iii) the marketing of its motion capture technology and
studio services, which commenced in the first quarter of fiscal 1995; and (iv)
the distribution of coin-operated video arcade games, which commenced in May
1996.
The Company believes the Software industry is driven by the size of the
installed base of Entertainment Platforms such as those manufactured by Nintendo
Co., Ltd. (Japan) (Nintendo Co., Ltd. (Japan) and its subsidiary, Nintendo of
America, Inc., are collectively herein referred to as 'Nintendo'), Sony
Corporation (Sony Corporation and its subsidiary, Sony Computer Entertainment of
America, are collectively herein referred to as 'Sony') and Sega Enterprises
Ltd. ('Sega') and PCs. The industry is characterized by rapid technological
change, resulting in Entertainment Platform and related Software product cycles.
No single Entertainment Platform or system has achieved long-term dominance in
the interactive entertainment market. See 'Risk Factors.'
In fiscal 1996, the Company suffered a substantial decrease in revenues as
compared to fiscal 1994 and 1995, and recorded a loss from operations of $274.5
million. The Company's decrease in revenues was primarily a result of the
transition in the interactive entertainment market from 16-bit platforms to the
next generation platforms. The Company had anticipated that Software sales for
the 16-bit Entertainment Platforms would continue at historic levels through
December 1996. However, the 16-bit Software market matured much more rapidly
than anticipated and the Company's Christmas 1995 16-bit Software sales were
substantially lower than anticipated and, by April 1996, the Company derived
minimal profits from such Software sales and exited the 16-bit and portable
cartridge market. Additionally, during the past three years the Company had
invested in three Software development studios, a comic book publishing
operation and a motion capture studio, all of which significantly increased the
Company's fixed operating costs. See 'Management's Discussion of Financial
Condition and Results of Operations.' The Company believes that the strength of
its anticipated new product releases, combined with its recently implemented
expense reduction initiatives and strong distribution channels, position the
Company to benefit from the expanding market for next generation Software to be
used on the new Entertainment Platforms.
On February 26, 1997, the Company closed the Initial Offering. The net
proceeds were used, in part, to retire $16.0 million of indebtedness to Midland
Bank plc ('Midland') and to pay down $2.0 million of indebtedness to Fleet Bank,
N.A. ('Fleet'). On March 5, 1997, the Company completed the sale of
substantially
4
<PAGE>
all of the assets and certain liabilities of Acclaim Redemption Games, Inc.
(formerly Lazer-Tron Corporation) ('Lazer-Tron') for $6 million in cash.
The Company sells its Software primarily to mass merchandisers, large
retail toy store chains, department stores and specialty stores, including Toys
R Us, Walmart, K Mart, Target and Sears, among others. The Company generally
does not have written agreements with its customers. The loss of any important
customer could have a material adverse effect on the Company. See 'Risk
Factors.'
A Delaware corporation, Acclaim was founded in 1987 and has overseas
operations in Japan, Canada, France, Germany, Spain and the United Kingdom.
The Company's principal executive offices are located at One Acclaim Plaza,
Glen Cove, New York 11542, and its telephone number is (516) 656-5000.
THE OFFERING
<TABLE>
<S> <C>
Securities Offered........................ $50.0 million aggregate principal amount of 10% Convertible
Subordinated Notes due 2002 (the 'Notes') and the Shares issuable
upon conversion thereof.
Interest Payment Dates.................... March 1 and September 1, commencing September 1, 1997.
Maturity.................................. March 1, 2002.
Conversion................................ The Notes are convertible into shares of Common Stock at any time
until maturity, unless previously redeemed, at a conversion price of
$5.18 per share, subject to adjustment under certain conditions.
Redemption at Option of Company........... The Notes are redeemable, in whole or in part, at the option of the
Company (subject to the rights of holders of Senior Indebtedness), at
any time on or after March 1, 2000, at the redemption prices
(expressed as a percentage of the principal amount) set forth below
for the 12-month period beginning March 1 of the years indicated:
2000..............................................104.00%
2001..............................................102.00%
and at maturity at 100% of principal, together in the case of any
such redemption with accrued interest to the redemption date.
Repurchase at Option of Holders........... If a Repurchase Event (as defined in the Indenture) occurs, each
Holder of the Notes will have the right, subject to certain
conditions and restrictions, to require the Company to repurchase all
outstanding Notes, in whole or in part, owned by such Holder at 100%
of their principal amount plus accrued interest, if any, to the date
of repurchase. If a Repurchase Event were to occur, there is no
assurance that the Company would have sufficient funds to pay the
repurchase price for all the Notes tendered by the Holders thereof.
The Company's ability to make such payments may be limited by its
leverage and the terms of its then existing borrowing and other
agreements. Specifically, the occurrence of a Repurchase Event is an
event of default under the Company's credit facility with its lead
senior lender. See 'Risk Factors' and 'Description of Notes--
Repurchase at Option of Holders Upon a Repurchase Event' for a more
complete discussion of the rights of Holders of the Notes upon the
occurrence of a Repurchase Event.
Certain Covenants......................... The Indenture contains certain covenants that, among other things,
limit the ability of the Company and its Subsidiaries (as defined in
</TABLE>
5
<PAGE>
<TABLE>
<S> <C>
the Indenture) to make restricted payments, to incur Indebtedness (as
defined in the Indenture), to issue preferred stock of Subsidiaries,
and to enter into merger and similar transactions. These covenants
are subject to important exceptions and qualifications. See
'Description of the Notes.'
Subordination............................. The Notes are subordinated to all existing and future Senior
Indebtedness of the Company and are effectively subordinated to all
indebtedness and other liabilities of the Company's subsidiaries. At
May 31, 1997, the Company had outstanding approximately $13.0 million
of Senior Indebtedness which included $3.7 million of letters of
credit and $4.4 million of obligations under capital leases. In
addition, a significant portion of the Company's trade payables and
other liabilities are liabilities of subsidiaries of the Company and,
therefore, the Notes are effectively subordinated to all such
liabilities. The Indenture permits the Company to incur certain
additional Indebtedness, including Senior Indebtedness.
</TABLE>
USE OF PROCEEDS
The Company will not receive any proceeds from the sale of any amount of
the Notes (or the Shares issuable upon conversion thereof) by the Selling
Securityholders.
RISK FACTORS
See 'Risk Factors' for a discussion of certain factors that should be
considered in evaluating an investment in the Company.
6
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SUMMARY CONSOLIDATED FINANCIAL INFORMATION
The following summary consolidated financial information should be read in
conjunction with the Consolidated Financial Statements of the Company and the
notes thereto and the 'Management's Discussion and Analysis of Financial
Condition and Results of Operations' section appearing elsewhere in this
Prospectus. The consolidated financial statement data as of and for the fiscal
years ended August 31, 1994, 1995 and 1996 are derived from, and are qualified
by reference to, the audited Consolidated Financial Statements of the Company
included elsewhere in this Prospectus. The Consolidated Financial Statements of
the Company have been audited by Grant Thornton LLP, independent certified
public accountants, for the fiscal years ended August 31, 1992, 1993, 1994 and
1995. The auditors' report for fiscal 1995 includes an emphasis paragraph as to
uncertainty relating to the eventual outcome of certain class action lawsuits.
The Consolidated Financial Statements of the Company for the fiscal year ended
August 31, 1996 have been audited by KPMG Peat Marwick LLP, independent
certified public accountants. The auditors' report for fiscal 1996 includes an
explanatory paragraph relating to the Company's ability to continue as a 'going
concern' and indicates that the auditors were unable to review the selected
quarterly data in accordance with professional standards. The consolidated
financial statement data with respect to the fiscal years ended August 31, 1992
and 1993 are derived from audited Consolidated Financial Statements of the
Company not included in this Prospectus. The consolidated financial statement
data as of and for the nine months ended May 31, 1996 and 1997 has been derived
from, and is qualified by reference to, the unaudited Consolidated Financial
Statements of the Company included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
FISCAL YEAR ENDED AUGUST 31, MAY 31,
---------------------------------------------------------- ----------------------
1992(1) 1993 1994(2) 1995(3) 1996(4) 1996(5) 1997
--------- -------- -------- -------- --------- --------- ---------
(IN 000'S, EXCEPT PER SHARE INFORMATION)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net revenues.......................... $ 214,628 $327,091 $480,756 $566,723 $ 161,945 $ 215,012 $ 147,264
Cost of revenues...................... 114,114 170,748 220,744 268,501 180,072 162,522 78,019
Gross profit (loss)................... 100,514 156,343 260,012 298,222 (18,127) 52,490 69,245
--------- -------- -------- -------- --------- --------- ---------
Selling, advertising, general and
administrative expenses............. 66,493 101,950 172,099 203,930 200,440 111,184 90,732
Research & development expenses....... 2,149 3,036 4,626 10,126 34,582 18,559 23,588
Operating interest.................... 1,583 1,183 1,979 3,957 6,417 5,255 1,625
Depreciation and amortization......... 3,197 3,227 3,838 9,543 14,910 10,867 12,554
Goodwill writedown.................... -- -- -- -- -- -- 25,200
Litigation settlements................ -- -- -- -- -- -- 8,300
Downsizing charge..................... -- -- -- -- -- -- 10,000
Earnings (loss) from operations....... 27,092 46,947 77,470 70,666 (274,476) (93,375) (102,754)
--------- -------- -------- -------- --------- --------- ---------
Other (expense) income, net........... (3,255) 1,138 (475) 5,608 5,609 5,463 (3,608)
--------- -------- -------- -------- --------- --------- ---------
Earnings (loss) before income taxes
and minority interest............... 23,837 48,085 76,995 76,274 (268,867) (87,912) (106,362)
--------- -------- -------- -------- --------- --------- ---------
Net earnings (loss)................... $ 13,846 $ 28,185 $ 45,055 $ 44,770 $(221,368) $ (59,144) $(105,546)
--------- -------- -------- -------- --------- --------- ---------
Net earnings (loss) per common and
common equivalent share(6).......... $ 0.37 $ 0.63 $ 1.00 $ 0.86 $ (4.47) $ (1.20) $ (2.13)
Weighted average number of common and
common equivalent shares
outstanding......................... 37,815 44,875 45,150 52,300 49,515 49,360 49,645
</TABLE>
<TABLE>
<S> <C> <C> <C> <C> <C> <C> <C>
OTHER DATA
Ratio of Earnings to fixed charges(7)... 9.26 20.47 30.07 11.39 (29.71) (14.27) (17.71)
</TABLE>
<TABLE>
<CAPTION>
MAY 31, 1997
------------
<S> <C>
BALANCE SHEET DATA:
Working capital (deficiency)............................................................................... $(24,202)
Total assets............................................................................................... 159,927
Current portion of capital leases, long-term debt and short-term borrowings................................ 8,542
Long-term liabilities...................................................................................... 55,364
Stockholders' (deficiency)................................................................................. (7,187)
</TABLE>
- ------------------
(1) Includes results of operations of Arena Entertainment, Inc. from January 4,
1992.
(Footnotes continued on next page)
7
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(Footnotes continued from previous page)
(2) Includes results of operations of Acclaim Comics, Inc. from July 29, 1994.
(3) Includes results of operations of Iguana Entertainment, Inc. from January 4,
1995 and of Lazer-Tron for the entire year.
(4) Includes results of operations of Sculptured Software, Inc. ('Sculptured
Software') and Probe Entertainment Limited ('Probe') for the entire year.
(5) Adjustments in the fourth quarter of fiscal 1996, on a pre-tax basis,
aggregated $138.3 million, a portion of which related to prior quarters.
Accordingly, for comparative quarterly purposes, during fiscal 1997, the
1996 quarterly operating results may not necessarily be indicative of the
results of operations for such quarterly periods if these year-end
adjustments could have been allocated to the respective quarters. See Note
22 of Notes to Consolidated Financial Statements.
(6) All common share information has been restated to reflect the three-for-two
stock split in the form of a 50% stock dividend distributed on August 23,
1993.
(7) For fiscal 1996 and the nine months ended May 31, 1997, the Company's
pre-tax earnings from operations were inadequate to cover fixed charges by
$268.9 million and $106.4 million, respectively.
8
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RISK FACTORS
In addition to the other information contained in this Prospectus, the
following factors, among others, should be considered carefully in evaluating
the investment in the Company offered hereby.
SUBSTANTIAL LEVERAGE AND ABILITY TO SERVICE DEBT
The Indenture governing the Notes permits the Company or its subsidiaries
to incur certain additional indebtedness, including Senior Indebtedness.
Additional indebtedness of the Company may rank senior or pari passu with the
Notes in certain circumstances, while additional indebtedness of the Company's
subsidiaries will rank effectively senior to the Notes. See 'Description of
Notes.' The Company's ability to satisfy its obligations to its lenders will be
dependent upon its future performance, which is subject to prevailing economic
conditions and financial, business and other factors, including factors beyond
the Company's control. See 'Management's Discussion and Analysis of Financial
Condition and Results of Operations.'
The level of the Company's indebtedness could have important consequences
to holders of the Notes and to investors in the Company, because: (i) a portion
of the Company's cash flow from operations must be dedicated to debt service,
including the Notes and the Company's existing bank obligations, and will not be
available for other purposes; (ii) the Company's ability to obtain additional
debt financing in the future for working capital, or to pursue possible
expansion of its business or acquisitions, may be limited; and (iii) the
Company's level of indebtedness could limit its flexibility in reacting to
changes in the interactive entertainment industry and economic conditions
generally making it more vulnerable to adverse economic conditions and limiting
its ability to withstand competitive pressures or take advantage of business
opportunities. Certain of the Company's competitors currently operate on a less
leveraged basis, and are likely to have significantly greater operating and
financing flexibility than the Company.
The Company believes that, based upon current levels of operations, it
should be able to meet its interest obligations on the Notes, and its interest
and principal obligations under its bank agreements, when due. However, if the
Company cannot generate sufficient cash flow from operations to meet its debt
obligations when due, the Company might be required to restructure or refinance
its indebtedness. There can be no assurance that any such restructuring or
refinancing will be effected on satisfactory terms or would be permitted by the
terms of the Indenture or the Company's existing indebtedness. There can be no
assurance that the Company's operating cash flows will be sufficient to meet its
debt service requirements or to repay the Notes at maturity or that the Company
will be able to refinance the Notes or other indebtedness at maturity. See
'Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources.'
SUBORDINATION
The Notes are unsecured subordinated obligations of the Company and are
subordinated in right of payment to all present and future Senior Indebtedness
and other liabilities of the Company and are effectively subordinated to all
indebtedness and other liabilities of the Company's subsidiaries. In the event
of bankruptcy, liquidation or reorganization of the Company, the assets of the
Company will be available to pay obligations on the Notes only after all Senior
Indebtedness has been paid in full, and there may not be sufficient assets
remaining to pay amounts due on any or all of the Notes then outstanding. The
holders of any indebtedness of the Company's subsidiaries will be entitled to
payment of such indebtedness from the assets of the subsidiaries prior to the
holders of any general unsecured obligations of the Company, including the
Notes. At May 31, 1997, the Company had outstanding approximately $13.0 million
of Senior Indebtedness which included $3.7 million of letters of credit and $4.4
million of obligations under capital leases. In addition, a significant portion
of the Company's trade payables and other liabilities are liabilities of
subsidiaries of the Company and, therefore, the Notes are effectively
subordinated to all such liabilities. In the event of a payment default with
respect to Senior Indebtedness, no payments may be made on account of the Notes
until such default no longer exists with respect to Senior Indebtedness of the
Company. In addition, in the event of other defaults on Senior Indebtedness
payments on the Notes may be delayed or prohibited. See 'Description of Notes'
and 'Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources.'
RISKS RELATED TO A REPURCHASE EVENT
Upon the occurence of a Repurchase Event, each Holder of the Notes may
require the Company to repurchase all or a portion of such Holder's Notes. If a
Repurchase Event were to occur, there can be no assurance that the Company would
have sufficient financial resources, or would be able to arrange financing, to
9
<PAGE>
pay the repurchase price for all the Notes tendered by Holders thereof. In
addition, the occurence of certain Repurchase Events would constitute an event
of default under certain of the Company's current debt agreements, including the
Company's main credit facility with BNY Financial Corporation ('BNY'), and the
Company's repurchase of the Notes as a result of the occurrence of a Repurchase
Event may be prohibited or limited by, or create an event of default under, the
terms of future agreements relating to borrowings of the Company, including
agreements relating to Senior Indebtedness. In the event a Repurchase Event
occurs at a time when the Company is prohibited from purchasing the Notes, the
Company could seek the consent of its lenders to purchase the Notes or could
attempt to refinance the borrowings that contain such prohibition. If the
Company does not obtain such a consent or repay such borrowings, the Company
would remain prohibited from purchasing the Notes. In such case, the Company's
failure to purchase tendered Notes would constitute an Event of Default under
the Indenture which would, in turn, constitute a further default under certain
of the Company's existing debt agreements and may constitute a default under the
terms of other indebtedness that the Company may incur from time to time. In
such circumstances, the subordination provisions in the Indenture would prohibit
payments to the Holders of the Notes. See 'Description of Notes--Repurchase at
Option of Holders Upon a Repurchase Event.'
SUBSIDIARY STRUCTURE AND PRIORITY OF THE NOTES
Certain of the Company's assets and operations are located in its
subsidiaries. Accordingly, to a certain extent the Company must rely on
dividends and other advances and transfers of funds from its subsidiaries to
generate the funds necessary to meet the Company's debt service obligations,
including payment of principal and interest on the Notes. The ability of the
Company's subsidiaries to pay such dividends and make such advances and
transfers will be subject to applicable state and foreign law regulating the
payment of dividends and the terms of the Company's existing bank agreements and
the Indenture. Claims of creditors of the Company's subsidiaries, including
general creditors, will generally have priority as to the assets of such
subsidiaries over the claims of the Company and the Holders of the Notes and
therefore the Notes are effectively subordinated to all liabilities of the
Company's subsidiaries. Further, because the Company has pledged as collateral
all of its and its North American subsidiaries' accounts receivable,
inventories, equipment and certain other assets, including its U.S. corporate
headquarters, to its existing lenders, any acceleration of the indebtedness
secured by such collateral may exhaust this collateral before the Company can
repay in full or in part other indebtedness of the Company, including the Notes.
In addition, the Company has guaranteed the debt obligations of certain of its
domestic and foreign subsidiaries.
The Notes rank junior to all Senior Indebtedness of the Company and
generally rank pari passu with all existing and future unsubordinated
indebtedness of the Company.
If the Company becomes insolvent or is liquidated or if any of its secured
indebtedness is accelerated, the holders of such secured indebtedness would be
entitled to payment in full out of the assets securing such indebtedness prior
to payment to Holders of the Notes. If the holders of secured indebtedness were
to foreclose on the collateral securing the Company's obligations to them, it is
possible that there would be insufficient assets remaining after satisfaction in
full of all such secured indebtedness to satisfy fully the claims of Holders of
the Notes. See 'Description of Notes.'
In addition, the Company conducts certain of its operations through
subsidiaries. To the extent that any such subsidiary incurs indebtedness and
becomes insolvent or is liquidated, secured and unsecured creditors of such
subsidiary would be entitled to payment from the proceeds of such subsidiary's
assets before the Company and its creditors would derive any value from such
subsidiary's assets. The Company's subsidiaries in the future may incur
additional indebtedness, subject to the restrictions of the Company's existing
bank agreements and the Indenture. See 'Description of Notes.'
RECENT OPERATING RESULTS
The Company's net revenues declined from $215.0 million for the nine months
ended May 31, 1996 to $147.3 million for the nine months ended May 31, 1997 and
from $566.7 million in fiscal 1995 to $161.9 million in fiscal 1996. The Company
had a net loss of $(59.1) million for the nine months ended May 31, 1996 and a
net loss of $(105.5) million for the nine months ended May 31, 1997 and net
earnings of $44.8 million in fiscal 1995 and a net loss of $(221.4) million in
fiscal 1996. The loss for fiscal 1996 includes, among other things, the second
and fourth quarter special cartridge video charges taken by the Company
aggregating approximately $114 million. Adjustments in the fourth quarter of
fiscal 1996, on a pre-tax basis, aggregated $138.3 million, a
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portion of which related to prior quarters. Accordingly, for comparative
quarterly purposes, during fiscal 1997, the 1996 quarterly operating results may
not necessarily be indicative of the results of operations for such quarterly
periods if these year-end adjustments could have been allocated to the
respective quarters. The Company's revenues and operating results from the sale
of its Software for 32- and 64-bit hardware platforms and for PCs during fiscal
1997 will be materially less than its revenues and operating profits in fiscal
1994 and 1995. The Company may not be able to offset the decline in 16-bit
Software sales with increased sales of Software for the new Entertainment
Platforms and PCs in fiscal 1998 and beyond. In such event, the Company's
results of operations and profitability will continue to be materially adversely
affected. See 'Management's Discussion and Analysis of Financial Condition and
Results of Operations--Results of Operations.'
LIQUIDITY AND BANK RELATIONSHIPS
The Company's net cash used in operations was approximately $25.3 million
and $11.0 million for the nine months ended May 31, 1996 and 1997, respectively.
An income tax refund of approximately $53 million related to the carryback of
the Company's loss for fiscal 1996 was included in the net cash used in
operating activities during the nine months ended May 31, 1997. The Company's
net cash used in operations increased from approximately $7.3 million in fiscal
1995 to approximately $38.3 million in fiscal 1996. Without giving effect to the
tax refund during the first quarter of fiscal 1997, the Company has experienced
negative cash flow from operations in recent periods primarily due to the
industry transition from 16-bit to 32- and 64-bit Entertainment Platforms and
related Software titles and due to increased operating expenses.
The Company anticipates that its cash flows from operations will not be
sufficient to cover its operating expenses during the remainder of fiscal 1997
or into fiscal 1998. There can be no assurance that the Company's operating
expenses will not materially exceed cash flows available from the Company's
operations in future periods. To provide liquidity, the Company has reduced the
number of its employees, raised approximately $47.4 million of net proceeds from
the Initial Offering, sold substantially all of the assets of its redemption
games subsidiary and is currently pursuing various alternatives, including
further expense reductions, the raising of additional capital, and the sale of
certain other assets.
As discussed below, the Company (i) on March 5, 1997, sold substantially
all of the assets and certain liabilities of Lazer-Tron for $6 million in cash,
(ii) used approximately $16.0 million of the net proceeds from the Initial
Offering to retire its indebtedness to Midland and $2.0 million of such proceeds
to pay down the mortgage loan from Fleet and (iii) recently effected a series of
amendments to its covenants with BNY and Fleet in connection with obtaining
waivers of its defaults under those agreements. There can be no assurance that
additional capital infusions will be available or that any additional capital
infusions or asset sales could be effected on satisfactory terms. In addition to
the foregoing, the Company's liquidity is materially dependent in the short-term
on the Company's ability to achieve its anticipated sales levels for its
Software titles, including Turok: Dinosaur Hunter, its ability to obtain
appropriate letters of credit for initial sales of Software for the Nintendo N64
platform, and in the future on its ability to develop and market 'hit' Software
for the Entertainment Platforms that dominate the interactive entertainment
market. See 'Management's Discussion and Analysis of Financial Condition and
Results of Operations--Liquidity.'
At August 31, 1996 and November 30, 1996, the Company was in default of
various financial and other covenants under its loan agreements with BNY and
Fleet. The inclusion of a 'going concern' paragraph in respect of the Company's
fiscal 1996 audit report also constituted an event of default under the loan
facility with BNY. BNY and Fleet have waived the defaults at August 31, 1996 and
November 30, 1996, including the 'going concern' default. As of May 31, 1997,
the Company was in default of certain financial covenants under its agreement
with BNY, which defaults have been waived by BNY. The Company has negotiated
revised financial covenants for future periods with BNY. Although the Company
believes it will be able to achieve compliance with the new financial covenants
negotiated with BNY, there can be no assurance that additional covenant
defaults, or a payment default, will not occur in the future. In connection with
the establishment of a research and development joint venture, the Company was
in default of certain covenants under its agreement with BNY, which default has
been waived through September 30, 1997 subject to the Company's delivery to BNY
of certain documents and collateral. The Company's ability to comply with its
covenants and meet its obligations could be affected by factors beyond its
control. There can be no assurance that the Company will be able to obtain
waivers of any future default or that the lenders will not exercise their
remedies including acceleration of the loans, demand for immediate repayment
and/or foreclosure on any collateral securing such loans. In such event, the
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Company's operations would be materially adversely affected and the Company may
be prohibited from paying interest and/or principal on and/or redeeming the
Notes.
NASDAQ DELISTING AND LIQUIDITY OF COMMON STOCK
In order to maintain the listing of the Common Stock on the NASDAQ National
Market System (the 'NMS'), the Company is currently required, among other
things, to maintain net tangible assets of at least $1 million (which amount is
anticipated to increase to at least $2 million at August 31, 1997). At May 31,
1997, the Company did not meet this requirement. Based on its review of certain
information provided by the Company, NASDAQ has informed the Company that it has
determined that the Common Stock remain listed on the NMS pending NASDAQ's
review of the Company's status upon filing of the Company's Annual Report on
Form 10-K for the year ending August 31, 1997. No assurance can be given that
the Common Stock will not be delisted from trading on the NMS thereafter.
If the Common Stock were to be delisted from trading on the NMS, in order
to obtain relisting of the Common Stock on the NMS, the Company must satisfy
quantitative designation criteria which it does not currently meet. No assurance
can be given that the Company will meet such relisting criteria in the near
future. In addition, the NASDAQ Stock Market has proposed new standards which
raise the minimum net tangible assets requirement for new listings on the NMS to
a level which the Company believes it will not be able to meet in the near
future, the Company does currently meet the proposed alternative new standards
to maintain eligibility for trading on the NMS. No assurance can be given that
the proposed rules will be adopted or that the Company will be able to rely on
the proposed maintenance requirements at this time in order to avoid delisting
of the Common Stock.
If the Common Stock were to be delisted from trading on the NMS, the
Company may seek to have the Common Stock listed for trading on the NASDAQ
Small-Cap Market. Although the Company meets the current listing criteria for
the NASDAQ Small-Cap Market, no assurance can be given as to the Company's
ability to obtain listing for the Common Stock on the NASDAQ Small-Cap Market or
as to the Company's ability to meet the maintenance requirements thereof.
If the Common Stock were to be delisted from trading on the NMS and were
neither relisted thereon nor listed for trading on the NASDAQ Small-Cap Market,
trading, if any, in the Common Stock may continue to be conducted on the OTC
Bulletin Board or in the non-NASDAQ over-the-counter market.
Delisting of the Common Stock would result in limited release of the market
price of the Common Stock and limited news coverage of the Company and could
restrict investors' interest in the Common Stock and materially adversely affect
the trading market and prices for the Common Stock and the Company's ability to
issue additional securities or to secure additional financing. In addition, if
the Common Stock were not listed and the trading price of the Common Stock were
less than $5.00 per share, the Common Stock could be subject to Rule 15g-9 under
the Securities Exchange Act of 1934 which, among other things, requires that
broker/dealers satisfy special sales practice requirements, including making
individualized written suitability determinations and receiving a purchaser's
written consent prior to any transaction. In such case, the Common Stock could
also be deemed to be a 'penny stock' under the Securities Enforcement and Penny
Stock Reform Act of 1990, which would require additional disclosure in
connection with trades in the Common Stock, including the delivery of a
disclosure schedule explaining the nature and risks of the penny stock market.
Such requirements could severely limit the liquidity of the Common Stock.
GOING CONCERN CONSIDERATIONS
The report of KPMG Peat Marwick LLP ('KPMG'), independent auditors for the
Company, on the Company's financial statements for the fiscal year ended August
31, 1996 includes an explanatory paragraph relating to substantial doubt as to
the ability of the Company to continue as a going concern. The Company incurred
significant losses from operations in fiscal 1996 and in the first nine months
of fiscal 1997 and anticipates incurring material losses for the remainder of
fiscal 1997. The Company was in default of various covenants under the
agreements with certain of its lenders. In addition, the Company has
experienced, and expects to continue to experience during fiscal 1997, and into
fiscal 1998, negative cash flow from operations, and is a party to significant
litigation, including various class action lawsuits. A 'going concern'
explanatory paragraph is expected to have a material adverse effect on the terms
of any bank financing or capital the Company may seek in the future. See Note 2
of Notes to Consolidated Financial Statements.
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LITIGATION
The Company and certain of its directors and executive officers are parties
to various litigations, including federal class actions, arising in connection
with the December 1995 revision of the Company's previously announced earnings,
the 1995 acquisition of Lazer-Tron, statements made with respect to the
Company's agreement with WMS Industries, Inc., a dispute with Spectrum Holobyte
California, Inc. and distribution arrangements with Digital Pictures, Inc. and
Sound Source Interactive, Inc. The Company is also subject to a private order of
investigation from the Commission arising out of the Company's earnings estimate
for fiscal 1995 and its decision in the second quarter of fiscal 1996 to exit
the 16-bit portable and cartridge markets and various other litigations and
claims arising in the ordinary course of business. See 'Legal Proceedings' and
Note 20 of Notes to the Consolidated Financial Statements. The Company could
issue significant amounts of its securities and/or use a portion of its cash in
order to settle such litigations. The Company could also be subject to material
claims from the former stockholders of Sculptured Software and Probe alleging,
among other things, violations of the antifraud provisions of federal and state
securities laws, breaches of contractual arrangements and/or based on the
inability of such persons, due to the Company's alleged failure to effect resale
registration statements, to sell all or a portion of the shares of Common Stock
owned by them at times when the Common Stock was publicly traded at
significantly higher prices as compared to its current market price.
Other than ordinary course litigations and the litigations that have been
settled subject to court approval, the resolution of which the Company believes
would not have a material adverse effect on its business, an adverse result in
the other litigations to which the Company is a party could have a material
adverse effect on the Company. In conjunction with certain litigations for which
the settlement obligation is currently probable and estimable (see 'Legal
Proceedings'), the Company recorded a primarily noncash charge of $8.3 million
in the quarter ended May 31, 1997. No assurance can be given that the Company
will not be required to record additional material charges in future periods in
conjunction with the various litigations to which the Company is a party. Any
additional charges to earnings could have a material adverse effect on the
financial condition and results of operations of the Company. A portion of any
settlement or judgment in one or more of the litigations to which the Company is
a party may be covered by the Company's insurance.
INDUSTRY TRENDS; PLATFORM TRANSITION; TECHNOLOGICAL CHANGE
The interactive entertainment industry is characterized by, and the Company
anticipates that in both the short- and long-term future it will continue to
undergo, rapid technological change due in large part to (i) the introduction of
Entertainment Platforms incorporating more advanced processors and operating
systems, (ii) the impact of technological changes embodied in PCs and Software
therefor, (iii) the development of electronic and wireless delivery systems, and
(iv) the entry and participation of new companies in the industry. These factors
have resulted in Entertainment Platform and Software life cycles. As a result,
the Company must continually anticipate and adapt its products to emerging
Entertainment Platforms and systems and evolving consumer preferences. There can
be no assurance that the Company will be successful in developing and marketing
Software for new Entertainment Platforms. No single Entertainment Platform or
system has achieved long-term dominance. The process of developing Software
products such as those offered by the Company is extremely complex and is
expected to become more complex and expensive in the future as consumers demand
more sophisticated and elaborate features and as new platforms and technologies
are introduced.
Development of Software for emerging Entertainment Platforms requires
substantial investments in research and development for new and improved
technologies in the areas of graphics, sound, digitized speech, music and video.
Such research and development must occur well in advance of the release of new
Entertainment Platforms in order to allow sufficient lead time to develop and
introduce new Software products on a timely basis. This generally requires the
Company to predict the probable success of future Entertainment Platforms as
much as 12 to 24 months prior to their introduction.
Substantially all of the Company's revenues in fiscal 1997 have been, and
are anticipated to continue to be, derived from the sale of Software designed to
be played on the Sony PlayStation, the Sega Saturn, the Nintendo N64 and PCs. At
any given time, the Company has expended significant development and marketing
resources on product development for platforms (such as the 16-bit Nintendo SNES
and Sega Genesis platforms) that could have shorter life cycles than the Company
expected, as in fiscal 1996, or on products designed for new platforms (such as
the Sony PlayStation and Nintendo N64) that have not yet achieved large
installed bases. If the Company does not accurately predict the success, size of
the installed base and life cycle of existing or future
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Entertainment Platforms due to, among other things, the long Software
development lead times involved, it could be in the position, as it was in
fiscal 1996 and in the first three quarters of fiscal 1997, of marketing
Software for (i) new Entertainment Platforms that have not yet achieved
significant market penetration and/or (ii) Entertainment Platforms that have
become or are becoming obsolete due to the introduction or success of new
Entertainment Platforms. There can be no assurance that the Company will be able
to predict accurately such matters, and its failure to do so would have a
material adverse effect on the Company.
Failure to develop products for Entertainment Platforms that achieve
significant market acceptance, discontinuance of development for a platform that
has a longer than expected life cycle, development for a platform that does not
achieve a significant installed base or continued development for a platform
that has a shorter than expected life cycle, may have a material adverse effect
on the Company's business, financial condition and operating results.
The Company's results of operations and profitability have been materially
adversely affected during the fiscal year ended August 31, 1996 and the nine
months ended May 31, 1997, and are anticipated to be so affected during the last
quarter of fiscal 1997, by the material decline in sales of the Company's 16-bit
Software and the transition to the new Entertainment Platforms described herein.
The Company is currently developing Software for the Sony PlayStation, the Sega
Saturn, the Nintendo N64 and PCs. There are a significant number of Software
titles for the 32-bit platform market competing for limited shelf space. In
addition, the 32-bit (PlayStation and Saturn) and 64-bit (N64) platforms have
not yet achieved market penetration similar to that of the 16-bit platforms
(Nintendo SNES and Sega Genesis); accordingly, the number of units of each
Software title sold for these newer Entertainment Platforms is significantly
less than the number of units of a title generally sold during 1993, 1994 and
1995 for the 16-bit platforms. There can be no assurance that any of the new
platforms will achieve market penetration similar to that achieved by the
Nintendo SNES and Sega Genesis systems.
REVENUE AND EARNINGS FLUCTUATIONS; SEASONALITY
The Company has historically derived substantially all of its revenues from
the publication and distribution of Software for then dominant Entertainment
Platforms. The Company's revenues are subject to fluctuation during transition
periods, as occurred in fiscal 1996 and the first three quarters of fiscal 1997,
when new Entertainment Platforms have been introduced but none has achieved mass
market penetration. In addition, the Company's earnings are materially affected
by the timing of release of new Software titles produced by the Company. Product
development schedules are difficult to predict due, in large part, to the
difficulty of scheduling accurately the creative process and, with respect to
Software for new Entertainment Platforms, the use of new development tools and
the learning process associated with development for new technologies. Earnings
may also be materially impacted by other factors including, but not limited to
(i) the level and timing of market acceptance of Software titles, (ii) increases
or decreases in development and/or promotion expenses for new titles and new
versions of existing titles, (iii) the timing of orders from major customers and
(iv) changes in shipment volume.
A significant portion of the Company's revenues in any quarter is generally
derived from sales of new Software titles introduced in that quarter or in the
immediately preceding quarter. If the Company were unable to commence volume
shipments of a significant new product during the scheduled quarter, the
Company's revenues and earnings would likely be materially and adversely
affected in that quarter. In addition, because a majority of the unit sales for
a product typically occur in the first 90 to 120 days following the introduction
of the product, the Company's earnings may increase significantly in a period in
which a major product introduction occurs and may decline in the following
period or in periods in which there are no major product introductions. Certain
operating expenses are fixed and do not vary directly in relation to revenue.
Consequently, if net revenue is below expectations, the Company's operating
results are likely to be materially and adversely affected.
The interactive entertainment industry is highly seasonal. Typically, net
revenue is highest during the last calendar quarter (which includes the holiday
buying season), declines in the first calendar quarter, is lowest in the second
calendar quarter and increases in the third calendar quarter. The seasonal
pattern is due primarily to the increased demand for Software during the
year-end holiday buying season. The Company's earnings, however, vary
significantly and are largely dependent on releases of major new products and,
as such, may not necessarily reflect the seasonal patterns of the industry as a
whole. The Company expects that its operating results will continue to fluctuate
significantly in the future.
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DEPENDENCE ON ENTERTAINMENT PLATFORM MANUFACTURERS; NEED FOR LICENSE RENEWALS
In fiscal years 1994, 1995 and 1996, the Company derived 45%, 47% and 29%
of its gross revenues, respectively, from sales of Nintendo-compatible products
and 55%, 46%, and 36% of its gross revenues, respectively, from sales of
Sega-compatible products. In addition, the Company derived 19% of its gross
revenues from sales of Sony-compatible products in fiscal year 1996. For the
nine months ended May 31, 1997, the Company derived 60%, 4% and 16% of its gross
revenues, respectively, from sales of Nintendo-, Sega- and Sony-compatible
products. Accordingly, the Company is substantially dependent on Nintendo as the
sole manufacturer of N64 hardware and Software for that platform and as the sole
licensor of the proprietary information and the technology needed to develop
Software for that platform; on Sega as the sole manufacturer of Saturn hardware
and as the sole licensor of the proprietary information and the technology
needed to develop Software for that platform; and on Sony as the sole
manufacturer of PlayStation hardware and Software and as the sole licensor of
the proprietary information and the technology needed to develop Software for
that platform. The dedicated hardware platform manufacturers have in the past
and may in the future limit the number of titles that the Company can release in
any year, which may limit any future growth in sales.
The Company has historically been able to renew and/or negotiate extensions
of its Software license agreements with Entertainment Platform developers.
However, there can be no assurance that, at the end of their current terms, the
Company will continue to be able to do so or that the Company will be successful
in negotiating definitive license agreements with developers of new hardware
systems. The Company has current, executed license agreements with Sony with
respect to the PlayStation platform in the United States, Canada and Japan and
is operating under an oral agreement with respect to the development and
publishing of titles for the Playstation in Europe. Currently, the Company and
Sega are operating in the ordinary course under the terms of an agreement that
expired in December 1995 and, with respect to the Saturn platform, under an oral
agreement and other arrangements. The Company has executed an agreement with
Nintendo with respect to the N64 platform, covering the release of approved
titles in Japan, and an agreement with respect to the development and production
of one Software title for N64 in the Western Hemisphere. The Company is yet to
execute a formal agreement with Nintendo with respect to further development of
titles for the N64 platform in North America and Europe, although the Company
has been advised of the basic terms of such N64 license and is doing business
with Nintendo under an oral agreement and other arrangements. There can be no
assurance, however, that the Company will be successful in negotiating
agreements with respect to the Sony PlayStation, Sega Saturn and Nintendo N64
platforms. The inability to negotiate agreements with developers of new
Entertainment Platforms or the termination of all of the Company's license
agreements or other arrangements will, and the termination of any one of the
Company's license agreements or other arrangements could, have a material
adverse effect on the Company's financial position and results of operations.
See 'Business--Platform License Agreements' and 'Intellectual Property
Licenses.'
The Company depends on Nintendo, Sega and Sony for the protection of the
intellectual property rights to their respective Entertainment Platforms and
technology and their ability to discourage unauthorized persons from producing
Software for Nintendo, Sega and Sony platforms. The Company also relies upon the
Entertainment Platform manufacturers for the manufacture of certain software
cartridge and CD-ROM Software.
RELIANCE ON NEW PRODUCTS; PRODUCT DELAYS
The Company's ability to maintain favorable relations with retailers and to
receive the maximum advantage from its advertising expenditures is dependent in
part on its ability to provide retailers with a timely and continuous flow of
product. The life cycle of a Software title generally ranges from less than
three months to upwards of twelve months, with the majority of sales occurring
in the first 90-120 days after release. The Company generally actively markets
its 10-15 most recent releases. Accordingly, the Company is constantly required
to develop, introduce and sell new Software in order to generate revenue and/or
to replace declining revenues from previously released products. In addition,
consumer preferences for Software are difficult to predict, and few Software
products achieve sustained market acceptance. There can be no assurance that new
products introduced by the Company will be released in a timely fashion, will
achieve any significant degree of market acceptance, or that such acceptance
will be sustained for any meaningful period. Competition for retail shelf space,
consumer preferences and other factors could result in the shortening of the
life cycle for older products and increase the importance of the Company's
ability to release product on a timely basis.
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The Company's current production schedules contemplate that the Company
will commence shipment of a number of new products in fiscal 1998. Shipment
dates will vary depending on the Company's own quality assurance testing, as
well as that by the applicable dedicated platform manufacturer, and other
development factors. The Company generally submits new games to the dedicated
platform manufacturers and other intellectual property licensors for approval
prior to development and/or manufacturing. Rejection as a result of bugs in
Software or a substantial delay in the approval of a product by an Entertainment
Platform manufacturer or licensor could have a material adverse effect on the
Company's financial condition and results of operations. In the past, the
Company has experienced significant delays in the introduction of certain new
products. There can be no assurance that such delays will not occur or
materially adversely affect the Company in the future. It is likely that in the
future certain new products will not be released in accordance with the
Company's internal development schedule or the expectations of public market
analysts and investors. A significant delay in the introduction of, or the
presence of a defect in, one or more new products could have a material adverse
effect on the ultimate success of such product. If the Company is not able to
develop, introduce and sell new competitive Software products on a timely basis,
its results of operations and profitability would be materially adversely
affected.
RELIANCE ON 'HIT' TITLES
The market for Software is 'hits' driven and, accordingly, the Company's
future success is dependent in large part on its ability to develop and market
'hit' titles for Entertainment Platforms with significant installed bases.
During the fiscal quarter ended May 31, 1997, sales of the Company's top title
accounted for approximately 57% of the Company's gross sales for that period.
There can be no assurance that the Company will be able to publish 'hit' titles
for Entertainment Platforms with significant installed bases and, if it is
unable to do so for any reason, its financial condition, results of operations
and profitability could be materially adversely affected, as they were in fiscal
1996 and in the first three quarters of fiscal 1997.
INVENTORY MANAGEMENT; RISK OF PRODUCT RETURNS
The Company is generally not contractually obligated to accept returns,
except for defective product. However, the Company permits its customers to
return or exchange Software titles and may provide price protection and
discounts on slow moving titles. Management must make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting periods.
Among the more significant of such estimates are allowances for estimated
returns, price concessions and other discounts. At the time of product shipment,
the Company establishes reserves in respect of such estimates taking into
account the potential for product returns and other discounts based on
historical return rates, seasonality, retail inventories and other factors. In
fiscal 1996, price protection, returns, exchanges and other concessions were
materially higher than the Company's reserves therefor, as a result of which the
Company's results of operations and liquidity in fiscal 1996 were materially
adversely affected. The Company believes that, as of May 31, 1997, it has
established adequate reserves for future price protection, returns, exchanges
and other concessions but there can be no assurance that the Company's reserves
therefor will not be exceeded, which event would have a material adverse affect
on the Company's financial condition and results of operations.
In addition, the Company has offered and anticipates that it will continue
to offer stock-balancing programs for its PC Software. The Company has
established reserves for such programs, which have not been material to date. No
assurance can be given that future stock-balancing programs will not become
material and/or will not exceed the Company's reserves for such programs and, if
so exceeded, the Company's results of operations and financial condition could
be materially adversely affected. See 'Management's Discussion and Analysis of
Financial Condition and Results of Operations.'
INCREASED PRODUCT DEVELOPMENT COSTS
In order to manage its Software development process and to ensure access to
a pool of Software developers, development tools and engines in an increasingly
competitive market, the Company acquired three Software development studios in
calendar 1995. However, such acquisitions resulted in the Company's fixed
Software development and operating costs being significantly higher in fiscal
1996 and in the first nine months of fiscal 1997 as compared to historical
levels and such costs were not offset by revenues from Software developed by the
studios. These costs further contributed to the Company's results of operations
and profitability being materially
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adversely affected in fiscal 1996 and in the first nine months of fiscal 1997.
No assurance can be given that such costs will not continue to have a material
adverse effect on the Company's operations in future periods.
COMPETITION
The market for consumer Software products is highly competitive. Only a
small percentage of products introduced in the Software market achieve any
degree of sustained market acceptance. Competition is based primarily upon
price, access to retail shelf space, product enhancements, ability to operate on
popular platforms, availability of titles (including 'hits'), new product
introductions, marketing support and distribution systems.
The Company competes with a variety of companies which offer products that
compete directly with one or more of the Company's products. Typically, the
Company's chief competitor on an Entertainment Platform is the hardware
manufacturer of that platform, to whom the Company pays royalties and, in some
cases, manufacturing charges. Accordingly, the hardware manufacturers have a
price, marketing and distribution advantage with respect to Software marketed by
them and such advantage is particularly important in a mature or declining
market which supports fewer full-priced titles and is characterized by customers
who make purchasing decisions on non-'hit' products based primarily on price (as
compared to developing markets with limited Software titles, when price has been
a less important factor in Software sales). The Company's competitors vary in
size from very small companies with limited resources to very large corporations
with greater financial, marketing and product development resources than those
of the Company, such as Nintendo, Sega and Sony. The Company's competitors also
include a number of independent Software publishers licensed by the hardware
manufacturers.
Additionally, the entry and participation of new industries and companies,
including diversified entertainment companies, in markets in which the Company
competes may adversely affect the Company's performance in such markets. The
availability of significant financial resources has become a major competitive
factor in the Software industry, principally as a result of the technical
sophistication of advanced multimedia computer game products requiring
substantial investments in research and development. In particular, many of the
Company's competitors are developing on-line interactive computer games and
interactive networks that will be competitive with the Company's products. As
competition increases, significant price competition and reduced profit margins
may result. In addition, competition from new technologies may reduce demand in
markets in which the Company has traditionally competed. Prolonged price
competition or reduced demand as a result of competing technologies would have a
material adverse effect on the Company's business, financial condition and
operating results. No assurance can be given that the Company will be able to
compete successfully. See 'Business--Competition.'
INTELLECTUAL PROPERTY LICENSES AND PROPRIETARY RIGHTS
To date, most of the Company's Software incorporates for marketing purposes
properties or trademarks owned by third parties, such as the World Wrestling
Federation ('WWF'), the National Basketball Association ('NBA'), National
Football League ('NFL') or their respective players' associations, which
properties are licensed to the Company. In addition, the Company in the past has
obtained agreements with outside developers for the development of a significant
portion of its Software under such agreements with independent developers, and
in such cases the Company usually acquires copyrights to the underlying Software
and obtains the exclusive right to such Software for a period of time and may
have a limited period in which to market and distribute Software. To the extent
future product releases are not derived from the Company's proprietary
properties, the Company's future success will also be dependent upon its ability
to procure licenses for additional popular intellectual properties. There is
intense competition for such licenses, and there can be no assurance that the
Company will be successful in acquiring additional intellectual property rights
with significant commercial value. There can be no assurance that such licenses
will be available on reasonable terms or at all.
The Company relies primarily on a combination of copyrights, trade secret
laws, patent and trademark laws, nondisclosure agreements and other copy
protection methods to protect its product and proprietary rights. It is the
Company's policy that all employees and third-party developers sign
nondisclosure agreements. There can be no assurance that these measures will be
sufficient to protect the Company's intellectual property rights against
infringement. The Company has 'shrinkwrap' license agreements with the end users
of its PC products, but the Company relies on the copyright laws to prevent
unauthorized distribution of its other Software. Existing copyright laws afford
only limited protection. However, notwithstanding the Company's rights to its
Software, it may be possible for unauthorized third parties to copy illegally
the Company's products or to reverse engineer or
17
<PAGE>
otherwise obtain and use information that the Company regards as proprietary.
Unauthorized illegal copying occurs within the Software industry, and if a
significant amount of unauthorized copying of the Company's published products
or products distributed by it were to occur, the Company's business, operating
results and financial condition could be materially adversely affected. Policing
illegal use of the Company's products is difficult, and Software piracy can be
expected to be a persistent problem. Further, the laws of certain countries in
which the Company's products are or may be distributed do not protect the
Company's products and intellectual property rights to the same extent as the
laws of the United States.
The Company believes that its products, trademarks and other proprietary
rights do not infringe on the proprietary rights of third parties. However, as
the number of Software products in the industry increases, the Company believes
that claims and lawsuits with respect to Software infringement will increase.
From time to time, third parties have asserted that features or content of
certain of the Company's products may infringe upon intellectual property rights
of such parties, and the Company has asserted that third parties have likewise
infringed the Company's proprietary rights; certain of these claims have
resulted in litigation by and against the Company. To date, no such claims have
had an adverse effect on the Company's ability to develop, market or sell its
products. There can be no assurance that existing or future infringement claims
by or against the Company will not result in costly litigation or require the
Company to license the intellectual property rights of third parties. See 'Legal
Proceedings.'
The owners of intellectual property licensed by the Company generally
reserve the right to protect such intellectual property against infringement.
See 'Business--Intellectual Property Licenses.'
INTERNATIONAL SALES
International sales represented approximately 25%, 41% and 50% of the
Company's net revenues in fiscal 1995 and 1996 and for the nine months ended May
31, 1997, respectively. The Company expects that international sales will
continue to account for a significant portion of its net revenues in future
periods. International sales are subject to inherent risks, including unexpected
changes in regulatory requirements, tariffs and other economic barriers,
fluctuating exchange rates, difficulties in staffing and managing foreign
operations and the possibility of difficulty in accounts receivable collection.
Because the Company believes exposure to foreign currency losses is not
currently material, the Company currently has no formal financial instruments in
place as a hedge against foreign currency risks. In some markets, localization
of the Company's products is essential to achieve market penetration. The
Company may incur incremental costs and experience delays in localizing its
products. These or other factors could have a material adverse effect on the
Company's future international sales and, consequently, on the Company's
business, operating results and financial condition.
NEW BUSINESS VENTURES
During the last three fiscal years, the Company has completed acquisitions,
or has commenced operations, of various new businesses including (i) the
publication of comic books, (ii) the distribution of Affiliated Labels Software,
(iii) the marketing of its motion capture technology and studio services, and
(iv) the distribution of coin-operated video games. The Company also acquired
three Software development studios in calendar 1995. The Company has made
significant investments and has incurred significant expenses in connection with
the acquisition and/or establishment of such businesses in fiscal 1995 and 1996,
and anticipates that it will continue to incur significant expenses in
connection with certain of the operations thereof. To date, none of such new
businesses has generated material revenues and there can be no assurance that
such businesses will generate material revenues or the timing thereof. To the
extent the Company continues to incur material expenses in connection with such
ventures during periods when they do not generate significant revenues, the
Company's results of operations and profitability will be materially adversely
affected.
DEPENDENCE ON KEY PERSONNEL AND EMPLOYEES
The interactive entertainment industry is characterized by a high level of
employee mobility and aggressive recruiting among competitors for personnel with
technical, marketing, sales, product development and management skills. The
ability to identify, hire and retain such personnel is essential to the
Company's success. No assurance can be given that the Company will be able to
attract and retain such personnel or that it will not experience significant
cost increases in order to do so.
In particular, the Company is highly dependent upon the management services
of Gregory Fischbach, Co-Chairman of the Board and Chief Executive Officer, and
James Scoroposki, Co-Chairman of the Board and
18
<PAGE>
Senior Executive Vice President, of the Company. The loss of the services of any
of the Company's senior management could have a material adverse effect on the
Company's business, operating results and financial condition. Although the
Company has employment agreements with Messrs. Fischbach and Scoroposki, there
can be no assurance that such employees will not leave or compete with the
Company. The Company's failure to attract additional qualified employees or to
retain the services of key personnel could materially and adversely affect the
Company's business, operating results and financial condition.
ANTI-TAKEOVER PROVISIONS
The Company's Board of Directors has the authority to issue shares of
preferred stock and to determine the designations, preferences and rights and
the qualifications or restrictions of those shares without any further vote or
action by the stockholders. The rights of the holders of Common Stock will be
subject to, and may be adversely affected by, the rights of the holders of any
preferred stock that may be issued in the future. The issuance of preferred
stock, while providing desirable flexibility in connection with possible
acquisitions and other corporate actions, could have the effect of making it
more difficult for a third-party to acquire a majority of the outstanding voting
stock of the Company. In addition, the Company is subject to the anti-takeover
provisions of Section 203 of the Delaware General Corporation Law (the 'DGCL').
In general, this statute prohibits a publicly held Delaware corporation from
engaging in a 'business combination' with an 'interested stockholder' for a
period of three years after the date of the transaction in which the person
became an interested stockholder, unless the business combination is approved in
a prescribed manner. Employment arrangements with certain members of the
Company's management provide for severance payments upon termination of their
employment after a 'change in control' of the Company as defined in such
agreements. See 'Management--Employment Agreements' and 'Description of
Capital Stock.'
VOLATILITY OF STOCK PRICE
There has been a history of significant volatility in the market prices of
companies engaged in the Software industry, including the Company. It is likely
that the market price of the Common Stock will continue to be highly volatile.
Factors such as the timing and market acceptance of product introductions by the
Company, the introduction of products by the Company's competitors, loss of key
personnel of the Company, variations in quarterly operating results or changes
in market conditions in the Software industry generally may, have a significant
impact on the market price of the Common Stock. In the past, the Company has
experienced significant fluctuations in its operating results and, if the
Company's future revenue or operating results or product releases do not meet
the expectations of public market analysts and investors, the price of the
Common Stock would likely be materially adversely affected. In addition, the
stock market has experienced and continues to experience extreme price and
volume fluctuations which have affected the market price of Software companies
and companies in the interactive entertainment industry and which have often
been unrelated to the operating performance of these companies. See 'Market
Price of and Dividends on the Company's Common Equity and Related Matters.'
ABSENCE OF PUBLIC MARKET FOR THE NOTES
Prior to this offering there has been no public market for the Notes. It is
currently anticipated that the Notes will be traded in the over-the-counter
market. There can be no assurance that a regular trading market will develop for
the Notes after this offering or that, if developed, such market will be
sustained or as to the ability of the Holders to sell their Notes or the prices
at which Holders would be able or willing to sell the Notes. If a market for the
Notes does develop, the Notes may trade at a discount from their initial public
offering price, depending on prevailing interest rates, the market for similar
securities, the performance of the Company, the market price of the Common Stock
and other factors.
SHARES ELIGIBLE FOR FUTURE SALE
The Company has 49,713,668 shares of Common Stock issued and outstanding,
of which 16,528,967 shares are 'restricted' securities within the meaning of
Rule 144 under the Securities Act. Generally, under Rule 144, a person who has
held restricted shares for one year may sell such shares, subject to certain
volume limitations and other restrictions, without registration under the
Securities Act. As of the date of this Prospectus, 5,351,099 shares of Common
Stock are covered by effective registration statements under the Securities Act
for sale on a delayed or continuous basis by certain stockholders of the
Company. In addition and subject to certain
19
<PAGE>
limitations, holders of approximately 19,570,759 shares of the Common Stock
(including Common Stock issuable upon the exercise of options or other
convertible securities including the BNY warrants referred to below, 2,625,000
shares covered by warrants granted to certain executive officers of the Company,
the shares of Common Stock issuable upon conversion of the Notes, the issuance
of which shares is covered by the registration statement of which this
Prospectus forms a part and, 2,895,175 shares for which the Company has recently
filed a registration statement on Form S-1), have contractual rights to require
the Company to register such shares for future sale. In addition, the Company
may be required to issue a material number of shares of Common Stock or
securities convertible into Common Stock in connection with settling certain
pending litigations to which it is a party. See 'Legal Proceedings.'
Further, the Company has registered on registration statements on Form S-8
an aggregate of 15,000,000 shares of Common Stock subject to options under the
Company's 1988 Stock Option Plan (the 'Plan'), and on a registration statement
on Form S-8 an aggregate of 123,540 shares of Common Stock issued under the
Company's 1995 Restricted Stock Plan. The Company intends to file a registration
statement on Form S-8 covering the issuance of an additional 10,000,000 shares
of Common Stock subject to options under the Plan. As of May 31, 1997, options
to purchase 14,653,396 shares of Common Stock were outstanding under the Plan,
of which options to purchase 5,255,304 shares were exercisable as of such date.
In addition, options to purchase 653,000 shares of Common Stock were granted
outside the Plan, of which options to purchase 290,007 shares remain outstanding
as of May 31, 1997. BNY has also been granted warrants to purchase 200,000
shares of Common Stock with respect to which BNY has certain registration
rights.
In connection with licensing and distribution arrangements and acquisitions
of other companies, the Company has issued and may continue to issue Common
Stock or securities convertible into Common Stock. Any such issuances or future
issuances of substantial amounts of Common Stock could adversely affect
prevailing market prices for the Common Stock and could adversely affect the
Company's ability to raise capital.
20
<PAGE>
MARKET PRICE OF AND DIVIDENDS ON THE COMPANY'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS
MARKET PRICE
There is no public market for the Notes.
The Common Stock is traded on NASDAQ. On September 19, 1997, the closing
sale price of the Common Stock was $4.0625 per share. As of such date, there
were approximately 1,270 registered holders of record of the Common Stock.
The following table sets forth the range of high and low sales prices for
the Common Stock for each of the periods indicated:
<TABLE>
<CAPTION>
PRICE PERIOD HIGH LOW
- --------------------------------------------------- -------- -------
<S> <C> <C>
Fiscal Year 1996
First Quarter.................................... $28.19 $19.56
Second Quarter................................... 20.00 10.00
Third Quarter.................................... 13.63 7.63
Fourth Quarter................................... 11.88 7.31
Fiscal Year 1997
First Quarter.................................... 8.63 3.94
Second Quarter................................... 6.88 3.00
Third Quarter.................................... 6.13 2.94
Fourth Quarter................................... 4.19 3.75
Fiscal Year 1998
First Quarter (through September 19, 1997)....... 4.19 3.88
</TABLE>
DIVIDEND POLICY
The Company has never declared or paid any cash dividends on the Common
Stock and has no present intention to declare or pay cash dividends on the
Common Stock in the foreseeable future. The Company is subject to various
financial covenants with its lenders that could limit and/or prohibit the
payment of dividends in the future. See 'Management's Discussion and Analysis of
Financial Condition and Results of Operations' and Note 13 of the Notes to
Consolidated Financial Statements. The Company intends to retain earnings, if
any, which it may realize in the foreseeable future to finance its operations.
USE OF PROCEEDS
The Company will not receive any proceeds from the sale of the Notes (or
the Shares issuable upon conversion thereof) by the Selling Securityholders.
21
<PAGE>
CAPITALIZATION
The following table sets forth the consolidated capitalization of the
Company at May 31, 1997. This table should be read in conjunction with the
Consolidated Financial Statements of the Company and the notes thereto, and
other information included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
MAY 31, 1997
-----------------
<S> <C>
(IN THOUSANDS)
LIABILITIES:
Short-term:
Short-term borrowings........................................................................ $ 5,550
Current portion of long-term debt............................................................ 1,168
Obligations under capital leases--current.................................................... 1,824
-----------------
Total short-term debt..................................................................... 8,542
-----------------
Long-term debt:
Convertible Subordinated Notes............................................................... 50,000
Obligations under capital leases--non-current................................................ 2,529
Mortgage Note................................................................................ 2,835
-----------------
Total debt................................................................................ 63,906
-----------------
STOCKHOLDERS' DEFICIENCY:
Preferred stock, $0.01 par value; 1,000 shares authorized; none issued....................... --
Common stock, $0.02 par value; 100,000 shares authorized; 50,121 shares issued............... 1,002
Additional paid-in capital................................................................... 172,514
Accumulated deficit.......................................................................... (176,188)
Treasury stock, 474 shares................................................................... (2,904)
Foreign currency translation adjustment...................................................... (1,611)
-----------------
Total stockholders' deficiency............................................................ (7,187)
-----------------
Total capitalization...................................................................... $ 56,719
-----------------
-----------------
</TABLE>
22
<PAGE>
SELECTED FINANCIAL INFORMATION
The following selected consolidated financial information should be read in
conjunction with the Consolidated Financial Statements of the Company and the
notes thereto and the 'Management's Discussion and Analysis of Financial
Condition and Results of Operations' section appearing elsewhere herein. The
consolidated financial statement information as of and for the fiscal years
ended August 31, 1994, 1995 and 1996 are derived from, and are qualified by
reference to, the audited Consolidated Financial Statements of the Company
included elsewhere in this Prospectus. The consolidated financial statement data
with respect to the fiscal years ended August 31, 1992 and 1993 are derived from
audited Consolidated Financial Statements of the Company not included in this
Prospectus. The Consolidated Financial Statements of the Company for the fiscal
years ended August 31, 1992, 1993, 1994 and 1995 have been audited by Grant
Thornton LLP, independent certified public accountants. The auditors' report for
fiscal 1995 includes an emphasis paragraph as to uncertainty relating to the
eventual outcome of certain class action lawsuits. The Consolidated Financial
Statements of the Company for fiscal 1996 have been audited by KPMG Peat Marwick
LLP, independent certified public accountants. The auditors' report for fiscal
1996 includes an explanatory paragraph relating to the Company's ability to
continue as a 'going concern' and indicates that the auditors were unable to
review the selected quarterly data in accordance with professional standards.
The consolidated financial statement data as of and for the nine months ended
May 31, 1996 and 1997 has been derived from, and is qualified by reference to,
the unaudited Consolidated Financial Statements of the Company included
elsewhere in this Prospectus.
<TABLE>
<CAPTION>
NINE MONTHS ENDED MAY
FISCAL YEAR ENDED AUGUST 31, 31,
--------------------------------------------------------- ----------------------
1992(1) 1993 1994(2) 1995(3) 1996(4) 1996(5) 1997
-------- -------- -------- -------- --------- --------- ---------
(IN 000'S, EXCEPT PER SHARE INFORMATION)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net revenues........................... $214,628 $327,091 $480,756 $566,723 $ 161,945 $ 215,012 $ 147,264
Cost of revenues....................... 114,114 170,748 220,744 268,501 180,072 162,522 78,019
Gross profit (loss).................... 100,514 156,343 260,012 298,222 (18,127) 52,490 69,245
Selling, advertising, general and
administrative expenses.............. 66,493 101,950 172,099 203,930 200,440 111,184 90,732
Research and development expenses...... 2,149 3,036 4,626 10,126 34,582 18,559 23,588
Operating interest..................... 1,583 1,183 1,979 3,957 6,417 5,255 1,625
Depreciation and amortization.......... 3,197 3,227 3,838 9,543 14,910 10,867 12,554
Goodwill writedown..................... -- -- -- -- -- -- 25,200
Litigation settlements................. -- -- -- -- -- -- 8,300
Downsizing charge...................... -- -- -- -- -- -- 10,000
Earnings (loss) from operations........ 27,092 46,947 77,470 70,666 (274,476) (93,375) (102,754)
Other (expense) income, net............ (3,255) 1,138 (475) 5,608 5,609 5,463 (3,608)
Earnings (loss) before income taxes and
minority interest.................... 23,837 48,085 76,995 76,274 (268,867) 87,912 (106,362)
Net earnings (loss).................... $ 13,846 $ 28,185 $ 45,055 $ 44,770 $(221,368) $ (59,144) $(105,546)
Net earnings (loss) per common and
common equivalent share.............. $ 0.37 $ 0.63 $ 1.00 $ 0.86 $ (4.47) $ (1.20) $ (2.13)
Weighted average number of common and
common equivalent shares
outstanding.......................... 37,815 44,875 45,150 52,300 49,515 49,360 49,645
OTHER DATA:
Ratio of Earnings to fixed
charges(7)........................... 9.26 20.47 30.07 11.39 (29.71) (14.27) (17.71)
BALANCE SHEET DATA:
Working capital (deficiency)........... $ 51,402 $ 80,564 $131,820 $200,455 $ (10,039) $ (24,202)
Total assets........................... 129,179 206,771 335,878 442,827 239,651 159,927
Current portion of capital leases,
long-term debt and short-term
borrowings........................... 87 87 1,538 25,196 32,529 8,542
Long-term liabilities.................. 3,380 2,538 41,754 461 4,032 55,364
Stockholders' equity (deficiency)...... 64,706 96,867 175,243 314,707 93,589 (7,187)
</TABLE>
- ------------------
(1) Includes results of operations of Arena Entertainment, Inc. from January 4,
1992.
(2) Includes results of operations of Acclaim Comics, Inc. from July 29, 1994.
(3) Includes results of operations of Iguana Entertainment, Ltd. from January 4,
1995 and of Lazer-Tron for the entire year.
(4) Includes results of operations of Sculptured Software, Inc. and Probe
Entertainment Limited for the entire year.
(5) Adjustments in the fourth quarter of fiscal 1996, on a pre-tax basis,
aggregated $138.3 million, a portion of which related to prior quarters.
Accordingly, for comparative quarterly purposes, during fiscal 1997, the
1996 quarterly operating results may not necessarily be indicative of the
results of operations for such quarterly periods if these year-end
adjustments could have been allocated to the respective quarters. See Note
22 of Notes to Consolidated Financial Statements.
(6) All common share information has been restated to reflect the three-for-two
stock split in the form of a 50% stock dividend distributed on August 23,
1993.
(7) For fiscal 1996 and the nine months ended May 31, 1997, the Company's
pre-tax earnings from operations were inadequate to cover fixed charges by
$268.9 million and $106.4 million, respectively.
23
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The Company is a developer, publisher and mass marketer of Software for use
with Entertainment Platforms and PCs. The Company operates its own Software
design studios and a motion capture studio, and markets and distributes its
products in the major territories throughout the world. The Company's operating
strategy is to develop Software for the Entertainment Platforms and PCs that
dominate the interactive entertainment market at a given time or which the
Company perceives as having the potential for achieving mass market acceptance.
The Company's strategy is to emphasize sports simulation and arcade-style titles
for Entertainment Platforms, and fantasy/role-playing, adventure and sports
simulation titles for PCs. The Company intends to continue to support its
existing key brands with the introduction of new titles supporting those brands
and to develop one additional key brand each year based on its original and
licensed properties, which may then be featured on an annual basis in successive
titles.
The Company also engages in: (i) the development and publication of comic
books; (ii) the distribution of Software titles developed by other Software
publishers; (iii) the marketing of its motion capture technology and studio
services; and (iv) the distribution of coin-operated video arcade games.
The Software industry is driven by the size of the installed base of
Entertainment Platforms such as those manufactured by Nintendo, Sony and Sega,
and PCs. The industry is characterized by rapid technological change, resulting
in Entertainment Platform and related Software product cycles. No single
Entertainment Platform or system has achieved long-term dominance in the
interactive entertainment market.
Based on information available in 1994 and based on its historical
experience with respect to the transition from 8-bit to 16-bit platforms, the
Company believed that Software sales for 16-bit platforms would, although
continuing to decrease overall, still dominate the interactive entertainment
market in 1995 and that such sales would remain substantial through the 1996
holiday season. Accordingly, although the Company's strategy for the Christmas
1995 season was to develop Software for multiple Entertainment Platforms and
PCs, the Company anticipated that substantially all of its revenues in fiscal
1995 would be derived from its 16-bit Software sales. The Company also
anticipated that its sales of 32-bit and PC Software in fiscal 1996 would grow
as compared to fiscal 1995 but that the majority of its revenues in fiscal 1996
would still be derived from 16-bit Software sales. However, the 16-bit Software
market matured much more rapidly than anticipated by the Company, the Company's
Christmas 1995 16-bit Software sales were substantially lower than anticipated
and, by April 1996, the Company derived minimal profits from such Software sales
and made the decision to exit the 16-bit and portable cartridge markets.
In connection with the Company's decision to exit the 16-bit and portable
Software markets in April 1996, the Company recorded a special cartridge video
charge of approximately $48.9 million in the second quarter of fiscal 1996,
consisting of provisions of approximately $28.8 million (reflected in net
revenues) and approximately $20.1 million (reflected in cost of revenues),
respectively, to adjust accounts receivable and inventories at February 29, 1996
to their estimated net realizable values in conjunction with management's
decision to exit the portable and 16-bit cartridge market.
The Company recorded a loss from operations of $274.5 million for fiscal
1996, which included an additional charge related to 16-bit and portable
Software of $65.0 million in the fourth quarter ended August 31, 1996, and a net
loss (on an after tax basis) of $221.4 million for fiscal 1996. The net loss for
the fourth quarter of fiscal 1996 of $162.2 million reflects additional
write-offs of receivables, the establishment of additional receivables and
inventory reserves, severance charges incurred in the fourth quarter in
connection with the downsizing of the Company and the reduction of certain
deferred costs, as well as an operating loss for the period resulting primarily
from price protection and similar concessions granted to retailers at greater
than anticipated levels in connection with the Company's 16-bit and 32-bit
Software. See 'Risk Factors' and Note 22 of Notes to Consolidated Financial
Statements.
As a result of the industry transition to 32- and 64-bit Entertainment
Platforms, the Company's Software sales during fiscal 1996 and the first nine
months of fiscal 1997 were significantly lower than in fiscal 1995 and the first
nine months of fiscal 1996, respectively. Management expects that, unless and
until the installed base of
24
<PAGE>
32- bit and 64-bit Entertainment Platforms increases substantially, the
Company's unit sales and revenues from the sale of Software for these platforms
will be substantially lower than Software sales levels achieved prior to fiscal
1996, when the current transition began. Management anticipates that the Company
will continue to incur material losses for the remainder of fiscal 1997 but that
the Company will be profitable in the first quarter of fiscal 1998. However, no
assurance can be given as to the future growth of the installed base of 32-bit
and 64-bit Entertainment Platforms or of the Company's results of operations and
profitability in future periods. See 'Risk Factors--Industry Trends; Platform
Transition; Technological Change.'
The Company is continuing to sell its existing 16-bit and portable
cartridge Software inventory and has released, and may continue to release,
16-bit and/or portable Software selectively to support its key brands and, if
requested by a retailer, may produce additional units of particular title(s) on
a special order basis. 16-bit and portable Software revenue represented only 4%
of total gross revenues for the quarter ended May 31, 1997.
The rapid technological advances in game systems have significantly changed
the look and feel of Software as well as the Software development process.
According to Company estimates, the average development cost for a title three
years ago was approximately $300,000 to $400,000, while the current average
development cost for a title is between $1 million and $2 million. As a result
of the Company's acquisitions of Iguana Entertainment, Inc. ('Iguana'),
Sculptured Software, Inc. ('Sculptured') and Probe Entertainment, Inc. ('Probe')
in 1995 (two of which were completed in fiscal 1996), the Company's fixed costs
relating to the development of Software and its general and administrative
expenses were substantially higher in fiscal 1996 and the first nine months of
fiscal 1997 as compared to prior periods. See 'Risk Factors' and '--Operating
Expenses.' Such expenses in the aggregate had a material adverse impact on the
Company's profitability in fiscal 1996 and in the first nine months of fiscal
1997. Management plans to reduce the dollar level of product development
expenses in the last quarter of fiscal 1997 and in fiscal 1998 as compared to
prior priods.
In August 1996, the Company down-sized and reorganized some of its
operations. Severance charges and other costs related to the downsizing of
approximately $5 million were incurred in the fourth quarter of fiscal 1996.
In May 1997, the Company effected another downsizing and put into place a
plan to effect substantial cost reductions. Severance charges and other costs
related to the downsizing and proposed cost reductions of approximately $10
million were recorded in the third quarter of fiscal 1997. Management believes
that the Company will realize operating expense reductions resulting therefrom
commencing in the fourth quarter of fiscal 1997.
Since the Company's acquisition of Acclaim Comics in July 1994, Acclaim
Comics has not achieved the sales and earnings projections prepared at the time
of acquisition primarily due to the steady decrease in demand for comic books.
Accordingly, Acclaim Comics recorded losses in fiscal 1995 and 1996, which were
insignificant in relation to the Company's overall results. In fiscal 1996, the
Company reduced the life of the goodwill relating to the acquisition of Acclaim
Comics from 40 years to 20 years, and continues to evaluate the recoverability
of such goodwill based on projected undiscounted cash flows over the remaining
amortization period of the goodwill.
Due to continuing operating losses by Acclaim Comics in the first nine
months of fiscal 1997, management's assessment of the current state of the comic
book industry, the longer-than-expected period of time required to ramp up
various new product introductions and management's current projections for
Acclaim Comics' operations, management believes that there is an impairment in
the carrying value of the goodwill relating to the acquisition of Acclaim
Comics. Accordingly, the Company recorded a write-down of $25.2 million of
goodwill in the quarter ended May 31, 1997 to reduce the carrying value of the
goodwill associated with Acclaim Comics to the related forecasted undiscounted
cash flows.
Goodwill recoverability was based on projected undiscounted cash flows over
19 years, which represents the remaining life of the goodwill as of May 31,
1997, based on historical actual results adjusted for recently introduced
products. The Company believes that the projected future results are the most
likely scenario.
In connection with certain litigations for which the settlement obligation
is currently probable and estimable (see 'Risk Factors-- Litigation' and 'Legal
Proceedings'), the Company recorded a primarily noncash charge of $8.3 million
in the quarter ended May 31, 1997. No assurance can be given that the Company
will not be
25
<PAGE>
required to record additional material charges in future periods in conjunction
with the various litigations to which the Company is a party.
The Company's ability to generate sales growth and profitability will be
materially dependent on (i) the growth of the Software market for 32-bit and
64-bit Entertainment Platforms and PCs, (ii) the Company's ability to identify,
develop and publish 'hit' Software for Entertainment Platforms with significant
installed bases, (iii) the development of, and the generation of revenues from,
its other entertainment operations, and (iv) the success of the Company's cost
reduction efforts.
RESULTS OF OPERATIONS
Net Revenues
The decrease in the Company's net revenues from $62.6 million for the three
months ended May 31, 1996 to $41.6 million for the three months ended May 31,
1997 was predominantly due to reduced unit sales of 16-bit and 32-bit Software.
The decrease in the Company's net revenues from $215.0 million for the nine
months ended May 31, 1996 to $147.3 million for the nine months ended May 31,
1997 was predominantly due to reduced unit sales of 16-bit Software, which were
not offset by sales of 32-bit, 64-bit and PC Software. See 'Risk Factors.'
Management anticipates that sales of the Company's 32-bit, 64-bit and PC
Software in fiscal 1997 will be materially short of levels necessary to offset
the reduction in revenues from sales of 16-bit Software and no assurance can be
given with respect to the Company's revenues in future periods. In addition, to
date, the Company has not generated material revenues from any of its operation
other than Software publishing and no assurance can be given that the Company
will be able to generate such revenues in the future.
The decrease in the Company's net revenues from $566.7 million for the year
ended August 31, 1995 to $161.9 million for the year ended August 31, 1996 was
predominantly due to reduced unit sales of 16-bit Software, increased returns
and allowances relating primarily to 16-bit Software and a reduction in average
unit selling prices for 16-bit Software. Management anticipates that sales of
the Company's 32- and 64-bit and PC Software in fiscal 1997 will not offset the
reduction in revenues from sales of 16-bit Software and no assurance can be
given with respect to the Company's revenues in fiscal 1998 and beyond.
The increase in the Company's net revenues from $480.8 million for the year
ended August 31, 1994 to $566.7 million for the year ended August 31, 1995 was
in part due to increased sales of 32-bit and PC Software and increased foreign
sales and, to a lesser extent, revenues of Lazer-Tron (which are included in the
Company's results of operations for the year) and Acclaim Comics.
A significant portion of the Company's revenues in any quarter are
generally derived from Software first released in that quarter or in the
immediately preceding quarter. In the quarter ended May 31, 1996, no single
product accounted for a significant portion of the Company's gross revenues and,
in the quarter ended May 31, 1997, Turok: Dinosaur Hunter (for the Nintendo
by-bit system) accounted for approximately 57% of the Company's gross revenues.
The Company is substantially dependent on Sony, Sega and Nintendo as the
sole manufacturers of the Entertainment Platforms marketed by them and as the
sole licensors of the proprietary information and technology needed to develop
Software for those platforms. For the three months ended May 31, 1996 and 1997,
the Company derived 11% and 60% of its gross revenues, respectively, from sales
of Nintendo-compatible Software, 33% and 4% of its gross revenues, respectively,
from sales of Sega-compatible Software and 30% and 16% of its gross revenues,
respectively, from sales of Software for the Sony PlayStation.
In fiscal years 1994, 1995 and 1996, the Company derived 45%, 47% and 29%
of its gross revenues, respectively, from sales of Nintendo-compatible Software
and in fiscal years 1994, 1995 and 1996, the Company derived 55%, 46% and 36% of
its gross revenues, respectively, from sales of Sega-compatible Software. In
addition, in fiscal 1996, the Company derived 19% of its gross revenues from
sales of Software for the Sony PlayStation.
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GROSS PROFIT
Excluding the impact of the special cartridge video charge, gross profit
fluctuates as a result of five factors: (i) the level of returns and allowances;
(ii) the number of 'hit' products and average unit selling prices; (iii) the
percentage of sales of CD Software; (iv) the percentage of foreign sales; and
(v) the percentage of foreign sales to third party distributors.
The Company's gross profit is adversely impacted by increases in the level
of returns and allowances to retailers, which reduces the average unit price
obtained for its Software sales. Similarly, lack of 'hit' titles or a low number
of 'hit' titles, resulting in lower average unit sales prices, adversely impacts
the Company's gross profits.
The Company's margins on sales of CD Software (currently, the 32-bit Sony
PlayStation and Sega Saturn systems and PCs) are higher than those on cartridge
Software (currently, the Nintendo N64 system) as a result of significantly lower
product costs.
The Company's margins on foreign Software sales are typically lower than
those on domestic sales due to higher prices charged by hardware licensors for
Software distributed by the Company outside North America. The Company's margins
on foreign Software sales to third party distributors are approximately
one-third lower than those on sales that the Company makes directly to foreign
retailers.
Gross profit decreased from $36.8 million (59% of net revenues) for the
three months ended May 31, 1996 to $16.2 million (39% of net revenues) for the
three months ended May 31, 1997 primarily as a result of higher levels of sales
of cartridge Software for the N64 system, which have a higher product cost than
CD Software. Gross profit increased from $52.5 million (24% of net revenues) for
the nine months ended May 31, 1996 to $69.2 million (47% of net revenues) for
the nine months ended May 31, 1997. Gross profit for the nine months ended May
31, 1997 reflected a special cartridge video charge of $48.9 million for which
there is no comparable amount in the current nine month period.
Gross profit decreased from $298.2 million (53% of net revenues) for the
year ended August 31, 1995 to a gross loss of $(18.1) million ((11.2)% of net
revenues) for the year ended August 31, 1996 predominantly due to increased
returns and allowances relating to 16-bit Software.
Gross profit increased from $260.0 million (54% of net revenues) for the
year ended August 31, 1994 to $298.2 million (53% of net revenues) for the year
ended August 31, 1995. The dollar increase is predominantly attributable to
increased sales volume. The reduction in gross profit as a percentage of net
revenues is primarily attributable to the lower percentage of sales of Sega
Software (all of which was manufactured by the Company) during fiscal 1995,
which was offset by increased sales of higher margin CD Software in that year.
Management anticipates that the Company's future gross profit will be
affected by (i) the percentage of returns, price protection and other similar
concessions in respect of the Company's Software sales and (ii) the Company's
product mix (i.e., the percentage of CD Software and sales related to the
Company's new businesses). Although gross margins on sales of CD Software are,
and are anticipated to continue to be, higher than those on sales of cartridge
Software, management believes that if the Company is required to institute
stock-balancing programs for its PC CD Software, the Company will experience
higher rates of returns of such product as compared to the historical rate of
return of cartridge Software. In such event, management anticipates that its
reserves for such returns will increase, thereby offsetting a portion of the
higher gross margins generated from PC CD Software sales.
The Company purchases substantially all of its products at prices payable
in United States dollars. Appreciation of the yen could result in increased
prices charged by Sony, Sega or Nintendo to the Company (although, to date, none
of them has effected such a price increase), which the Company may not be able
to pass on to its customers and which could adversely affect its results of
operations.
OPERATING EXPENSES
Selling, advertising, general and administrative expenses decreased from
$111.2 million (52% of net revenues) for the nine months ended May 31, 1996 to
$90.7 million (62% of net revenues) for the nine months ended May 31, 1997. The
dollar decrease is primarily attributable to reduced selling and advertising
expenses
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resulting from decreased sales volume and cost reduction efforts initiated by
the Company to reduce its operating expenses. The percentage increase is
attributable to reduced sales volume.
Selling, advertising, general and administrative expenses decreased from
$203.9 million (36% of net revenues) for fiscal 1995 to $200.4 million (124% of
net revenues) for fiscal 1996. The dollar decrease is primarily attributable to
the decreased sales volume discussed above offset, in part, by increased
overhead expenses relating to the operations of the studios in fiscal 1996. The
percentage increase is attributable to reduced sales volume.
Selling, advertising, general and administrative expenses increased from
$172.1 million (36% of net revenues) for fiscal 1994 to $203.9 million (36% of
net revenues) for fiscal 1995. The dollar increase is attributable to increased
sales volume.
Research and development expenses increased from $18.6 million (9% of net
revenues) for the nine months ended May 31, 1996 to $23.6 million (16% of net
revenues) for the nine months ended May 31, 1997 due to increased internal
Software development resulting from the acquisition of two Software studios in
the first quarter of fiscal 1996. Research and development expenses decreased
from $7.2 million (11% of net revenues) for the three months ended May 31, 1996
to $6.6 million (16% of net revenues) for the three months ended May 31, 1997
primarily due to cost reduction efforts recently initiated by the Company.
Research and development expenses increased from $4.6 million (1% of net
revenues) in fiscal 1994 to 10.1 million (2% of net revenues) in fiscal 1995 to
$34.6 million (21% of net revenues in fiscal 1996 due to the increase in
Software development resulting from the acquisition of the three Software
studios in calendar 1995. A substantial portion of such expenses were previously
included as royalties paid to independent Software studios.
Operating interest expense was $2.1 million (3% of net revenues) for the
three months ended May 31, 1996 and $0.4 million (1% of net revenues) for the
three months ended May 31, 1997 and $5.3 million (2% of net revenues) for the
nine months ended May 31, 1996 and $1.6 million (1% of net revenues) for the
nine months ended May 31, 1997. The decrease was primarily attributable to
decreased sales volume and to lower outstanding balances under the Company's
principal credit facility.
Operating interest expense was $2.0 million (0.4% of net revenues) for
fiscal 1994, $4.0 million (0.7% of net revenues) for fiscal 1995 and $6.4
million (4% of net revenues) for fiscal 1996. The increase was primarily
attributable, in fiscal 1995, to increased sales volume and, in fiscal 1996, to
higher outstanding balances under the Company's principal credit facility.
Depreciation and amortization increased from $10.9 million (5% of net
revenue) for the nine months ended May 31, 1996 to $12.6 million (9% of net
revenues) for the nine months ended May 31, 1997. The increase is primarily
attributable to depreciation relating to fixed assets held by the Software
studios and to the reduction, in the fourth quarter of fiscal 1996, of the
estimated remaining life of goodwill relating to Acclaim Comics from forty to
twenty years.
Depreciation and amortization increased from $3.8 million (1% of net
revenue) for fiscal 1994 to $9.5 million (2% of net revenues) for fiscal 1995 to
$14.9 million (9% of net revenues) for fiscal 1996. The increase in fiscal 1995
is primarily attributable to increased amortization of the excess of costs over
net assets acquired arising from the acquisition of Acclaim Comics and Iguana
and depreciation relating to the acquisition of the Company's corporate
headquarters. The increase in fiscal 1996 is primarily attributable to
depreciation relating to the Company's corporate headquarters and of fixed
assets held by the studios.
During the fourth quarter of fiscal 1996, based on current conditions in
the comic book industry, the Company reduced the estimated remaining life of
goodwill relating to Acclaim Comics from forty years to twenty years, which
increased the related amortization expense by approximately $300,000 in the
fourth quarter.
In May 1997, the Company effected another downsizing and put into place a
plan to effect substantial cost reductions. Severance charges and other costs
related to the downsizing and proposed cost reductions of approximately $10
million were recorded in the third quarter of fiscal 1997. Management believes
that the Company will realize operating expense reductions resulting therefrom
commencing in the fourth quarter of fiscal 1997.
Since the Company's acquisition of Acclaim Comics in July 1994, Acclaim
Comics has not achieved the sales and earnings projections prepared at the time
of acquisition primarily due to the steady decrease in demand
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for comic books. Accordingly, Acclaim Comics recorded losses in fiscal 1995 and
1996, which were insignificant in relation to the Company's overall results. In
fiscal 1996, the Company reduced the life of the goodwill relating to the
acquisition of Acclaim Comics from 40 years to 20 years, and continues to
evaluate the recoverability of such goodwill based on projected undiscounted
cash flows over the remaining amortization period of the goodwill.
Due to continuing operating losses by Acclaim Comics in the first nine
months of fiscal 1997, management's assessment of the current state of the comic
book industry, the longer-than-expected period of time required to ramp up
various new product introductions and management's current projections for
Acclaim Comics' operations, management believes that there is an impairment in
the carrying value of the goodwill relating to the acquisition of Acclaim
Comics. Accordingly, the Company recorded a write-down of $25.2 million of
goodwill in the quarter ended May 31, 1997 to reduce the carrying value of the
goodwill associated with Acclaim Comics to the related forecasted undiscounted
cash flows.
Goodwill recoverability was based on projected undiscounted cash flows over
19 years, which represents the remaining life of the goodwill as of May 31,
1997, based on historical actual results adjusted for recently introduced
products. The Company believes that the projected future results are the most
likely scenario.
In connection with certain litigations for which the settlement obligation
is currently probable and estimable (see 'Risk Factors-- Litigation' and 'Legal
Proceedings'), the Company recorded a primarily noncash charge of $8.3 million
in the quarter ended May 31, 1997. No assurance can be given that the Company
will not be required to record additional material charges in future periods in
conjunction with the various litigations to which the Company is a party.
SEASONALITY
The Company's business is seasonal, with higher revenues and operating
income typically occurring during its first and second fiscal quarters (which
correspond to the Christmas and post-Christmas selling season). The timing of
the delivery of Software titles and the releases of new products cause material
fluctuations in the Company's quarterly revenues and earnings.
LIQUIDITY AND CAPITAL RESOURCES
The Company used net cash in operating activities of approximately $25.3
million and $11.0 million during the nine months ended May 31, 1996 and 1997,
respectively. An income tax refund of approximately $53 million related to the
carryback of the Company's loss for fiscal 1996 was included in the net cash
used in operating activities during the nine months ended May 31, 1997. The
decrease in cash received from customers is primarily attributable to lower
sales resulting from the maturation of the 16-bit market and the related
transition to 32- and 64-bit platforms. See '--Overview.'
The Company used net cash from operating activities of approximately $38.3
million and $7.3 million in fiscal 1996 and 1995, respectively, and derived
approximately $29.1 million of net cash from operating activities in fiscal
1994. The decrease in net cash from operations in fiscal 1996 as compared to
fiscal 1995 was primarily attributable to a decrease in cash received from
customers. The decrease in cash received from customers is primarily
attributable to lower sales resulting from the maturation of the 16-bit market
and the related transition to 32- and 64-bit platforms. See '--Overview.'
The decrease in net cash from operations in fiscal 1995 as compared to
fiscal 1994 was primarily attributable to relatively lower proceeds received
from the Company's customers and, to a lesser extent, higher payments of
interest to the Company's commercial lenders in connection with higher
outstanding balances on the Company's working capital loans and acquisition
financing. See Notes 2, 3 and 13 of Notes to Consolidated Financial Statements.
The Company derived net cash from investing activities of approximately
$9.5 million and $13.2 million during the nine months ended May 31, 1996 and
1997, respectively. The increase in net cash from investing activities in the
nine months ended May 31, 1997 as compared to the nine months ended May 31, 1996
is primarily attributable to lower cash amounts expended on the acquisition of
fixed assets, partially offset by lower proceeds from the sale of marketable
equity securities.
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The Company derived net cash from investing activities of approximately
$7.4 million and $26.4 million in fiscal 1996 and 1995, respectively, and used
net cash in financing activities of approximately $63.0 million in fiscal 1994.
The decrease in net cash from investing activities in fiscal 1996 as compared to
fiscal 1995 is primarily attributable to lower proceeds (approximately $14.6
million and $57.2 million in fiscal 1996 and 1995, respectively) derived from
the sale of capital stock of TCI (due to sales of a lower number of shares of
such stock), partially offset by (i) higher cash associated with the acquisition
of certain subsidiaries (approximately $7.9 million from Sculptured and Probe in
fiscal 1996 as compared to $1.7 million from Lazer-Tron and Iguana in fiscal
1995), which reflects cash held by subsidiaries at the respective dates of
acquisition, and (ii) lower cash expended on the acquisition of fixed assets in
fiscal 1996 as compared to fiscal 1995. See Notes 5, 6, and 9 of Notes to
Consolidated Financial Statements.
The increase in net cash provided by investing activities in fiscal 1995 as
compared to fiscal 1994 is primarily attributable to (i) the sale of TCI capital
stock in fiscal 1995, (ii) cash used for the acquisition of Acclaim Comics in
fiscal 1994 partially offset by higher cash expended on the acquisition of fixed
assets in fiscal 1995 as compared to fiscal 1994. See Notes 6 and 9 of Notes to
Consolidated Financial Statements.
The Company derived net cash from financing activities of approximately
$25.2 million and $4.1 million during the nine months ended May 31, 1997 and
1996, respectively.
The increase in net cash derived from financing activities in the nine
months ended May 31, 1997 as compared to the nine months ended May 31, 1996 is
primarily attributable to the Initial Offering. The Notes were sold at par with
proceeds to the Company of $47.4 million, net of expenses. The Indenture
contains covenants that, among other things, substantially limit the Company's
ability to incur additional indebtedness, issue preferred stock, pay dividends
and make certain other payments. The Notes are convertible into shares of Common
Stock at any time prior to maturity, unless previously redeemed, at a conversion
price of $5.18 per share, subject to adjustment under certain conditions. The
Notes are redeemable, in whole or in part, at the option of the Company (subject
to the rights of holders of senior indebtedness) at 104% of the principal
balance at any time on or after March 1, 2000 through February 28, 2001 and at
102% of the principal balance thereafter until maturity.
The Company derived net cash from financing activities of approximately
$5.0 million in fiscal 1996, used net cash from financing activities of
approximately $9.6 million in fiscal 1995 and derived net cash from financing
activities of approximately $41.2 million in fiscal 1994.
The increase in net cash provided by financing activities in fiscal 1996 as
compared to fiscal 1995 is primarily attributable to (i) proceeds from mortgage
financing of the Company's headquarters in Glen Cove, (ii) the restructuring of
the Midland financing in fiscal 1995, which required pre-payment of a portion of
such debt and (iii) an increase in proceeds from short-term bank loans in fiscal
1996. See Notes 11 and 13 of Notes to Consolidated Financial Statements.
The decrease from approximately $41.2 million of net cash provided by
financing activities in fiscal 1994 as compared to approximately $9.6 million of
net cash used in financing activities in fiscal 1995 is primarily attributable
to the $40 million loan from Midland in fiscal 1994 in connection with the
acquisition of Acclaim Comics.
The Company generally purchases its inventory of Nintendo and Sega (to the
extent not manufactured by the Company) Software by opening letters of credit
when placing the purchase order. At May 31, 1997, the amount outstanding under
letters of credit was approximately $3.7 million. Other than such letters of
credit, the Company does not currently have any material operating or capital
expenditure commitments.
The Company has a revolving credit and security agreement with BNY, its
principal domestic bank, which agreement expires on January 31, 2000. The credit
agreement will be automatically renewed for another year by its terms, unless
terminated upon 90 days' prior notice by either party. The Company draws down
working capital advances and opens letters of credit against the facility in
amounts determined on a formula based on factored receivables, inventory and the
cost of imported goods under outstanding letters of credit, which advances are
secured by the Company's assets. This bank also acts as the Company's factor for
the majority of its North American receivables, which are assigned on a
pre-approved basis. At May 31, 1997, the factoring charge was 0.25% of the
receivables assigned and the interest on advances was at the bank's prime rate
plus one percent. At August 31, 1996 and November 30, 1996, the Company was in
default of various financial and other covenants
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under its revolving credit agreement, including the prohibition on having a
'going concern' explanatory paragraph in its fiscal 1996 audit report. BNY
waived these defaults, conditioned upon the Company receiving at least $46
million in net proceeds from the Initial Offering. On February 26, 1997, the
Initial Offering was completed and the Company received net proceeds of $47.4
million. In connection with obtaining the waivers as well as BNY's consent to
effect the Initial Offering, the advance formula was significantly modified to
restrict and reduce the eligible receivables and inventory against which
advances and letters of credit would be made, the financial covenants were made
more restrictive on the Company and were otherwise revised to reflect the
decrease in sales, profitability and cash flow of the Company and anticipated
operations in future periods, and certain additional events of default were
added.
The Company is current in its payment obligations under the revolving
credit facility. As of May 31, 1997, the Company was in default of certain
financial covenants under its agreement with BNY, which defaults have been
waived by BNY. The Company has negotiated revised financial covenants for future
periods with BNY.
In connection with the establishment of a research and development joint
venture, the Company was in default of certain covenants under its agreement
with BNY, which default has been waived through August 31, 1997. BNY has also
agreed to make advances to the Company in amounts in excess of the formula set
forth in the credit agreement; the Company is required to repay to BNY, on
October 31, 1997, a portion of the advances in excess of the formula amount and,
by no later than November 15, 1997, all such advances. See 'Risk Factors--
Liquidity and Bank Relationships.'
In connection with its acquisition by the Company, Acclaim Comics entered
into a credit agreement with Midland for a loan (the 'Loan') of $40 million. The
Company used approximately $16.0 million of the proceeds of the Initial Offering
to repay the Loan in full.
As of August 31, 1996 and November 30, 1996, the Company was also in
default of its financial covenants and of the cross default provisions of the
financing arrangements with Fleet relating to the mortgage on its corporate
headquarters. The lender has waived the defaults conditioned upon receiving $2.0
million from the net proceeds from the Initial Offering. On February 27, 1997,
the Company paid down $2 million of the mortgage loan with a portion of the
proceeds of the Initial Offering, and is obligated to make an additional
accelerated payment of $500,000 payable over nine months in addition to
quarterly payments of $181,000 payable until February 1, 2002, when the
principal balance of the mortgage note is due, and the Company has agreed to
accelerated payment terms for the balance of the loan and to provide Fleet with
a second secured position in certain collateral. See 'Risk Factors--Liquidity
and Bank Relationships.'
Management anticipates that the Company's cash flows from operations will
not be sufficient to cover its operating expenses during the remainder of fiscal
1997 or into fiscal 1998. To provide for its short- and long-term liquidity
needs, the Company has reduced the number of its employees, consummated the
Initial Offering, sold substantially all of the assets of Lazer-Tron and is
currently pursuing various alternatives, including further expense reductions,
raising additional capital, and the sale of certain other assets. There can be
no assurance that further cost reductions will be effected or that additional
capital infusions will be available or that any capital infusions or sales of
assets could be effected on satisfactory terms. In addition, the Company's
future liquidity will be materially dependent on its ability to develop and
market Software that achieves widespread market acceptance for use with the
hardware platforms that dominate the market. There can be no assurance that the
Company will be able to publish titles for Entertainment Platforms with
significant installed bases. See 'Risk Factors--Liquidity and Bank
Relationships.'
The Company is party to various litigations arising in the course of its
business, the resolution of none of which, the Company believes, will have a
material adverse effect on the Company's liquidity, financial condition and
results of operations. The Company is also party to certain class action
litigations, certain of which have been settled subject to court approval.
In connection with certain litigations for which the settlement obligation
is currently probable and estimable (see 'Risk Factors-- Litigation' and 'Legal
Proceedings'), the Company recorded a primarily noncash charge of $8.3 million
in the quarter ended May 31, 1997. No assurance can be given that the Company
will not be required to record additional material charges in future periods in
conjunction with the various litigations to which the Company is a party.
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BUSINESS
INTRODUCTION
The Company is a developer, publisher and mass marketer of Software for use
with Entertainment Platforms and PCs. The Company operates its own software
design studios and a motion capture studio, and markets and distributes its
products in the major territories throughout the world. The Company's operating
strategy is to develop Software for the dedicated Entertainment Platforms and
PCs that dominate the interactive entertainment market at a given time or which
the Company perceives as having the potential for achieving mass market
acceptance. The Company's strategy is to emphasize sports simulation and
arcade-style titles for Entertainment Platforms and fantasy/role-playing,
adventure and sports simulation titles for PCs. The Company intends to continue
to support its existing brands with the introduction of new titles supporting
those brands and to develop one additional key brand each year based on its
original and licensed properties, which may then be featured on an annual basis
in successive titles.
The Company also engages in: (i) the development and publication of comic
books, which commenced in July 1994 through the acquisition of Acclaim Comics;
(ii) the distribution of Affiliated Labels Software, which commenced in the
first quarter of fiscal 1995; (iii) the marketing of its motion capture
technology and studio services, which commenced in the first quarter of fiscal
1995; and (iv) the distribution of coin-operated video arcade games, which
commenced in May 1996.
INTERACTIVE ENTERTAINMENT INDUSTRY OVERVIEW
The Software industry is driven by the size of the installed base of
Entertainment Platforms (such as those manufactured by Nintendo, Sony and Sega)
and PCs. The industry is characterized by rapid technological change, resulting
in Entertainment Platform and related Software product cycles. No single
Entertainment Platform or system has achieved long-term dominance in the
interactive entertainment market.
The home interactive entertainment industry started a new period of growth
in 1985 when Nintendo introduced the NES, an 8-bit system. In 1990, Sega
introduced the 16-bit Genesis and, in 1991, Nintendo introduced the 16-bit SNES.
The 16-bit systems were more sophisticated than the 8-bit systems, producing
faster and more complex images with more life-like animation and better sound
effects. The industry experienced rapid rates of growth commencing in 1992,
fueled by sales of the 16-bit cartridge Entertainment Platforms manufactured by
Nintendo and Sega.
In 1993, Sega introduced the Sega CD, a CD player consisting of an
attachment for its 16-bit Genesis cartridge system. Atari launched Jaguar, its
64-bit cartridge-based system, in November 1993 and Sega launched 32X, its
32-bit cartridge-based attachment for its 16- bit Genesis system, in November
1994.
Sega and Sony launched 32-bit CD-based systems in Japan in November 1994.
Sega shipped its Saturn system in the United States commencing in May 1995 and
Sony released its PlayStation system in the United States in September 1995.
Nintendo released N64, its new 64-bit ROM cartridge-based system, in Japan in
June 1996 and in North America in September 1996. Matsushita has announced plans
to release M2, its 64-bit CD-based hardware system, in Japan in 1997.
The rapid technological advances in game systems have significantly changed
the look and feel of Software as well as the Software development process.
According to Company estimates, the average development cost for a title three
years ago was approximately $300,000 to $400,000, while the average development
cost for a 32-bit console title is currently between $1 and $2 million. Once a
title is developed, the competition for shelf space in the primary retail
outlets is intense. Retailers typically prefer to deal with companies that have
proven track records of producing successful titles and a broad product line.
Additionally, Software products, especially those for the console market,
require significant marketing support to generate high sales volume. The
introduction of faster microprocessors, graphics accelerator chips, enhanced
operating systems, and increases in memory and processing power have facilitated
the development of Software for the PC market. The increase in the installed
base of multimedia capable PCs has resulted in an increased demand for Software
capable of being used on such systems.
PRODUCTS
Since inception, the Company has developed and sold Software for a variety
of dedicated Entertainment Platforms. Although older Software titles may
continue to be available for sale, the Company generally actively markets only
its ten to fifteen most recently released titles.
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The life cycle of a Software title generally ranges from less than three
months to upwards of twelve months for its key titles. The life cycle of a
particular title is dependent on its initial success. Although actual results
vary greatly from title to title, the retail sell-through of a title is highest
during the 90-120 days immediately after its introduction.
The Company plans to produce high quality titles and address a wide range
of interactive entertainment categories and audiences, such as puzzle, sports,
arcade conversions, action/adventure and fantasy.
In fiscal 1996, the Company released 39 32-bit titles, 22 16-bit titles and
9 portable titles. The Company made the decision to exit the 16-bit and portable
Software markets in April 1996. Since such time, the Company has released two
new 16-bit titles for the European market (Ultimate Mortal Kombat on Nintendo
SNES and Sega Genesis) and published three portable titles. The Company is
currently selling its remaining inventory of 16-bit and portable Software. The
Company may, from time to time, (a) publish 16-bit and/or portable titles
selectively to support its key brands and (b) if requested by a retailer,
produce additional units of a particular title(s) on a special order basis.
In calendar 1997, the Company currently plans to release between 10 and 15
titles for the Sony PlayStation, approximately two to five titles for the Sega
Saturn platform, and to convert for PCs six to eight titles originally developed
for Entertainment Platforms. With respect to the Nintendo N64 platform, the
Company intends to release three Software titles in calendar 1997. One Software
title for N64 (Turok: Dinosaur Hunter) was shipped in late February 1997 under
the Company's current N64 agreement with Nintendo. See '--Platform License
Agreements.'
SOFTWARE DEVELOPMENT
The Company's Software development strategy is driven by the Entertainment
Platforms that are marketed and/or are anticipated to be marketed from time to
time, the time and cost of Software development for each platform, the cost of
manufacturing Software for a particular platform and the attendant retail price
points for Software. Historically, the development time for 8-bit and portable
cartridge Software was between six and twelve months and, for 16-bit cartridge
Software, between ten and fourteen months. The development time for Software for
32-bit CD-ROM platforms and for the 64-bit cartridge platform is currently
between fourteen and twenty months. The cost of manufacturing cartridge Software
is significantly higher than CD-ROM Software. See 'Management's Discussion and
Analysis of Financial Condition and Results of Operations.'
Currently, the Company's Software development efforts are focused on the
Sony PlayStation, the Sega Saturn, the Nintendo N64 and PCs. Once the Company
has decided which Entertainment Platforms and systems it intends to support, the
Company then focuses on the types of Software to be developed for each platform.
The Company's product development methods and organization are modeled on those
used in the Software entertainment industry. 'Producers' employed by the Company
oversee and are responsible for development of the Company's Software. The
producers direct teams comprised of either the Company's own Software studios or
independent Software studios and, among other things, manage and monitor the
delivery schedule and budget for each title, ensure that the title follows the
approved treatment and story boards, act as facilitators with licensors whose
trademarks or brands may be incorporated in the title, if necessary, and
coordinate testing and final approval of the title.
The Company constantly seeks new sources of brands from which to develop
Software and has historically obtained such rights from a variety of sources in
the film (e.g., Batman Forever), comic book publishing (e.g., X-O Manowar and
Turok: Dinosaur Hunter), sports (e.g., NFL Quarterback Club and World Wrestling
Federation), arcade (e.g., NBA Jam Extreme) and other areas of the entertainment
industry. Certain of the contractual agreements granting the Company rights to
use such brands are restricted to individual properties and certain agreements
cover a series of properties or grant rights to create Software based on or
featuring particular personalities or icons over a period of time.
The Company has invested in the creation of programming tools and engines
that are used in the design and development of its Software. The Company
believes that these tools and engines allow for the creation of state of the art
Software. The Company has also invested in a motion capture studio for the
application of its animation technology and, in fiscal 1995, the Company
completed the construction of its 'ultimatte' or 'blue screen' studio.
In 1995, the Company expanded its ability to develop Software internally
through its acquisition of three Software studios: Iguana in January 1995 and
Sculptured and Probe in October 1995. Prior thereto, the Company
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relied exclusively on independent Software studios and paid them advances and,
after recoupment of such advances, royalties based on the related product sales.
The majority of the Company's Software released in fiscal 1997 has been
developed internally. The Company believes that internal development allows it
to better control the product quality of its Software and allows the Company to
take advantage of its proprietary tools and engines. From time to time, the
Company may selectively use independent Software studios to develop Software
titles based on the expertise of the independent Software studios in respect of
the particular type of Software title to be programmed and/or when the Company
does not have the capacity to develop all Software to be released in any
particular time period.
From time to time, the Company also enters into selected licensing
agreements with independent publishers to market and distribute, in selected
markets, Software titles developed by them. The Company pays the publisher a
royalty based on sales and retains the inventory and marketing risk of such
Software.
The Company checks Software developed by its internal and independent
Software studios prior to manufacture for defects ('bugs'). The Software
developed for the various Nintendo, Sega and Sony formats are also tested by
those manufacturers for bugs. The Company's Software for PC Systems is tested
for bugs both internally and by independent testing organizations. To date, the
Company has not had to recall any Software titles due to bugs.
MARKETING AND ADVERTISING
The Company's marketing strategy is based on Software featuring (i)
original properties, (ii) brands, personalities and/or icons and (iii)
successful arcade properties. Original properties are generally titles created
by the Company's Software studios and are based upon an original story or
concept developed by the Company. The Company also creates Software based on or
featuring well-known or identifiable brands (such as NFL Quarterback Club, NBA
Jam and WWF) and personalities or icons (such as Frank Thomas, Spiderman, Turok:
Dinosaur Hunter and X-O Manowar) licensed or created by the Company. Arcade
properties are coin-operated games based upon which the Company creates
Software.
The target consumer for the Company's Software for Entertainment Platforms
are primarily males aged 11 to 21 and, for PCs, are primarily males aged 15 to
25. In developing a strategy for the marketing of a Software title, the Company
seeks story concepts and brands, personalities or icons that it believes will
appeal to the imagination of its target consumer. The Company creates marketing
campaigns consistent with the target consumer for each title. The Company
markets its Software with, among other things, television, radio, print and
on-line advertisements; consumer contests and promotions; publicity activities;
and trade shows. In addition, the Company enters into cooperative advertising
arrangements with certain of its customers, pursuant to which the Company's
products are featured in the retail customer's own advertisements to its
customers. Dealer displays and in-store merchandising are also used to increase
consumer awareness of the Company's products.
The Company's ability to promote and market its products is important to
its success. The Company's plan is to develop one key brand each year based on
its original properties, which may then be featured on an annual basis in
successive titles across multiple Entertainment Platforms. For example, the
Company's WWF titles have been published on 11 platforms over eight years. By
creating key brands, the Company is able to take advantage of
cross-merchandising opportunities, to benefit from economies of scale and to
capitalize on the name recognition of the brands in each subsequent year in
which they are used.
PRODUCTION, SALES AND DISTRIBUTION
The Company believes that the most efficient way to distribute its Software
is by tailoring the distribution method to each geographic market and, when the
market can support it, the Company distributes directly through a subsidiary in
an effort to maximize revenues and profits.
Pursuant to the terms of its license with Sony, the Company is required to
purchase PlayStation Software from Sony. Sony generally manufactures and
delivers Software to the Company within four weeks after the placement by the
Company of a purchase order. Reorders are generally delivered within two weeks
by Sony.
The Company manufactures (through subcontractors) all of its Software for
PC Systems and substantially all of its Sega Software. The cost of Sega Software
when manufactured by the Company, together with the royalties payable to Sega
for such manufacturing, is slightly lower than the cost of the Company's
Software when manufactured by Sega. Orders for CD Software manufactured by the
Company (through sub-contractors) are
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generally filled within 20-30 days of the placement of the order. Re-orders for
such Software are generally filled within 10 days.
According to the Company's agreements and arrangements with Nintendo, the
Company must purchase Software it develops for the Nintendo platforms from
Nintendo. The lead-time for the manufacture of cartridge Software is longer than
for CD Software. Historically, the Company placed a purchase order and opened a
letter of credit with respect to a particular title and Nintendo manufactured
and delivered such Software to the Company within 60 to 90 days thereafter.
Nintendo has informed the Company that it will be required to purchase its N64
Software from Nintendo on a similar basis and the Company anticipates that the
lead times for production of such Software will be comparable to its historical
experience.
In North America, the Company's Software is sold by regional sales
representative organizations which receive commissions based on the net sales of
each product sold. The Company maintains an in-house sales management team to
supervise the sales representatives. The sales representatives also act as sales
representatives for certain of the Company's competitors. Two of the sales
representative organizations marketing the Software are owned in whole or in
part by James Scoroposki, an officer, director and principal stockholder of the
Company. See 'Certain Relationships and Related Transactions.'
The Company sells its Software primarily to mass merchandisers, large
retail toy store chains, department stores and specialty stores. The Company
does not have written agreements with its customers. The loss of any important
customer could have a material adverse effect on the Company.
The Company utilizes independent distributors for its Software in Japan,
France, Spain, Germany and the United Kingdom. The sales and distribution
activities of Acclaim's European subsidiaries are administered through a central
management division, Acclaim Europe, based in London. For sales in other
markets, the Company appoints regional distributors.
The Company's key domestic retail customers include Toys R Us, Walmart,
Best Buy, Blockbuster Video and Target.
The Company is generally not contractually obligated to accept returns,
except for defective product. However, in order to maintain retail
relationships, the Company may permit its customers to return or exchange
Software titles and may provide price protection or other concessions for titles
unsold by a customer. The Company establishes reserves for such concessions;
however, concessions materially exceeded reserves therefor in fiscal 1996 and no
assurance can be given that such concessions will not exceed the reserves
established therefor in a future period. See 'Risk Factors--Inventory
Management, Risk of Product Returns' and 'Management's Discussion and Analysis
of Financial Condition and Results of Operations.'
The Company's warranty policy is to provide the original purchaser with
replacement or repair of defective Software for a period of 90 days after sale.
To date, the Company has not experienced significant warranty claims.
PLATFORM LICENSE AGREEMENTS
In December 1994, the Company entered into an agreement (the 'Sony
Agreement') with Sony, pursuant to which the Company received, among other
things, a non-exclusive license to develop and distribute Software for the Sony
PlayStation platform in the United States and Canada. The Sony Agreement expires
in December 1998. The Company is operating under an oral agreement with an
affiliate of Sony pursuant to which it received a non-exclusive license to
develop and distribute Software for the Sony PlayStation platform in Japan and
an oral agreement with Sony with respect to the development and publishing of
titles for the PlayStation in Europe.
In April 1992, the Company entered into an agreement with Sega (the 'Sega
Agreement') and has certain other arrangements, pursuant to which the Company
received the non-exclusive right to utilize the 'Sega' name and its proprietary
information and technology in order to develop and distribute Software titles
for use with various Sega platforms. The Sega Agreement, as amended, expired in
December 1995. The Company and Sega are continuing to operate in the ordinary
course under the terms of the expired Sega Agreement and such arrangements with
respect to older platforms and, with respect to the Saturn platform, under an
oral agreement and other arrangements. No assurance can be given that the
Company will be successful in negotiating a new agreement. The Company believes
that the terms of any new agreement with Sega, if one is entered into, will not
impose materially greater obligations on the Company than the Sega Agreement,
although there can be no assurance of that result.
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The Company has various license agreements with Nintendo (collectively, the
'Nintendo License Agreements') pursuant to which it has the nonexclusive right
to utilize the 'Nintendo' name and its proprietary information and technology in
order to develop and market Software titles for various 8-bit, 16-bit and
portable Nintendo platforms in various territories throughout the world. The
Nintendo License Agreements for the different platforms expire at various times
between 1997 and the end of 1998. The Company also has an agreement with
Nintendo for the development and marketing of one Software title for Nintendo's
N64 system in North America. The Company began shipping the N64 title (Turok:
Dinosaur Hunter) in late February 1997. The Company has an N64 agreement for
Japan, covering the release of approved titles. The Company has been advised by
Nintendo of the basic terms of the N64 license for the United States and Europe
and that Nintendo will offer such license to the Company. However, no assurance
can be given that the Company will receive such new license.
Sony, Nintendo and Sega charge their licensees a fixed amount per unit
based, in part, on memory capacity, chip configuration and/or the market price
for compact disk manufacture. With respect to Software for Nintendo platforms,
this charge covers manufacturing, printing and packaging of the unit, as well as
a royalty for use of their respective names, proprietary information and
technology. With respect to Software for Sony's PlayStation, the Company is
required to make a separate royalty payment to Sony for each Software unit
manufactured by Sony for the Company; this payment is made upon manufacture of
the units. The charges are subject to adjustment by Sony, Nintendo and Sega at
their discretion. The Company manufactures (through subcontractors)
substantially all of its Sega Software titles for worldwide distribution and
pays Sega a royalty for each Software unit so manufactured and sold; this
payment is made upon sale of the units by the Company. See '--Production, Sales
and Distribution.' However, the Company does not have the right to manufacture
any Software for the Sony PlayStation or Nintendo N64 platforms. See
'Management's Discussion and Analysis of Financial Condition and Results of
Operations.'
Sony, Nintendo and Sega have the right to review and evaluate, under
standards established by them, the game program for each title and the right to
inspect and evaluate all art work, packaging and promotional materials used by
the Company in connection with the Software. The Company is responsible for
resolving at its own expense any warranty or repair claims brought with respect
to the Software. To date, the Company has not experienced any material warranty
claims.
Under each of these license agreements, the Company bears the risk that the
information and technology licensed from Sony, Nintendo or Sega and incorporated
in the Software may infringe the rights of third parties and must indemnify
Sony, Nintendo or Sega with respect to, among other things, any claims for
copyright or trademark infringement brought against Sony, Nintendo or Sega and
arising from the development and distribution of the game programs incorporated
in the Software by the Company. To date, the Company has not received any
material claims of infringement; no assurance can be given that the Company will
not receive such claims in the future. See '--Trademark, Copyright and Patent
Protection.'
Although the Company has historically been able to renew and/or negotiate
extensions of its Software license agreements with hardware developers, there
can be no assurance that, at the end of their current terms, the Company will
continue to be able to do so or that the Company will be successful in
negotiating definitive license agreements with developers of new Entertainment
Platforms. The inability to negotiate agreements with developers of new
Entertainment Platforms or the termination of all of the Company's license
agreements will, and the termination of any one of the Company's license
agreements could, have a material adverse effect on the Company's financial
position and results of operations.
INTELLECTUAL PROPERTY LICENSES
Certain of the Company's products relate to properties licensed from third
parties, such as the WWF, NBA, and NFL and their respective players'
associations. Typically, the Company is obligated to make certain minimum
guaranteed royalty payments over the term of the license and to advance payment
against such guarantees, which payments can be recouped by the Company against
certain royalty payments otherwise due in respect of future sale. See 'Risk
Factors--Ability to Negotiate Future License Agreements.' License agreements
generally extend for a term of two to three years, are terminable in the event
of material breach (including failure to pay any amounts owing to the licensor
in a timely manner) by, or bankruptcy or insolvency of, the Company and certain
other events, and, in some cases, are renewable upon payment of certain minimum
guarantees or the attainment of specified sales levels during the term of the
license. Certain licenses are limited to specific territories or platforms. Each
license typically provides that the licensor retains the right to exploit the
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licensed property for all other purposes, including the right to license the
property for use with other products and, in some cases, software for other
interactive hardware platforms. See 'Risk Factors--Intellectual Property
Licenses and Proprietary Rights.'
PATENT, TRADEMARK, COPYRIGHT AND PRODUCT PROTECTION
Each of Sony, Nintendo and Sega incorporate a security device in the
Software and their respective hardware units in order to prevent unlicensed
software publishers from infringing Sony's, Nintendo's or Sega's proprietary
rights, as the case may be, by manufacturing games compatible with their
hardware. Under its various license agreements with Sony, Nintendo and Sega, the
Company is obligated to obtain or license any available trademark, copyright and
patent protection for the original work developed by the Company and embodied in
or used with the Software and to display the proper notice thereof, as well as
notice of the licensor's intellectual property rights, on all its Software.
Each Software title may embody a number of separately protected
intellectual properties: (i) the trademark for the brand featured in the
Software (for example, WWF); (ii) the software copyright; (iii) the name and
label trademarks, such as 'LJN' and 'Acclaim'; and (iv) the copyright for
Sony's, Nintendo's or Sega's proprietary technical information.
The Company has registered the logo 'Acclaim' in the United States and in
certain foreign territories and owns the copyrights for many of its game
programs. 'Nintendo,' 'Nintendo Entertainment System,' 'Game Boy,' 'Super NES'
and 'N64' are trademarks of Nintendo of America, Inc.; 'Sega,' 'Sega Genesis,'
'Master System,' 'Sega MegaDrive,' 'Game Gear' and 'Saturn' are trademarks of
Sega and 'Sony,' 'Sony Computer Entertainment' and 'PlayStation' are trademarks
of Sony. The Company does not own the trademarks, copyrights or patents covering
the proprietary information and technology utilized in the NES, SNES, Game Boy,
N64, Genesis, Master System, MegaDrive, Game Gear, Saturn or PlayStation or, to
the extent licensed from third parties, the brands, concepts and game programs
featured in and comprising the Software. Accordingly, the Company must rely on
the trademarks, copyrights and patents of such licensors for protection of such
intellectual property from infringement. Under the Company's license agreements
with certain of the independent Software developers, the Company may bear the
risk of claims of infringement brought by third parties and arising from the
sale of Software and each of the Company and such developers has agreed to
indemnify the other for costs and damages incurred arising from such claims and
attributable to infringing proprietary information, if any, embodied in the
Software and provided by the indemnitor.
There can be no assurance that the information and technology licensed or
developed by the Company will not be independently developed or misappropriated
by third parties.
COMPETITION
Competition to develop and market Software for the interactive
entertainment industry is intense. The Company's competitors include
Entertainment Platform manufacturers, most notably Nintendo, Sega and Sony, and
a number of independent software publishers licensed by hardware manufacturers.
The availability of significant financial resources has become a major
competitive factor in the Software industry, principally as a result of the
technical sophistication of advanced multimedia computer game products requiring
substantial investments in research and development. While the Company's
competitors vary in size from very small companies with limited resources to
very large corporations with greater financial, marketing and product
development resources than those of the Company, the Company believes that it is
one of the largest independent publishers of Software for dedicated platforms in
the United States. The market for Software for PC systems is fragmented and the
Company believes that it has a small share of that market. Competition is
increasing in this market as increasing numbers of companies begin to develop
on-line interactive computer games and interactive networks and other new
Software technologies.
Competition is based primarily upon price, access to retail shelf space,
product enhancements, ability to operate on popular platforms, availability of
titles (including 'hits'), new product introductions, marketing support and
distribution systems. The Company relies upon its marketing and sales abilities,
capital resources, proprietary technology and product development capability,
product quality, and the depth of its worldwide retail distribution channels and
management experience to compete in the interactive entertainment industry. No
assurance can be given that the Company will compete successfully on any of
these factors. See 'Risk Factors--Competition.'
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COMIC BOOK PUBLISHING
Through the acquisition of Acclaim Comics in July 1994, the Company
commenced its development and publication of comic books. To date, substantially
all of Acclaim Comics' revenues have been derived from sales of comic books on a
nonreturnable basis through unaffiliated distributors to the comic book direct
market, which consists of comic book specialty stores and mail order comic book
dealers. The Company did not derive significant revenues from the sale of comic
books by Acclaim Comics in fiscal 1995, fiscal 1996 or in the first nine months
of fiscal 1997.
Acclaim Comics has created a superhero comic book series featuring
characters created or licensed by it, which are published under its 'VALIANT'
imprint. In 1995, Acclaim Comics entered into an agreement with Diamond Comic
Distributors, Inc. for exclusive distribution of these books. In fiscal 1997,
Acclaim Comics plans to continue to publish comic books under its VALIANT
imprint and to launch publications under its Acclaim Books imprint, which
primarily Penguin Books will distribute. At present, Acclaim Comics plans to
publish under the Acclaim Books imprint (a) Acclaim Young Reader books,
featuring characters licensed from Walt Disney, the Fox Children's Television
Network and Saban Entertainment, which were released in June 1997, and (b)
Classics Illustrated titles in a study guide format, as well as collector's
editions and in CD-ROM format. The Classics Illustrated titles, which are
licensed from First Classics Inc., were released in January 1997.
The Company has released and intends to continue to release Software
products for a variety of platforms based on characters licensed or created by
Acclaim Comics, such as X-O Manowar and Turok: Dinosaur Hunter (released in late
February 1997).
Acclaim Comics' future revenues growth, if any, will depend on the
licensing and merchandising of its characters in interactive entertainment and
other media such as motion picture or television, the use of its characters in
the Company's Software and coin-operated games, increased sales of comic books,
the introduction of new comic titles, and Acclaim Comics' entry into the mass
market for distribution and sales of its comic books outside the United States.
See 'Management's Discussion and Analysis of Financial Condition and Results of
Operations.'
DISTRIBUTION OF AFFILIATED LABELS
The Company, through Acclaim Distribution, Inc. ('ADI'), commenced the
marketing and distribution of Affiliated Labels in October 1994. The Company
currently distributes products for, among others, Interplay. The Company
receives a distribution fee from such publishers. To date, the Company has not
derived significant revenues from the Affiliated Labels program. See
'Management's Discussion and Analysis of Financial Condition and Results of
Operations.'
MOTION CAPTURE SERVICES
The technology utilized in the Company's motion capture services was
developed in part by ATG. ATG was initially established in January 1991 to
develop tools that would enable the Company's independent Software developers to
create state of the art Software with enhanced game play and product quality.
The Company believes its motion capture services employing state of the art
technology ensure the most realistic and exciting game play experience as
demonstrated by the development of Turok: Dinosaur Hunter and NBA Jam Extreme.
With the advancement of CD-ROM technology, ATG's activities expanded to
include motion capture (a three-dimensional animation creation process) and the
design of tools for use in programming Software for CD-ROM platforms or
cartridge-based platforms utilizing 32-bit or 64-bit processors. The Company has
constructed a motion capture studio and a blue screen studio utilizing advanced
'ultimatte' software and proprietary video processing tools for compositing and
layering characters in a variety of entertainment media. The Company has
utilized its motion capture technology in titles such as NBA Jam Extreme, NFL
Quarterback Club, Turok: Dinosaur Hunter and Frank Thomas Big Hurt Baseball.
The Company believes that its motion capture technology may have
applications in other entertainment media and has marketed its technology and
studio services. Warner Bros. used the Company's motion capture technology and
studio services to create certain of the special effects for Batman Forever,
which was released in the summer of 1995, and for Batman and Robin, which was
released in the summer of 1997. New Line Cinema utilized the Company's motion
capture technology to create certain home video animation special effects for
Mortal Kombat and Twentieth Century Fox utilized the Company's motion capture
technology to create certain special effects for the 1995 motion picture, Power
Rangers.
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To date, the Company's revenues from the licensing of its motion capture
technology and studio services have not been material. No assurance can be given
that the Company will be successful in marketing its technology and selling its
studio services and, even if it were successful, that revenues generated
therefrom will be material.
COIN-OPERATED ARCADE GAMES
In July 1994, the Company established Acclaim Coin-Operated Entertainment,
Inc. ('Acclaim Coin-Op'), a wholly owned subsidiary, for the creation and
distribution of stand-alone coin-operated games. Acclaim Coin-Op shipped two
video games in fiscal 1996. The Company currently plans to release approximately
two coin-operated games per year.
To date, the Company has not derived significant revenues from the sale of
coin-operated video games distributed by Acclaim Coin-Op. The successful
creation and marketing of such games will be dependent, in large part, on the
Company's ability to hire and retain developers for the creation of, and to
create or license properties for use in, coin-operated games which achieve
widespread market acceptance. There can be no assurance that the Company will be
successful in creating and marketing coin-operated games or that any revenues
derived by the Company from the sale of such games will be material.
The Company licensed certain hardware technology from Sony Computer
Entertainment of America and Sega for the development of its first two
coin-operated games. The Company is developing its own proprietary hardware
technology for future applications, although there can be no assurance that the
Company will be successful in creating such technology. In addition, the Company
has developed new data compression audio technology with high fidelity, motion
picture sound quality, which has applications in the coin-operated arcade game
platform, as well as other high-end game platforms.
EMPLOYEES
At May 31, 1997, the Company employed approximately 675 persons worldwide
on a full-time basis, approximately 420 of whom are employed in the United
States. The Company believes that its relationship with its employees is good.
PROPERTIES
The Company's corporate headquarters are located in a 70,000 square foot
office building, which was purchased by the Company in fiscal 1994. The Company
also leases approximately 15,000 square feet of office space in Glen Cove, New
York and owns a 10,000 square foot office building in Oyster Bay, New York,
which has been leased to a third party tenant. The Company's motion capture
studio, located in Glen Cove, New York, was completed in September 1994 and, in
November 1995, the Company completed the purchase of the Glen Cove building
containing its ultimatte studio.
In addition, the Company's United States subsidiaries lease and occupy
approximately 10,000 square feet of office space in New York, and approximately
13,000, 37,000 and 33,000 square feet of office space in California, Utah and
Texas, respectively.
The Company's foreign subsidiaries lease office space in Japan, Germany and
the United Kingdom.
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LEGAL PROCEEDINGS
The Company and certain of its directors and/or executive officers were
sued in an action entitled Digital Pictures, Inc. v. Acclaim Entertainment,
Inc.; Gregory E. Fischbach; and Anthony Williams (Case No. 96-3-3301 TC) filed
in December 1996 in the United States Bankruptcy Court in the Northern District
of California. The plaintiff seeks an accounting and compensatory, punitive and
exemplary damages in an amount equal to at least $8 million based on allegations
that the defendants falsified sales, failed to provide timely statements and to
pay amounts the Company owes the plaintiff pursuant to the July 1994 Sales and
Distribution Agreement between the Company and the plaintiff under which the
plaintiff granted the Company the exclusive worldwide right to sell and
distribute the plaintiff's software products for a term of five years. In
addition, the plaintiff alleges, among other things, fraud and negligent
misrepresentation. The Company intends to defend this action vigorously.
The Company was also sued in an action entitled Sound Source Interactive,
Inc. v. Acclaim Distribution, Inc.; Acclaim Entertainment, Inc.; and DOES 1
through 100, inclusive (Case No. BC162531) filed in December 1996 in the
Superior Court of the State of California for the County of Los Angeles.
Defendant Acclaim Distribution, Inc. ('ADI') is a wholly owned subsidiary of the
Company. The plaintiff claims compensatory, general, special and consequential
damages in excess of $22 million and punitive damages based on allegations that
the defendants breached (i) the Sales and Distribution Agreement dated as of
June 15, 1995 between ADI and the plaintiff (the 'Sales and Distribution
Agreement') under which the plaintiff granted ADI the exclusive right to sell
and distribute the plaintiff's software products by, among other things,
providing the plaintiff with false accounting statements, misrepresenting
product orders, and failing to return or account for software products shipped
by the plaintiff to ADI and wrongfully retaining restock and distribution fees;
and (ii) the Termination Agreement dated as of March 31, 1996 between the
plaintiff and ADI pursuant to which the Sales and Distribution Agreement was
terminated by, among other things, failing to account, failing to pay monies due
and failing to return or account for software products shipped by the plaintiff
to ADI. In addition, the plaintiff alleges, among other things, fraud and
negligent misrepresentation. The Company intends to defend this action
vigorously.
The Company was also sued in an action entitled Spectrum Holobyte
California, Inc.; Microprose Software, Inc. v. Acclaim Entertainment, Inc.,
(Case No. 97-0247 MEJ) filed in January 1997 in the United States District Court
for the Northern District of California. In that complaint, plaintiffs Spectrum
Holobyte California, Inc. ('Spectrum') and Microprose Software, Inc.
('Microprose') allege that the Company breached a confidential settlement
agreement among the parties dated November 4, 1996 (the 'Settlement Agreement').
The purpose of the Settlement Agreement was to resolve a suit brought by the
Company in 1996, which included counterclaims by Spectrum and Microprose,
regarding each parties' allegations of infringement of their respective
exclusive rights to intellectual property licensed to them by Wizards of the
Coast, Inc. The property involves the characters, depictions and game
methodology of Magic: The Gathering, a popular fantasy-adventure story and card
game created by Wizards of the Coast, Inc. Plaintiffs allege that the Company
breached the Settlement Agreement by failing to release the appropriate number
of games of Magic: The Gathering--BattleMage in the United States and the United
Kingdom by January 10, 1997, the date provided for in the Settlement Agreement.
Plaintiffs seek unspecified monetary damages, attorneys' fees and costs. The
Company intends to defend this action vigorously.
In January 1997, the Company was sued in an action entitled Ocean of
America, Inc. v. Acclaim Entertainment, Inc. (Index No. 97-445) in the Supreme
Court of the State of New York, County of Nassau, and an amended complaint was
filed in March 1997. The plaintiff alleges non-payment under a license agreement
entered into between the plaintiff and the Company, and seeks damages in the
aggregate amount of approximately $6.5 million plus costs and expenses. The
parties are currently negotiating settlement terms with respect to this action.
The Company and certain of its current and former directors and/or
executive officers were sued in various complaints filed in December 1995, which
were consolidated into an action entitled In re: Acclaim Ent. Shareholder
Litigation, 95 Civ. 4979 (E.D.N.Y.) (TCP) in the United States District Court in
the Eastern District of New York. The plaintiffs, on behalf of a class of the
Company's stockholders, claim unspecified damages arising from the Company's
December 4, 1995 announcement that it was revising results for the fiscal year
ended August 31, 1995 to reflect a decision to defer $18 million of revenues and
$10.5 million of net income previously
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reported on October 17, 1995 for the fiscal year ended August 31, 1995.
Defendants have answered the complaint and discovery is in progress. The parties
are currently negotiating settlement terms with respect to this action.
By summons and complaint dated December 11, 1995, certain of the Company's
current and former directors and/or executive officers were named as defendants,
and the Company was named as a nominal defendant, in a shareholder derivative
action entitled Eugene Block v. Gregory E. Fischbach, James Scoroposki, Robert
Holmes, Bernard J. Fischbach, Michael Tannen, Robert H. Groman and James
Scibelli, defendants, and Acclaim Entertainment, Inc., Nominal Defendant (CV
95-036316) (Supreme Court of the State of New York, County of Nassau) (the
'Derivative Action'). The Derivative Action was brought on behalf of the Company
(as nominal defendant), alleging that the individual defendants violated their
fiduciary duties to the Company in connection with the Company's revision of its
revenues for the fiscal year ended August 31, 1995. Plaintiff alleges that the
individual defendants (1) breached their duty of care and candor, (2) caused the
Company to waste corporate assets, and (3) breached their duty of good faith,
and, accordingly, seeks unspecified damages. Plaintiff withdrew his complaint
and on October 2, 1996 filed an amended complaint. Defendants have moved to
dismiss based on plaintiff's failure to make a proper demand. The parties are
currently negotiating settlement terms with respect to this action.
The Company and certain of its current and former directors and/or
executive officers also are defendants in an action entitled Adrienne Campbell
and Donna Sizemore, individually and on behalf of all others similarly situated,
v. Acclaim Entertainment, Inc., Anthony R. Williams, James Scoroposki, and
Robert Holmes, C-95-04395 (EFL), which was commenced in the United States
District Court for the Northern District of California. In that action,
plaintiffs, two former shareholders of Lazer-Tron, filed a class action
complaint on December 8, 1995 on behalf of all former Lazer-Tron shareholders
who exchanged their Lazer-Tron stock for Common Stock pursuant to the August 31,
1995 merger transaction. Plaintiffs allege violations of Sections 10(b), 14(a)
and 14(e) of the Securities Exchange Act of 1934, Sections 11 and 12(2) of the
Securities Act of 1933, fraud and breach of fiduciary duty. On October 8, 1996,
the Judicial Panel on Multidistrict Litigation ordered the transfer of the
action from the Northern District of California to the United States District
Court for the Eastern District of New York for coordinated or consolidated
pretrial proceedings with the action entitled In re Acclaim Ent. Shareholder
Litigation discussed above. The parties have agreed to the terms of a settlement
of this action, subject to court approval.
The Commission has issued orders directing a private investigation relating
to, among other things, the Company's earnings estimate for fiscal 1995 and its
decision in the second quarter of fiscal 1996 to exit the 16-bit portable and
cartridge markets. The Company has provided documents to the Commission, and the
Commission has taken testimony from Company representatives. The Company intends
to fully cooperate with the Commission in its investigation. No assurance can be
given as to whether there will be any litigation or, if so, as to the outcome of
this matter.
The Company's subsidiary, Lazer-Tron, was sued in an action entitled Eric
Goldstein, on behalf of himself and all others similarly situated, v. Lazer-Tron
Corporation, Norman B. Petermeier, Matthew F. Kelly, Bryan M. Kelly, Morton
Grosser, Bob K. Pryt and Roger V. Smith (V-009846-7) in the Superior Court of
the State of California, County of Alameda, Eastern Division. The plaintiffs
allege, among other things, breach of fiduciary duty, abuse of control,
negligence and negligent misrepresentation. In addition, certain former
directors and officers of Lazer-Tron have been named as defendants in an action
entitled Adrienne Campbell, individually and on behalf of all others similarly
situated, v. Norman B. Petermeier, Matthew F. Kelly, Bryan M. Kelly, Morton
Grosser, Bob K. Pryt, Roger V. Smith and Does 1 through 50, inclusive, Civil No.
760717-4, in the Superior Court of the State of California, County of Alameda.
The plaintiffs, on behalf of a class of Lazer-Tron's shareholders, claim damages
based on allegations that, as a result of lack of due diligence by the named
defendants in fully investigating the proposed acquisition by the Company of
Lazer-Tron, the defendants breached their fiduciary duties to Lazer-Tron's
shareholders. These two actions have been consolidated and are scheduled to be
tried in May. The parties have agreed to the terms of a settlement of this
action, subject to court approval.
The Company and certain of its current and former directors and/or
executive officers were sued in various complaints filed in April 1994, which
were consolidated into an action entitled In re Acclaim Entertainment, Inc.
Securities Litigation (CIV 94 1501) (the 'WMS Action'). The plaintiffs, on
behalf of a class of the Company's
41
<PAGE>
stockholders consisting of all those who purchased the Common Stock for the
period January 4, 1994 to March 30, 1994, claim damages arising from (i) the
Company's alleged failure to comply with the disclosure requirements of the
securities laws in respect of the Company's relationship with WMS Industries
Inc. ('WMS') and the status of negotiations on and the likelihood of renewal of
an agreement with WMS, pursuant to which WMS granted the Company a right of
first refusal to create software for 'computer games', 'home video games' and
'handheld game machines' based on arcade games released by WMS through March 21,
1995, (ii) statements made by the Company's representative that rumors relating
to the nonrenewal of the agreement were 'unsubstantiated' and that talks between
the Company and WMS were continuing, which allegedly were materially false and
misleading and (iii) a claim that the defendants should have disclosed the
likely nonrenewal of the agreement. Discovery is complete. The parties are
currently negotiating settlement terms with respect to this action.
The Company has also asserted a third-party action against its insurance
company, Mt. Hawley Insurance Company ('Mt. Hawley') based on Mt. Hawley's
disclaimer of coverage for liability which may result from the WMS Action and
for fees and expenses up to the amount of the policy incurred in connection with
the defense of the WMS Action. A separate trial of this action after the trial
of the WMS Action has been ordered.
The New York State Department of Taxation and Finance (the 'Department'),
following a field audit of the Company with respect to franchise tax liability
for its fiscal years ended August 31, 1989, August 31, 1990 and August 31, 1991,
has notified the Company that a stock license fee (plus interest and penalties)
of approximately $1.9 million, relating to the Company's outstanding capital
stock as of 1989, is due to the State of New York. The Company is contesting the
fee and a petition denying liability has been filed. No assurance can be given
as to the outcome of this matter.
A portion of any settlement or award arising from or out of one or more of
the above litigations may be covered by the Company's insurance.
The Company is also party to various litigations arising in the course of
its business, the resolution of none of which, the Company believes, will have a
material adverse effect on the Company's liquidity or results of operations. See
also Note 20 of Notes to Consolidated Financial Statements. Other than the
ordinary course litigations and the litigations that have been settled subject
to court approval, the resolution of which the Company believes would not have a
material adverse affect on its business, an adverse result in the other
litigations to which the Company is a party could have a material adverse effect
on the Company.
The Company could also be subject to material claims from the former
stockholders of Sculptured Software and Probe alleging, among other things,
violations of the antifraud provisions of federal and state securities laws,
breaches of contractual arrangements and/or based on the inability of such
persons, due to the Company's alleged failure to effect resale registration
statements, to sell all or a portion of the shares of Common Stock owned by them
at times when the Common Stock was publicly traded at significantly higher
prices as compared to its current market price.
In connection with certain litigations for which the settlement obligation
is currently probable and estimable, the Company recorded a primarily noncash
charge of $8.3 million in the quarter ended May 31, 1997. No assurance can be
given that the Company will not be required to record additional material
charges in future periods in conjunction with the various litigations to which
the Company is a party.
42
<PAGE>
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
Certain information concerning directors and executive officers of the
Company is set forth below:
<TABLE>
<CAPTION>
NAME AGE POSITION AND PRINCIPAL OCCUPATION
- --------------------------------------------- --- --------------------------------------------------
<S> <C> <C>
Gregory E. Fischbach......................... 55 Co-Chairman of the Board, President and Chief
Executive Officer
James Scoroposki............................. 49 Co-Chairman of the Board, Senior Executive Vice
President, Secretary and Treasurer
J. Mark Hattendorf........................... 46 Executive Vice President and Chief Financial and
Accounting Officer
Anthony Williams............................. 39 Executive Vice President
Kenneth L. Coleman........................... 54 Director
Bernard J. Fischbach......................... 52 Director
Michael Tannen............................... 57 Director
Robert H. Groman............................. 54 Director
James Scibelli............................... 47 Director
Bruce W. Ravenel............................. 47 Director
</TABLE>
Gregory E. Fischbach, a founder of the Company, has been Chief Executive
Officer of the Company since its formation, a member of the Board of Directors
since 1987 and Co-Chairman of the Board of Directors since March 1989. Mr.
Fischbach was also President of the Company from its formation until January
1990 and has been President of the Company since October 1996. From June 1986
until January 1987, he was President of RCA/Ariola International, responsible
for the management of its record operations outside the U.S. and in charge of
its seventeen operating subsidiaries.
James Scoroposki, a founder of the Company, has been Senior Executive Vice
President since December 1993, a member of the Board of Directors since 1987 and
Co-Chairman of the Board since March 1989. Mr. Scoroposki has been Secretary and
Treasurer of the Company since its formation. Mr. Scoroposki was also Chief
Financial Officer of the Company from April 1988 to May 1990 and Executive Vice
President of the Company from formation to November 1993. Since December 1979,
he has also been the President and sole shareholder of Jaymar Marketing Inc.
('Jaymar'), a sales representation organization. See 'Certain Relationships and
Related Transactions.'
J. Mark Hattendorf has been the Executive Vice President and Chief
Financial and Accounting Officer of the Company since July 1996. From October
1995 to June 1996, Mr. Hattendorf served as Senior Vice President and Chief
Financial Officer of Prodigy Services Company, an online consumer services
company. From September 1993 to October 1995, Mr. Hattendorf served as Senior
Vice President and Chief Financial Officer of Herbalife International Inc., a
nutritional direct selling organization. From 1991 to 1993, Mr. Hattendorf
served as a full time financial consultant to Canal+, a French entertainment
company engaged, among other things, in international satellite television
broadcasting.
Anthony Williams has been Executive Vice President of the Company since
1992. Prior to such time and for more than the preceding five years, Mr.
Williams held a variety of positions with the Company.
Kenneth L. Coleman has been a member of the Board of Directors since July
1997. Mr. Coleman is currently Senior Vice President, Customer and Professional
Services, for Silicon Graphics, Inc. in Mountain View, California. For more than
the past five years, Mr. Coleman has held several positions at Silicon Graphics,
Inc.
Bernard J. Fischbach has been a member of the Board of Directors since 1987
and has been engaged in the private practice of law in Los Angeles, California
since 1976 with Fischbach, Perlstein, Lieberman & Yanny and its predecessor
firms. See 'Certain Relationships and Related Transactions.'
Michael Tannen has been a member of the Board of Directors since 1989 and
is currently the President and Chief Executive Officer of Tannen Media Ventures,
a media investment company. Since 1988, Mr. Tannen was the President and Chief
Executive Officer of InterVision, Inc., a subsidiary of Millicom Incorporated, a
company involved in publishing, television production and home video
distribution and sales. From June 1992 to October 1996, Mr. Tannen served as
Chief Executive Officer of Kinnevik Media Ventures, Ltd., a media service
subsidiary of A.B. Kinnevik, a Swedish conglomerate engaged, among other things,
in international satellite television broadcasting, cable television networks
and cellular mobile telephone and paging operations. From
43
<PAGE>
June 1992 to October 1996, Mr. Tannen also served as Chief Executive Officer of
Television Holdings International, S.A., a wholly owned subsidiary of A.B.
Kinnevik.
Robert H. Groman has been a member of the Board of Directors since 1989 and
has, for more than the preceding five years, been a partner in the general
practice law firm of Groman, Ross & Tisman, P.C. (and its predecessor firms)
located in Long Island, New York. See 'Certain Relationships and Related
Transactions.'
James Scibelli has been a member of the Board of Directors since 1995 and
has, since March 1986, served as president of Roberts & Green, Inc., a New York
financial consulting firm offering a variety of financial and investment
consulting services. Mr. Scibelli is also a director of Boardwalk Casino, Inc.,
which owns and operates a hotel and casino.
Bruce W. Ravenel has been a member of the Board of Directors since 1995 and
is currently President and Chief Executive Officer of TCI.Net, Inc., a wholly
owned subsidiary of Tele-Communications, Inc. ('TCI'). Since January 1996, Mr.
Ravenel has also served as President and Chief Operating Officer of the TCI
Internet Services, Inc. unit of TCI and Senior Vice President for Internet
Services of TCI Communications, Inc., a wholly owned subsidiary of TCI, in which
capacities he has been responsible for all Internet-related business activities
of TCI. From 1994 to 1996, Mr. Ravenel was Senior Vice President and Chief
Operating Officer of TCI Technology Ventures, Inc. ('TCI Technology'), a
division of TCI, and from 1992 to 1994 he served as Senior Vice President of TCI
Technology, Inc.
Messrs. Gregory E. and Bernard J. Fischbach are brothers. There is no
family relationship among any other directors or executive officers of the
Company.
Mr. Ravenel was elected as a director of the Company in February 1995 in
connection with the sale by the Company of 4,348,795 shares of its common stock
to TCI GameCo Holdings, Inc. ('TCI Sub'), an indirect wholly owned subsidiary of
TCI, in February 1995. In addition, in February 1995, Messrs. Gregory Fischbach
and Scoroposki entered into a voting agreement with TCI Sub pursuant to which
each party agreed to vote all shares beneficially owned by it in favor of those
individuals nominated by the Board of Directors of the Company for election to
the Board of Directors at any annual or special meeting of the stockholders of
the Company at which directors are to be elected provided that, subject to
certain exceptions, such nominees include Messrs. Gregory Fischbach and
Scoroposki (or their designees or successors) and one individual proposed by TCI
Sub.
The Company has agreed with each of Messrs. G. Fischbach and Scoroposki
pursuant to the terms of their respective employment agreements and/or
arrangements with the Company to use its best efforts to cause him to be elected
as a director.
There is no other arrangement or understanding pursuant to which any person
has been elected as a director or executive officer of the Company.
COMMITTEES OF THE BOARD OF DIRECTORS
The Board of Directors has an Executive Committee (the 'Executive
Committee'), the members of which are Messrs. Tannen, Groman, Scibelli, B.
Fischbach and Scoroposki. The Executive Committee has such powers as may be
assigned to it by the Board of Directors from time to time. It is currently
charged with meeting with the management of the Company and monitoring
management's efforts in respect of the Company's plans for fiscal 1997.
The Board of Directors has an Audit Committee (the 'Audit Committee'), the
members of which are Messrs. Coleman, Groman, Scibelli and Tannen. The Audit
Committee has such powers as may be assigned to it by the Board of Directors
from time to time. It is charged with recommending to the Board of Directors the
engagement or discharge of independent public accountants, reviewing the plan
and results of the auditing engagement with the officers of the Company, and
reviewing with the officers of the Company the scope and nature of the Company's
internal accounting controls.
The Board of Directors also has a Compensation and Stock Option Committee
(the 'Compensation Committee'), the members of which are Messrs. Coleman and
Scibelli. The Compensation Committee has such powers as may be assigned to it by
the Board of Directors from time to time. It is charged with determining
compensation packages for the Chief Executive Officer and the Senior Executive
Vice President of the Company, establishing salaries, bonuses and other
compensation for the Company's executive officers and with administering the
Plan and the Company's 1995 Restricted Stock Plan, and recommending to the Board
of Directors changes to the Plan.
44
<PAGE>
EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The following table summarizes all plan and non-plan compensation awarded
to, earned by or paid to the Company's Chief Executive Officer and its four
other executive officers (together, the 'Named Executive Officers') who were
serving as executive officers during and at the end of the last completed fiscal
year ended August 31, 1996 for services rendered in all capacities to the
Company and its subsidiaries for each of the Company's last three fiscal years:
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
AWARDS
------------
ANNUAL COMPENSATION SECURITIES ALL OTHER
------------------------------ UNDERLYING COMPENSATION*
SALARY BONUS OPTIONS -------------
NAME AND PRINCIPAL POSITION YEAR $ $ # $
- ------------------------------------------------ ---- -------- ---------- ------------ -------------
<S> <C> <C> <C> <C> <C>
Gregory E. Fischbach ........................... 1996 $775,000 $ 0 150,000 $19,200
Co-Chairman and 1995 775,000 2,775,000 150,000 17,000
Chief Executive Officer 1994 775,000 2,685,000 300,000 14,500
James Scoroposki ............................... 1996 500,000 0 150,000 5,100
Co-Chairman, Senior 1995 500,000 2,350,000 150,000 4,600
Executive Vice President, 1994 483,000 2,685,000 300,000 4,300
Treasurer and Secretary
Robert Holmes .................................. 1996 605,000 0 0 6,000
President and Chief 1995 550,000 2,350,000 325,000 6,000
Operating Officer 1994 500,000 1,467,000 450,000 5,400
J. Mark Hattendorf ............................. 1996 250,000 0 165,000 0
Executive Vice President
and Chief Financial
and Accounting Officer
Anthony Williams ............................... 1996 225,000 0 0 2,100
Executive Vice 1995 225,000 45,000 140,000 2,000
President 1994 200,000 100,000 200,000 1,800
</TABLE>
- ------------------
* Represents dollar value of insurance premiums paid by the Company during the
fiscal year with respect to term life insurance for the benefit of the Named
Executive Officers.
No restricted stock awards, stock appreciation rights or long-term
incentive plan awards (all as defined in the proxy regulations promulgated by
the Securities and Exchange Commission) were awarded to, earned by, or paid to
the Named Executive Officers during any of the Company's last three fiscal
years.
45
<PAGE>
OPTION GRANTS IN LAST FISCAL YEAR
The following table sets forth information with respect to grants of stock
options to purchase Common Stock pursuant to the Company's 1988 Stock Option
Plan (the 'Plan') granted to the Named Executive Officers during the fiscal year
ended August 31, 1996:
<TABLE>
<CAPTION>
POTENTIAL
INDIVIDUAL GRANTS REALIZABLE VALUE
----------------------------------------------------- AT ASSUMED ANNUAL
NUMBER OF PERCENT OF RATES OF STOCK
SECURITIES TOTAL OPTIONS PRICE APPRECIATION
UNDERLYING GRANTED TO EXERCISE FOR OPTION TERM
OPTIONS EMPLOYEES IN PRICE EXPIRATION --------------------------------------
NAME GRANTED(#) FISCAL YEAR ($/SH) DATE 5%($) 10%($)
- ------------------------------ ---------- ------------- -------- ---------- ----------------- -----------------
<S> <C> <C> <C> <C> <C> <C>
Gregory E. Fischbach.......... 150,000 3.7% $ 7.50 7/23/2006 $ 860,215 $ 2,036,123
James Scoroposki.............. 150,000 3.7% 7.50 7/23/2006 $ 860,215 $ 2,036,123
Robert Holmes................. 0 NA NA NA NA NA
J. Mark Hattendorf(1)......... 39,999 1.0% 7.50 7/23/2006 229,385 542,953
125,001 3.1% 6.38 7/23/2006 856,852 1,836,784
Anthony Williams.............. 0 NA NA NA NA NA
All Stockholders(2)........... -- -- -- -- 255,697,943 647,988,790
</TABLE>
- ------------------------
(1) On October 28, 1996, the Company granted to Mr. Hattendorf options to
purchase an aggregate of 165,000 shares of Common Stock at an exercise price
of $3.94 per share, which options were granted in lieu of, and subject to
the cancellation of, the options referred to above.
(2) These figures were calculated assuming that the price of the 49,693,000
shares of Common Stock issued and outstanding on August 31, 1996 increased
from $8.125 per share at compound rates of 5% and 10% per year for ten
years. The purpose of including this information is to indicate the
potential realizable value at the assumed annual rates of stock price
appreciation for the ten-year option term for all of the Company's
stockholders.
AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR-END OPTION VALUES
The following table sets forth information with respect to each exercise of
stock options during the fiscal year ended August 31, 1996 by the Named
Executive Officers and the value at August 31, 1996 of unexercised stock options
held by the Named Executive Officers.
<TABLE>
<CAPTION>
NUMBER OF SECURITIES
SHARES UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
ACQUIRED VALUE OPTIONS IN-THE-MONEY OPTIONS AT
ON EXERCISE REALIZED(1) AT FISCAL YEAR-END((#) FISCAL YEAR-END($)
NAME # ($) EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE
- ------------------------------------- ----------- ----------- ------------------------- -------------------------
<S> <C> <C> <C> <C>
Gregory Fischbach.................... 0 $0 1,365,000/300,000 $5,807,814/93,750
James Scoroposki..................... 0 0 1,365,000/300,000 5,807,814/93,750
Robert Holmes........................ 0 0 1,342,085/316,667 4,505,771/0
J. Mark Hattendorf(2)................ 0 0 0/165,000 0/243,751
Anthony Williams..................... 0 0 377,166/165,334 1,034,375/0
</TABLE>
- ------------------------
(1) Fair market value of securities underlying the options at fiscal year end
minus the exercise price of the options.
(2) On October 28, 1996, the Company granted to Mr. Hattendorf options to
purchase an aggregate of 165,000 shares of Common Stock at an exercise price
of $3.94 per share, which options were granted in lieu of, and subject to
the cancellation of, the options referred to above.
46
<PAGE>
DIRECTORS' COMPENSATION
Directors who are not also employees of the Company receive a $10,000
annual fee, reimbursement of expenses for attending meetings of the Board and
generally receive an annual grant of options to purchase 18,750 shares under the
Plan. In addition, options may be granted under the Plan to non-employee
directors who render services to the Company and who are not also members of the
Compensation Committee. See 'Certain Relationships and Related Transactions.'
EMPLOYMENT CONTRACTS, TERMINATION OF EMPLOYMENT AND CHANGE-IN-CONTROL
ARRANGEMENTS
The Company has employment agreements with each of Gregory Fischbach and
James Scoroposki, providing for Mr. Gregory Fischbach's employment as President
and Chief Executive Officer and for Mr. Scoroposki's employment as Senior
Executive Vice President, Secretary and Treasurer, for terms expiring in August
2000.
The agreements with Messrs. Gregory Fischbach and Scoroposki provide for
annual base salaries of $775,000 and $500,000, respectively, for the term of the
agreements. In addition, each of the agreements provides for annual bonus
payments to Mr. Fischbach in an amount equal to 3.25% of the Company's net
pre-tax profits for each fiscal year and to Mr. Scoroposki in an amount equal to
2.75% of the Company's net pre-tax profits for each fiscal year. The agreement
with Mr. Scoroposki specifically allows him to devote that amount of his
business time to the business of certain sales representative organizations
controlled by him as does not interfere with the services to be rendered by him
to the Company. The sales representative organizations under his control have
officers and employees who oversee the operations of such organizations. Mr.
Scoroposki attends board meetings of such companies but has no active
involvement in their day to day operations. Under the agreements, the Company
provides each of Messrs. Gregory Fischbach and Scoroposki with $2 million term
life insurance and disability insurance.
If the employment agreement of either of Messrs. Gregory Fischbach or
Scoroposki is terminated within one year after occurrence of a change in control
of the Company (other than a termination for cause) or if either of Messrs.
Gregory Fischbach or Scoroposki terminates his employment agreement upon the
occurrence of both a change in control of the Company and a change in the
circumstances of his employment, he would be entitled to receive severance
benefits in an amount equal to the total of (i) three years' base salary and
(ii) three times the largest bonus paid to him for the three fiscal years
immediately preceding any such termination of his employment.
The Company has an agreement in principle with Mr. Robert Holmes for his
employment as President and Chief Operating Officer, which provides for a
current annual base salary of $605,000. The term of the agreement expires on
August 31, 1999. The agreement guarantees Mr. Holmes a 10% annual increase in
his base salary for the term of the agreement. In addition, the agreement
provides for annual bonus payments equal to 2.75% of the Company's net pre-tax
profits for each fiscal year. The Company provides Mr. Holmes with a $2 million
term life insurance policy and disability insurance. Under the agreement with
Mr. Holmes, if his employment is terminated within one year after the occurrence
of a change in control of the Company (other than a termination for cause) or if
he terminates his agreement upon the occurrence of both a change in control of
the Company and a change in the circumstances of his employment, he would be
entitled to receive severance benefits in an amount equal to the total of (i)
three years' base salary and (ii) three times the largest bonus paid to him for
the three fiscal years immediately preceding any such termination of his
employment. In October 1996, Mr. Holmes relinquished his roles as President and
Chief Operating Officer, but remains an employee of the Company under the
existing agreement in principle as a special advisor to the Board reporting to
Mr. Gregory Fischbach. On February 3, 1997 Mr. Holmes resigned his position as a
director of the Company and of its subsidiaries. The Company has had discussions
with Mr. Holmes with respect to negotiating his severance from the Company.
The Company also has an agreement in principle with Mr. Williams for his
employment as Executive Vice President and Chief Financial and Accounting
Officer, which provides for a current annual base salary of $225,000. In July
1996, Mr. Williams relinquished his roles as Chief Financial and Accounting
Officer, but retains his role as Executive Vice President under the terms of the
existing agreement in principle. The agreement expires on August 31, 1999. Mr.
Williams is also entitled to a bonus in an amount to be determined at the
discretion of the Board of Directors if the Company achieves certain financial
performance objectives. The
47
<PAGE>
Company provides Mr. Williams with a $1 million term life insurance policy and
disability insurance. If Mr. Williams' employment is terminated within one year
after the occurrence of a change in control of the Company (other than a
termination for cause) or if he terminates his agreement upon the occurrence of
both a change in control of the Company and a change in the circumstances of his
employment, he would be entitled to receive severance benefits in an amount
equal to the total of (i) one year's base salary and (ii) two times the bonus
paid to him for the fiscal year immediately preceding any termination of his
employment. The Company has had discussions with Mr. Williams with respect to
negotiating his severance from the Company.
Each of the agreements with Messrs. Gregory Fischbach, Scoroposki, Holmes
and Williams provides that, in the event of a change in control of the Company,
all options theretofore granted to each of them shall vest and become
immediately exercisable and the Company has agreed to indemnify each of them
against any excise taxes imposed on such executive by section 4999(a) of the
Internal Revenue Code of 1986, as amended (including all applicable taxes on
such indemnification payment).
Each of the agreements with Messrs. Gregory Fischbach, Scoroposki, Holmes
and Williams prohibits disclosure of proprietary and confidential information
regarding the Company and its business to anyone outside the Company both during
and subsequent to employment. In addition, the employees agree, for the duration
of their employment with the Company and for one year thereafter, not to engage
in any competitive business activity, nor to persuade or attempt to persuade any
customer, software developer, licensor, employee or other party with whom the
Company has a business relationship to sever its ties with the Company or reduce
the extent of its relationship with the Company.
In addition, at the end of their respective terms, if the agreements with
each of Messrs. Gregory Fischbach, Scoroposki, Holmes and Williams are not
renewed on substantially similar terms, the employee would be entitled to
receive severance benefits in an amount equal to the total cash compensation
paid to him during the 12-month period immediately preceding such termination of
his employment.
The Company has an employment agreement with Mr. Hattendorf for his
employment as Chief Financial Officer of the Company, which provides for a
current annual base salary of $275,000. Under the agreement with Mr. Hattendorf,
if his employment is terminated for any reason other than for cause, Mr.
Hattendorf is entitled to receive severance benefits equal to the total of (i)
nine months of his then applicable base salary and (ii) the cost of outplacement
services (not to exceed $7,500).
BENEFIT PLANS
The Company does not have a pension plan. For information with respect to
options granted to executive officers of the Company under the Company's 1988
Stock Option Plan, see page 46.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The members of the Compensation Committee are Kenneth Coleman and James
Scibelli, who are intended to be 'non-employee directors' within the meaning of
Rule 16b-3(b)(3)(i) promulgated under the Exchange Act and 'outside directors'
within the contemplation of section 162(m)(4)(C)(i) of the Internal Revenue Code
of 1986, as amended.
48
<PAGE>
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information as of September 19, 1997
(except as otherwise indicated) with respect to the number of shares of Common
Stock beneficially owned by each person who is known to the Company to
beneficially own more than 5% of the Common Stock, the number of shares of
Common Stock beneficially owned by each director of the Company and each
executive officer of the Company, and the number of shares of Common Stock
beneficially owned by all executive officers and directors of the Company as a
group. Except as otherwise indicated, each such stockholder has sole voting and
investment power with respect to the shares beneficially owned by such
stockholder.
<TABLE>
<CAPTION>
PERCENT OF
COMMON
AMOUNT AND NATURE OF STOCK
NAME AND ADDRESS BENEFICIAL OWNERSHIP(1) OUTSTANDING
- ----------------------------------------------------------------------------- ----------------------- -----------
<S> <C> <C>
Gregory E. Fischbach(2)(3) .................................................. 7,648,151 14.6%
One Acclaim Plaza
Glen Cove, New York 11542
James Scoroposki(3)(4) ...................................................... 7,102,451 13.5
One Acclaim Plaza
Glen Cove, NY 11542
The Capital Group Companies, Inc.(5) ........................................ 6,949,400 13.9
333 South Hope Street
Los Angeles, CA 90071
Merrill Lynch & Co., Inc.(6) ................................................ 6,868,611 13.7
World Financial Center
North Tower
250 Vesey Street
New York, NY 10281
TCI GameCo Holdings, Inc.(3) ................................................ 4,348,795 8.7
Terrace Tower II
5619 DTC Parkway
Englewood, CO 80111
Bernard J. Fischbach(7) ..................................................... 331,276 *
1925 Century Park East
Suite 1260
Los Angeles, CA 90067
Robert H. Groman(8) ......................................................... 100,000 *
196 Peachtree Lane
Roslyn Heights, NY 11577
Michael Tannen(8) ........................................................... 94,875 *
90 Riverside Drive, #5B
New York, NY 10024
James Scibelli(9) ........................................................... 44,500 *
2936 Bay Drive
Merrick, NY 11566
Bruce W. Ravenel(10) ........................................................ 10,250 *
5750 DTC Parkway, 2nd Floor
Englewood, CO 80111
</TABLE>
49
<PAGE>
<TABLE>
<CAPTION>
PERCENT OF
COMMON
AMOUNT AND NATURE OF STOCK
NAME AND ADDRESS BENEFICIAL OWNERSHIP(1) OUTSTANDING
- ----------------------------------------------------------------------------- ----------------------- -----------
<S> <C> <C>
Kenneth L. Coleman .......................................................... -0- -0-
2011 North Shoreline Blvd.
Mountain View, CA 94043
J. Mark Hattendorf .......................................................... 0 0
One Acclaim Plaza
Glen Cove, NY 11542
Anthony R. Williams(11) ..................................................... 170,000 *
One Acclaim Plaza
Glen Cove, NY 11542
All executive officers and directors as a group
(10 persons)(10)(12) ...................................................... 15,201,675 27.2%
</TABLE>
- ------------------
* Less than 1% of class.
(1) Includes shares issuable upon exercise of warrants and options which are
exercisable within the next 60 days.
(2) Includes 2,827,500 shares issuable upon exercise of warrants and options,
36,276 shares held as co-trustee of trusts for the benefit of Mr.
Scoroposki's children and 156,276 shares settled by Mr. Gregory Fischbach
in trust for the benefit of his children. Each of Mr. Gregory Fischbach and
Mr. Scoroposki has agreed to vote, or cause to be voted, all shares of
Common Stock beneficially owned by him in the manner in which all shares of
Common Stock beneficially owned by the other are voted on all matters
presented to a vote of stockholders at any annual or special meeting of the
Company's stockholders.
(3) Messrs. Gregory Fischbach and Scoroposki and TCI have entered into a voting
agreement pursuant to which they have agreed to vote all shares
beneficially owned by each of them in favor of those individuals nominated
by the Board of Directors of the Company for election to the Board of
Directors at any annual or special meeting of the stockholders of the
Company at which directors are being elected provided that, subject to
certain exceptions, such nominees include Messrs. Gregory Fischbach and
Scoroposki (or their designees or successors) and one individual proposed
by TCI Sub.
(4) Includes 2,827,500 shares issuable upon exercise of warrants and options,
156,276 shares held as co-trustee of trusts for the benefit of Mr. Gregory
Fischbach's children and 36,276 shares settled by Mr. Scoroposki in trust
for the benefit of his children. Each of Mr. Scoroposki and Mr. Gregory
Fischbach has agreed to vote, or cause to be voted, all shares of Common
Stock beneficially owned by him in the manner in which all shares of Common
Stock beneficially owned by the other are voted on all matters presented to
a vote of stockholders at any annual or special meeting of the Company's
stockholders.
(5) Information in respect of the beneficial ownership of The Capital Group
Companies, Inc. has been derived from its Schedule 13-G, dated February 12,
1997, filed on its behalf and on behalf of Capital Research and Management
Company ('CRMC') with the Commission. The Company has been advised that (a)
CRMC is a registered investment adviser and an operating subsidiary of The
Capital Group Companies, Inc., (b) at February 12, 1997, CRMC exercised
investment discretion with respect to 3,635,000 shares of Common Stock,
which were owned by various institutional investors and (c) CRMC has no
power to direct the vote of such shares. Capital Guardian Trust Company, a
bank as defined in Section 3(a) of the Securities Act and a wholly-owned
subsidiary of The Capital Group Companies, Inc., is the beneficial owner of
3,292,900 shares of Common Stock as the result of its serving as the
investment manager of various institutional accounts.
(Footnotes continued on next page)
50
<PAGE>
(Footnotes continued from previous page)
(6) Information in respect of the beneficial ownership of Merrill Lynch & Co.,
Inc. ('ML&Co.') has been derived from Amendment No. 3 to its Schedule 13-G,
dated February 14, 1997, filed on its behalf and on behalf of Merrill Lynch
Group, Inc. ('ML Group'), Princeton Services, Inc, ('PSI'), Merrill Lynch
Asset Management, L.P. d/b/a Merrill Lynch Asset Management ('MLAM') and
Merrill Lynch Technology Fund, Inc. ('MLTF') with the Commission. Based
solely on such Amendment No. 3 to Schedule 13-G, ML&Co., ML Group and PSI
are parent holding companies, MLAM is a registered investment adviser and
MLTF is a registered investment company (for which MLAM acts as investment
adviser), which has an interest that relates to greater than 5% of the
Common Stock.
(7) Represents 175,000 shares issuable upon exercise of options and 156,276
shares held as co-trustee of trusts for the benefit of Mr. Gregory
Fischbach's children.
(8) Represents shares issuable upon exercise of options.
(9) Includes 37,500 shares issuable upon exercise of options.
(10) Does not include 4,348,795 shares held by TCI Sub. Mr. Ravenel is an
executive officer of TCI Internet Services, Inc., a subsidiary of TCI and
an affiliate of TCI Sub. Includes (i) 6,250 shares issuable on exercise of
options and (ii) 2,000 shares held by Mr. Ravenel's wife, as to which
shares Mr. Ravenel disclaims beneficial ownership.
(11) Includes 150,000 shares issuable upon exercise of options.
(12) Includes 6,218,625 shares issuable upon exercise of warrants and options.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Mr. James Scoroposki, an officer, director and principal stockholder of the
Company, is the sole stockholder, a director and president of a sales
representative organization selling interactive entertainment software and a 50%
stockholder, a director and executive vice president of another sales
representative organization selling interactive entertainment software. Such
sales representative organizations act as sales representatives for the Company,
receive commissions from the Company with respect to interactive entertainment
software sold by them and will continue to do so during the fiscal year ending
August 31, 1997. For the fiscal year ended August 31, 1996, the commissions paid
by the Company to these sales representative organizations amounted to
approximately $515,000. The agreements between the Company and these sales
representatives are on terms that are at least as favorable to the Company as
could have been obtained from unaffiliated third parties. In addition to
representing the Company's products, these companies also represent competitors
of the Company who distribute Software, and derive most of their revenue from
representing companies other than the Company.
Mr. Scoroposki is also the sole shareholder of The Crescent Club, which
provides restaurant services and related entertainment and meeting facilities to
the Company and will continue to do so for the fiscal year ending August 31,
1997. For the fiscal year ended August 31, 1996, payments made by the Company to
The Crescent Club amounted to approximately $83,000.
The firm of Fischbach, Perlstein, Liebermann & Yanny, of which Bernard J.
Fischbach is a partner, performs legal services for the Company and will
continue to do so for the fiscal year ending August 31, 1997. Payments made by
the Company for said services amounted to approximately $858,000 for the fiscal
year ended August 31, 1996.
The firm of Groman, Ross & Tisman, P.C. of which Robert H. Groman is a
partner, also performs legal services for the Company and will continue to do so
for the fiscal year ending August 31, 1997. Payments made by the Company for
said services amounted to approximately $43,000 for the fiscal year ended August
31, 1996.
51
<PAGE>
SELLING SECURITYHOLDERS
The Notes and Shares covered hereby will be offered and sold by the
following Selling Securityholders:
<TABLE>
<CAPTION>
BENEFICIAL OWNERSHIP AGGREGATE PRINCIPAL BENEFICIAL
OF NOTES AMOUNT OF NOTES OWNERSHIP AFTER
NAME OF NOTEHOLDER PRIOR TO OFFERING BEING OFFERED OFFERING(1)
- -------------------------------------------------------- -------------------- ------------------- ---------------
<S> <C> <C> <C>
Franklin Custodian Funds, Inc., Income Series........... $ 29,000,000 $29,000,000 0
Franklin Valuemark Funds, Income Securities Fund........ 11,000,000 11,000,000 0
Alexandra Global Investment Fund I, Ltd.
c/o Alexandra Investment Management................... 4,500,000 4,500,000 0
The Alpine Group, Inc.
c/o Alexandra Investment Management................... 500,000 500,000 0
Laterman Strategies 90S LLC............................. 500,000 500,000 0
Offshore Strategies Ltd................................. 1,000,000 1,000,000 0
Highbridge Capital Corporation.......................... 1,500,000 1,500,000 0
Winchester Convertible Plus Ltd......................... 600,000 600,000 0
Foundation Account No. 1................................ 150,000 150,000 0
Philip S. Minkin Rev Lvg Tr UAD 9-30-91 AS AMD FBO
Philip S. Minkin TTEE................................. 50,000 50,000 0
Maurice Chandler TTEE AS AMD 8-26-92
Maurice Chandler AMD & Restated Declaration of Trust.. 50,000 50,000 0
A. Bart Lewis REV LVG TR U/A DTD 2/27/87
FBO A. BART LEWIS, TRUSTEE............................ 50,000 50,000 0
Susan Gail Lewis REV LVG TR UTA DTD 2/28/87
FBO SUSAN GAIL LEWIS, TRUSTEE......................... 50,000 50,000 0
Peter D. Brown & Dorothy Brown
COTTEES UTA DTD 12-5-75 AS AMD for
the Peter Brown Rev Lvg Tr............................ 50,000 50,000 0
Willis W. Shenk......................................... 50,000 50,000 0
Lancaster Newspapers Pension Plan....................... 200,000 200,000 0
John Frederick Steinman Foundation...................... 50,000 50,000 0
The James Hale Steinman Foundation...................... 50,000 50,000 0
G. Walter Loewenbaum.................................... 250,000 250,000 0
Woodland Partners....................................... 250,000 250,000 0
Sonem Partners.......................................... 100,000 100,000 0
Dorothy D. Power........................................ 50,000 50,000 0
</TABLE>
- ------------------
(1) Assumes that the entire outstanding principal amount of the Notes (and all
Shares issuable upon conversion thereof) are sold by the Selling
Securityholders pursuant to this Prospectus. The Selling Securityholders may
choose to dispose of none or only a portion of the Notes (and Shares
issuable upon conversion thereof) held by him, her or it pursuant to this
Prospectus. The Company is not required to keep the Registration Statement
effective after the date that all of the outstanding Notes (and Shares
issuable upon conversion thereof) may be sold without registration under the
Securities Act. Accordingly, it is anticipated that any unsold principal
amount of Notes (or Shares issuable upon conversion thereof) would be sold
thereafter in reliance upon Rule 144 promulgated under the Securities Act.
All of the Notes were issued to the Selling Securityholders by the Company
in a privately-negotiated offering pursuant to Section 4(2) under the Securities
Act and Regulation D promulgated thereunder. The Notes (and the Shares issuable
upon conversion thereof) are restricted securities within the meaning of the
Securities Act and cannot be offered or sold without an effective registration
statement covering such offer and sale or pursuant to an applicable exemption
from the registration requirements of the Securities Act. Pursuant to the terms
and provisions of the sales agency agreement entered into by the Company and the
placement agent in connection with the Initial Offering, the Company filed the
Registration Statement (of which this Prospectus forms a part) and will use its
best efforts to keep the Registration Statement effective until the earlier to
occur of (i) the date all of the Notes (and Shares issuable upon conversion
thereof) have been sold and (ii) the date that all of the outstanding Notes (and
Shares issuable upon conversion thereof) may be resold without registration
under the Securities Act. The Company will pay all expenses relating to the
registration of the Notes (and the Shares issuable upon conversion thereof)
under the Securities Act, including the legal fees and expenses of the Selling
Securityholders, provided that in no event shall the Company be required to pay
the fees and expenses of more than one law firm on behalf of the Selling
Stockholders.
52
<PAGE>
Neither the Company nor any of its affiliates has had any material
relationship with any Selling Securityholder within the past three years.
PLAN OF DISTRIBUTION
The Selling Securityholders have advised the Company (1) that they intend
that the Notes (and the Shares issuable upon conversion thereof) be offered for
sale and sold or distributed, from time to time, by the Selling Securityholders,
or by the pledgees, donees, transferees or other successors in interest, on one
or more exchanges or in the over-the-counter market, or otherwise at prices and
at terms then prevailing or at prices related to the then current market price,
or in negotiated transactions; (2) that such sales or distributions may be made
by one or more of the following: (a) a block trade in which the broker or dealer
so engaged will attempt to sell the Notes (and the Shares issuable upon
conversion thereof) as agent but may position and resell a portion of the block
as principal to facilitate the transaction; (b) purchases by a broker or dealer
as principal and resale by such broker or dealer for its own account pursuant to
this Prospectus; (c) an exchange distribution in accordance with the rules of
such exchange; (d) ordinary brokerage transactions and transactions in which the
broker solicits Purchasers; (e) in negotiated transactions; and (f) through
other means; and (3) that no sales or distributions other than as described in
(2) (a) through (2) (e) above will be effected until after this Prospectus shall
have been appropriately amended or supplemented, if required to set forth the
terms thereof. In effecting sales, brokers or dealers engaged by the Selling
Securityholders may arrange for other brokers or dealers to participate in such
sales. In addition, any securities covered by this Prospectus which qualify for
sale pursuant to Rule 144 promulgated under the Securities Act may be sold under
such Rule 144 rather than pursuant to this Prospectus.
Brokers or dealers may receive commissions or discounts from the Selling
Securityholders in amounts to be negotiated immediately prior to the sale. The
Selling Securityholders and any underwriters, dealers or agents that participate
in the distribution of the Notes may be deemed to be 'underwriters' within the
meaning of the Securities Act, and any profit on the resale of the Notes by them
or any discounts, commissions or concessions received by any such underwriters,
dealers or agents may be deemed to be underwriting discounts and commissions
under the Securities Act.
The Company has agreed to indemnify the Selling Securityholders, each
underwriter, if any, of the Notes (or Common Stock issuable upon conversion
thereof) (including any broker or dealer through which such shares may be sold)
and each person, if any, who controls the Selling Securityholders or any such
underwriter within the meaning of Section 15 of the Securities Act, against
certain liabilities, including liabilities under the Securities Act.
Each of the Selling Securityholders has represented and warranted to, and
agreed with the Company that, during such time as he may be engaged in a
distribution of the Notes, the Selling Securityholder will, among other things,
(a) not engage in any stabilization activity in connection with the Company's
securities, (b) furnish to each broker or dealer through whom or which he offers
securities copies of the Prospectus, as may be required, (c) inform such broker
or dealer as to the principal amount of Notes (or the number of shares of Common
Stock issuable upon conversion thereof) he is selling, that such securities are
part of a distribution and that he is subject to the provisions of Rule 10b-6 of
the General Rules and Regulations under the Exchange Act, (d) report to the
Company any disposition of the Notes (or the Common Stock issuable upon
conversion thereof) if any such disposition shall have occurred, and (e) not bid
for, or purchase, any Company securities other than as permitted under the
Exchange Act.
53
<PAGE>
DESCRIPTION OF NOTES
The Notes offered hereby have been issued under an Indenture, dated as of
February 26, 1997, between the Company and IBJ Schroder Bank & Trust Company, as
Trustee (the 'Trustee'). The following summary of certain provisions of the
Indenture does not purport to be complete and is subject to, and is qualified in
its entirety by reference to, the Trust Indenture Act of 1939, as amended (the
'TIA'), and to all of the provisions of the Indenture, including the definitions
of certain terms therein and those terms made a part of the Indenture by
reference to the TIA as in effect on the date of the Indenture. Wherever a
particular Section, Article or defined term is referred to, such Section,
Article or defined term refers to the Indenture and is incorporated herein by
reference.
GENERAL
The Notes are unsecured subordinated obligations of the Company, are
limited to an aggregate principal amount of $50,000,000 and will mature on March
1, 2002. The Notes bear interest at the rate per annum shown on the front cover
of this Prospectus from the date of initial issuance, or from the most recent
Interest Payment Date to which interest has been paid or provided for, payable
semi-annually on March 1 and September 1 of each year, commencing September 1,
1997, to the Person in whose name the Notes (or any predecessor Notes) are
registered at the close of business on the Regular Record Date for such
interest, which shall be February 15 or August 15 (whether or not a Business
Day), as the case may be, next preceding such Interest Payment Date. Interest on
the Notes will be paid on the basis of a 360-day year of twelve 30-day months,
based on actual days elapsed. (Section 2.04 and 6.01)
Principal of, and premium, if any, and interest on the Notes is payable,
and the transfer of Notes is registerable, at the office or agency of the
Company maintained for such purposes in the Borough of Manhattan, the City of
New York. In addition, payment of interest may, at the option of the Company, be
made by check mailed to the address of the Person entitled thereto as it appears
in the Note Register. (Sections 2.03, 6.01 and 6.02)
The Notes will be issued only in fully registered form, without coupons, in
denominations of $1,000 and any integral multiples thereof. (Section 2.02) No
service charge will be made for any registration of transfer or exchange of the
Notes, but the Company may require payment of a sum sufficient to cover any tax
or other governmental charge payable in connection therewith. The Company is not
required (i) to issue, register the transfer of or exchange any Note during a
period beginning at the opening of business 15 days before the mailing of notice
fixed for any redemption and ending at the close of business on such Redemption
Date or (ii) to register the transfer of or exchange any Notes for redemption in
whole or in part, except the unredeemed portion of the Notes being redeemed in
part. (Section 2.07)
All monies paid by the Company to the Trustee or any Paying Agent for the
payment of principal of and premium, if any, and interest on any Note which
remains unclaimed for two years after such principal, premium or interest
becomes due and payable may be repaid to the Company. Thereafter, the Holder of
such Note may, as an unsecured general creditor, look only to the Company for
payment thereof. (Section 13.04)
The Indenture does not contain any provisions that would provide protection
to Holders of the Notes against a sudden and dramatic decline in the credit
quality of the Company resulting from any takeover, recapitalization or similar
restructuring, except as described below under 'Repurchase at Option of Holders
Upon a Repurchase Event' and 'Consolidation, Merger and Sale of Assets.'
CONVERSION RIGHTS
The Notes are convertible into the Common Stock of the Company at any time
up to and including the maturity date (subject to prior redemption by the
Company on not less than 30 nor more than 60 days' notice to the Trustee) of the
principal amount thereof, initially at the Conversion Price stated on the cover
page of this Prospectus (subject to adjustment as described below). The right to
convert the Notes called for redemption or delivered for repurchase will
terminate at the close of business on the Redemption Date or the Repurchase
Date, unless the Company defaults in making the payment due upon redemption or
repurchase. (Section 5.01) For information as to notices of redemption, see
'Optional Redemption.'
54
<PAGE>
The Conversion Price is subject to adjustment in certain events, including
(i) dividends (and other distributions) payable in Common Stock or any class of
capital stock of the Company, (ii) the issuance to all holders of Common Stock
of rights, warrants or options entitling them to subscribe for or purchase
Common Stock at less than the current market price, (iii) subdivisions or
combinations of Common Stock, (iv) distributions to all holders of Common Stock
or evidences of indebtedness of the Company, cash or other assets (including
securities, but excluding those dividends, rights, warrants, options and
distributions referred to above and excluding dividends and distributions paid
exclusively in cash), (v) distributions consisting exclusively of cash
(excluding any cash portion of distributions referred to in (iv) above or cash
distribution upon a merger or consolidation to which the second succeeding
paragraph applies) to all holders of Common Stock in an aggregate amount that,
combined together with (a) all other such all-cash distributions made within the
preceding 12 months in respect to which no adjustment has been made and (b) any
cash and the fair market value of other consideration paid or payable in respect
of any tender offers by the Company for Common Stock concluding within the
preceding 12 months in respect of which no adjustment has been made, exceeds
12.5% of the Company's market capitalization (defined as being the product of
the current market price of the Common Stock times the number of shares of
Common Stock then outstanding) on the record date for such distribution, and
(vi) the purchase of Common Stock pursuant to a tender offer made by the Company
or any of its Subsidiaries which involves an aggregate consideration that
together with (a) any cash and the fair market value of any other consideration
paid or payable in any other tender offer by the Company or any of its
subsidiaries of Common Stock expiring within the 12 months preceding the
expiration of such tender offer in respect of which no adjustment has been made
and (b) the aggregate amount of any such all-cash distributions referred to in
(v) above to all holders of Common Stock within the 12 months preceding the
expiration of such tender offer in respect of which no adjustments have been
made, exceeds 12.5% of the Company's market capitalization on the expiration of
such tender offer. No adjustment in the Conversion Price is required unless such
adjustment (plus any adjustments not previously made) would require an increase
or decrease of at least 1% in such price; provided, however, that any
adjustments which by reason of this sentence are not required to be made shall
be carried forward and then taken into account in any subsequent adjustment.
(Section 5.04)
In addition to the foregoing adjustments, the Company is permitted to make
such reduction in the Conversion Price as it considers to be advisable in order
that any event treated for Federal income tax purposes as a dividend or
distribution of stock or stock rights will not be taxable to the holders of the
Common Stock. (Section 5.04)
Subject to the rights of Holders of the Notes described below under
'Repurchase at Option of Holders Upon a Repurchase Event,' in case of certain
consolidations or mergers to which the Company is a party or the transfer of
substantially all of the assets of the Company, each Note then outstanding
would, without the consent of any Holders of the Notes, become convertible only
into the kind and amount of securities, cash and other property receivable upon
the consolidation, merger or transfer by a holder of the number of shares of
Common Stock into which such Note might have been converted immediately prior to
such consolidation, merger or transfer (assuming such holder of Common Stock
failed to exercise any rights of election and received per share the kind and
amount received per share by a plurality of non-electing shares). (Section 5.10)
Fractional shares of Common Stock will not be issued upon conversion, but,
in lieu thereof, the Company will pay a cash adjustment based upon market price.
(Section 5.03) Notes surrendered for conversion during the period from the close
of business on any Regular Record Date next preceding any Interest Payment Date
to the opening of business on such Interest Payment Date (except the Notes
called for redemption on a Redemption Date within such period) must be
accompanied by payment of an amount equal to the interest thereon which the
registered Holder is to receive. In the case of any Note that has been converted
after any Regular Record Date but on or before the next Interest Payment Date,
interest whose stated maturity is on such Interest Payment Date will be payable
on such Interest Payment Date notwithstanding such conversion, and such interest
will be paid to the Holder of such Note on such Regular Record Date. A Holder of
Notes called for redemption on any Interest Payment Date will (if such Holder is
the registered Holder on the applicable Record Date) receive the interest on
such Notes payable on that date and will be able to exchange such Notes after
the Record Date for such payment of interest without paying an amount equal to
such interest to the Company upon conversion. Except as described above, no
interest on converted Notes will be payable by the Company on any Interest
Payment Date subsequent
55
<PAGE>
to the date of conversion. No other payment or adjustment for interest or
dividends will be made upon conversion. (Section 5.02)
If at any time the Company makes a distribution of property to its
stockholders that would be taxable to such stockholders as a dividend for
Federal income tax purposes (e.g., distributions of evidence of indebtedness or
assets of the Company, but generally not stock dividends or rights to subscribe
for Common Stock) and, pursuant to the antidilution provisions of the Indenture,
the Conversion Price of the Notes is reduced, such reduction may be deemed to be
the payment of a taxable dividend to Holders of the Notes. Holders of the Notes
could, therefore, have taxable income as a result of an event pursuant to which
they receive no cash or property that could be used to pay the related income
tax.
RESTRICTION ON INCURRENCE OF INDEBTEDNESS AND ISSUANCE OF PREFERRED STOCK
The Indenture provides that the Company will not, and will not permit any
of its Subsidiaries to, directly or indirectly, create, incur, issue, assume,
Guarantee or otherwise become directly or indirectly liable, contingently or
otherwise, with respect to (collectively, 'incur'), after the date of issuance
of the Notes, any Indebtedness (including Acquired Debt) and the Company will
not issue any Disqualified Capital Stock and will not permit any of its
Subsidiaries to issue any shares of preferred stock. Indebtedness consisting of
reimbursement obligations in respect of a letter of credit will be deemed to be
incurred when the letter of credit is first issued.
The foregoing provisions do not apply to:
(i) the incurrence by the Company and its Subsidiaries of Indebtedness
represented by the Notes;
(ii) the incurrence by the Company or any of its Subsidiaries of
Permitted Refinancing Indebtedness in exchange for, or the net proceeds of
which are used to extend, refinance, renew, replace, defease or refund, in
whole or in part, Indebtedness that was permitted by the Indenture to be
incurred (including, without limitation, Existing Indebtedness);
(iii) the incurrence by the Company or any of its Subsidiaries or any
Affiliate of the Company or any Subsidiary of intercompany Indebtedness
between or among the Company and any of its Subsidiaries or any such
Affiliate;
(iv) the incurrence by the Company or any of its Subsidiaries of
Indebtedness represented by performance bonds, standby letters of credit or
appeal bonds, in each case to the extent incurred in the ordinary course of
business of the Company or such Subsidiary;
(v) the incurrence by the Company or any of its Subsidiaries of
Indebtedness, which, together with all other Indebtedness outstanding as of
the date of such incurrence, does not exceed (x) five and one half times
EBITDA for the last four fiscal quarters ending immediately preceding such
date plus (y) $6.5 million of any Capital Lease Obligations; and
(vi) the incurrence of (a) up to an aggregate of $70.0 million under
the Company's Credit Facility with BNY; (b) up to an aggregate of $5.0
million under the Company's mortgage indebtedness to Fleet (the 'Fleet
Loan'); (c) up to an aggregate of $7.5 million under a short term loan from
BNY; (d) up to an aggregate of $17.5 million under international working
capital lines of credit and; (e) up to an aggregate of $15.0 million of
borrowings from hardware vendors.
Notwithstanding the foregoing, the Company may not use the proceeds from
any of the above-referenced items in paragraph (vi) above to make an acquisition
of a business having a purchase price in excess of $5.0 million unless and only
to the extent that after the use of such proceeds the Company is able to incur
at least $1.00 of additional Indebtedness on a pro forma basis under the test
described in paragraph (v) above.
'Acquired Debt' means, with respect to any specified Person, (i)
Indebtedness of any other Person existing at the time such other Person is
merged with or into or becomes a Subsidiary of such specified Person, including,
without limitation, Indebtedness incurred in connection with, or in
contemplation of, such other Person merging with or into or becoming a
Subsidiary of such specified Person, and (ii) Indebtedness secured by a lien
encumbering any asset acquired by such specified Person. 'Acquired Debt' shall
be deemed to be Indebtedness
56
<PAGE>
incurred by such Person at the time of such merger, or upon the other Person
becoming a Subsidiary or upon the acquisition of such asset.
'Capital Lease Obligation' means, at the time any determination thereof is
to be made, any obligation of the Person for the payment of rent or other
amounts under a lease of property or assets which obligation is required to be
classified and accounted for as a capitalized lease on the balance sheet of the
Person under generally accepted accounting principles.
'Consolidated Net Income' means, with respect to any Person for any period,
the aggregate of the Net Income of such Person and its Subsidiaries for such
period, on a consolidated basis, determined in accordance with GAAP; provided
that (i) the Net Income of any Person that is not a Subsidiary or that is
accounted for by the equity method of accounting shall be included only to the
extent of the amount of dividends or distributions paid in cash to the referent
Person or a wholly-owned Subsidiary thereof, (ii) the Net Income of any
Subsidiary shall be excluded to the extent that the declaration or payment of
dividends or similar distributions by that Subsidiary of that Net Income is not
at the date of determination permitted without any prior governmental approval
(that has not been obtained) or, directly or indirectly, by operation of the
terms of its charter or any agreement, instrument, judgment, decree, order,
statute, rule or governmental regulation applicable to that Subsidiary or its
stockholders, (iii) the Net Income of any Person acquired in a pooling of
interests transaction for any period prior to the date of such acquisition shall
be excluded and (iv) the cumulative effect of a change in accounting principles
shall be excluded.
'Disqualified Capital Stock' means, with respect to any person, any Capital
Stock of such Person that, by its terms (or by the terms of any security into
which it is convertible or for which it is exercisable, redeemable or
exchangeable), matures, or is mandatorily redeemable, pursuant to a sinking fund
obligation or otherwise, or is redeemable at the option of the holder thereof,
in whole or in part, on or prior to the maturity of the Notes.
'Existing Indebtedness' means Indebtedness of the Company and its
Subsidiaries in existence on the date of the Indenture, until such amounts are
repaid, including all reimbursement obligations with respect to letters of
credit outstanding as well as the maximum availability which possibly may be
borrowed under the terms and in the amounts of the credit facilities described
in paragraph (vi) under 'Restriction on Incurrence of Indebtedness and Issuance
of Preferred Stock.'
'EBITDA' means, with respect to any Person for any period, the Consolidated
Net Income of such Person for such period plus (i) an amount equal to any
extraordinary or nonrecurring loss plus any net loss realized in connection with
a Sale of Assets (to the extent such losses were deducted in computing such
Consolidated Net Income), plus (ii) provision for taxes based on income or
profits of such Person and its Subsidiaries for such period, to the extent that
such provision for taxes was included in computing such Consolidated Net Income,
plus (iii) the Fixed Charges of such Person and its Subsidiaries for such
period, to the extent that such Fixed Charges were deducted in computing such
Consolidated Net Income, plus (iv) depreciation and amortization of such Person
and its Subsidiaries for such period to the extent that such depreciation and
amortization were deducted in computing such Consolidated Net Income, plus (v)
other non-cash charges to the extent that such non-cash charges were deducted in
computing such Consolidated Net Income, in each case, on a consolidated basis
and determined in accordance with GAAP. Notwithstanding the foregoing, the
provision for taxes on the income or profits of, and the depreciation and
amortization of a Subsidiary of the referent Person shall be added to
Consolidated Net Income to compute EBITDA only to the extent (and in the same
proportion) that the Net Income of such Subsidiary was included in calculating
the Consolidated Net Income of such Person and only of a corresponding amount
would be permitted at the date of determination to be dividended to such Person
by such Subsidiary without prior approval (that has not been obtained), pursuant
to the terms of its charter and all agreements, instruments, judgments, decrees,
orders, statutes, rules and governmental regulations applicable to that
Subsidiary or its stockholders.
'Fixed Charges' means, with respect to any Person for any period, the sum
of (i) the consolidated interest expense of such Person and its Subsidiaries for
such period, whether paid or accrued (including, without limitation,
amortization of original issue discount, non-cash interest payments, the
interest component of any deferred payment obligations, the interest component
of all payments associated with Capital Lease Obligations, commissions, and
discounts and other fees and charges incurred in respect of letters of credit or
bankers' acceptance financings, (ii) the consolidated interest expense of such
Person and its Subsidiaries that was
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capitalized during such period, (iii) any interest expense on Indebtedness of
another Person that is Guaranteed by such Person or one of its Subsidiaries or
secured by a lien on assets of such Person or one of its Subsidiaries (whether
or not such Guarantee or lien is called upon), (iv) the product of (a) all cash
dividend payments (and non-cash dividend payments in the case of a Person that
is a Subsidiary) on any series of preferred stock of such Person, times (b) a
fraction, the numerator of which is one and the denominator of which is one
minus the then current combined federal, state and local statutory tax rate of
such Person, expressed as a decimal, in each case, on a consolidated basis and
in accordance with GAAP, and (v) (without duplication of any of the foregoing)
one-third of the aggregate rental obligations of such Person and its
Subsidiaries for such period, whether paid or accrued, in respect of leases of
real and personal property, whether or not such obligations are reflected as
liabilities on the balance sheet of such Person and its Subsidiaries.
'Indebtedness' means, with respect to any Person, any of the following
(without duplication): (i)(a) any liability or obligation of the Person for
borrowed money (including, without limitation, principal and premium, if any,
interest, fees, penalties, expenses, collection expenses, and other obligations
in respect thereof, and, to the extent permitted by applicable law, interest
accruing after the filing of a petition initiating any proceeding under the
Bankruptcy Code whether or not allowed as a claim in such proceeding),whether or
not evidenced by bonds, debentures, notes or other written instruments, and any
other liability or obligation evidenced by notes, bonds debentures or similar
instruments (other than the Notes) whether or not contingent and, with respect
to any of the foregoing, whether outstanding on the date of execution of the
Indenture or thereafter created, incurred or assumed, (b) any deferred payment
obligation of the Person for the payment of the purchase price of property or
assets evidenced by a note or similar instrument (excluding any obligation for
accounts payable, trade payables, royalties, advances or guarantees of minimum
royalties in respect of agreements for the acquisition, development or
distribution of intellectual properties, games or other products in the ordinary
course of business recorded as deferred expenses or current liabilities, or
obligations constituting the deferred purchase price of property or assets which
is not evidenced by a note or similar instrument and which is unsecured), (c)
Capital Lease Obligations (d) all obligations of the Person under interest rate
and currency swaps, floors, caps, or similar arrangements intended to fix
interest rate obligations or currency fluctuation risks, (e) all obligations of
the Person evidenced by a letter of credit or any reimbursement obligation of
the Person in respect of a letter of credit, whether outstanding on the date of
execution of the Indenture or thereafter created, incurred or assumed (f) all
obligations of others secured by a lien to which any of the properties or assets
of the Person are subject (including, without limitation, leasehold interests
and any intangible property rights), whether or not the obligations secured
thereby have been assumed by the Person or shall otherwise be the Person's legal
obligation, whether outstanding on the date of execution of the Indenture or
thereafter created, incurred or assumed and (g) all obligations of others of the
kinds described in the preceding clauses (a),(b),(c),(d) or (e) assumed by or
guaranteed by the Person and the obligations of the Person under guarantees of
any such obligations; and (ii) any amendments, renewals, extensions, deferrals,
modifications, refinancing and refunding of any of the foregoing. 'Indebtedness'
shall not include; (i) any indebtedness of the Person to any Subsidiary or to
any Affiliate of the Person or any of the Subsidiaries or of any Subsidiary or
Affiliate of any Subsidiary of the Person to the Person, (ii) any indebtedness
incurred in connection with the purchase of goods, assets, materials or services
in the ordinary course of business or representing amounts recorded as accounts
payable, trade payables, royalties, advances or guarantees of minimum royalties
in respect of agreements for the acquisition, development or distribution of
intellectual properties, games or other products in the ordinary course of
business recorded as deferred expenses or current liabilities, other current
liabilities (other than for borrowed money) or deferred revenue and deposits of
the Person on the books of the Person (which are unsecured), (iii) any
indebtedness of or amount owed by the Person to employees for services rendered
to the Person or in connection with the severance of such employment, and (iv)
any liability for Federal, state, local or other taxes owing or owed by the
Person.
'Net Income' means, with respect to any Person, the net income (loss) of
such Person, determined in accordance with GAAP and before any reduction in
respect of preferred stock dividends, excluding, however, (i) any gain (but not
loss), together with any related provision for taxes on such gain (but not
loss), realized in connection with any Sale of Assets and (ii) any extraordinary
or nonrecurring gain (but not loss), together with any related provision for
taxes on such extraordinary or nonrecurring gain (but not loss).
'Permitted Refinancing Indebtedness' means any Indebtedness of the Company
or any of its Subsidiaries issued in exchange for, or the net proceeds of which
are used solely to extend, refinance, renew, replace, defease
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or refund, in whole or in part, other Indebtedness of the Company or any of its
Subsidiaries; provided that: (i) the principal amount of such Permitted
Refinancing Indebtedness does not exceed the principal amount of the
Indebtedness so extended, refinanced, renewed, replaced, defeased or refunded
(plus the amount of any premiums paid and reasonable expenses incurred in
connection therewith); (ii) such Permitted Refinancing Indebtedness has a final
maturity date equal to or later than the final maturity date of, and has a
Weighted Average Life to Maturity equal to or later than the Weighted Average
Life to Maturity of, the Indebtedness being extended, refinanced, renewed,
replaced, defeased or refunded provided that the restrictions set forth in this
subparagraph (ii) shall not apply to any refinancing of the Fleet Loan which
refinancing shall in any case be deemed to be Permitted Refinancing
Indebtedness; (iii) if the Indebtedness being extended, refinanced, renewed,
replaced, defeased or refunded is subordinated in right of payment to the Notes,
such Permitted Refinancing Indebtedness has a final maturity date equal to or
later than the final maturity date of, and is subordinated in right of payment
to, the Notes on terms at least as favorable to the Holders of Notes as those
contained in the documentation governing the Indebtedness being extended,
refinanced, renewed, replaced, defeased or refunded; and (iv) such Indebtedness
is incurred either by the Company or by the Subsidiary who is the obligor on the
Indebtedness being extended, refinanced, renewed, replaced, defeased or
refunded.
'Weighted Average Life to Maturity' means, when applied to any Indebtedness
at any date, the number of years obtained by dividing (i) the sum of the
products obtained by multiplying (a) the amount of each then remaining
installment, sinking fund, serial maturity or other required payments of
principal, including payment at final maturity, in respect thereof, by (b) the
number of years (calculated to the nearest one-twelfth) that will elapse between
such date and the making of such payment, by (ii) the then outstanding principal
amount of such Indebtedness.
RESTRICTED PAYMENTS
The Indenture provides that the Company shall not make any Restricted
Payment to any Person and the Company shall not permit any Subsidiary or
Affiliate to make any Restricted Payment other than to the Company. (Section
6.11) 'Restricted Payment' means, (i) the declaration or payment of any dividend
or the occurrence of any liability to make any other payment or distribution of
cash or other property or assets (other than payment or distribution of Capital
Stock, other than Disqualified Capital Stock) by such Person in respect of such
Person's Stock, excluding dividends from one Subsidiary to another or to the
Company and excluding cash dividends by the Company which do not exceed $2
million in the aggregate in any fiscal year, (ii) except for the purchase of
shares of Common Stock of the Company in the aggregate amount of up to $2
million in any fiscal year, any payment on account of the purchase, redemption,
defeasance or other retirement of such Person's Stock (other than payment or
distribution of Capital Stock, other than Disqualified Capital Stock) or any
other payment or distribution made in respect thereof, either directly or
indirectly, or (iii) any payment, loan, contribution, or other transfer of funds
or other property (other than payments or distributions of Capital Stock, other
than Disqualified Capital Stock) to any Stockholder of such Person in their
capacity as Stockholders as opposed to employees, directors or consultants;
provided, however, that no Event of Default exists or would be caused by the
making of a Restricted Payment. (Section 1.01)
SUBORDINATION
The payment of the principal of and premium, if any, and interest on the
Notes is, to the extent set forth in the Indenture, subordinated in right of
payment to the prior payment in full of all Senior Indebtedness. Upon any
payment or distribution of assets to creditors upon any liquidation,
dissolution, winding-up, reorganization, assignment for the benefit of
creditors, marshaling of assets or any bankruptcy, insolvency or similar
proceedings of the Company, the holders of all Senior Indebtedness will be first
entitled to receive payment in full of all amounts due or to become due thereon
before the Holders of the Notes will be entitled to receive any payment in
respect of the principal of or premium, if any, or interest on the Notes. No
payment or distribution of any assets of the Company shall be made on account of
principal of and premium, if any, or interest on the Notes, in the event and
during the continuation of (i) any default in the payment of principal of or
premium, if any, or interest on any Senior Indebtedness beyond any applicable
grace period with respect thereto or (ii) any other event of default with
respect to any Senior Indebtedness permitting the holders of such Senior
Indebtedness (or a trustee or other representative on behalf of the holders
thereof) to declare such Senior Indebtedness due and payable
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prior to the date on which it would otherwise have become due and payable, upon
written notice thereof to the Company and the Trustee by any holders of Senior
Indebtedness (or a trustee or other representative on behalf of the holders
thereof) (the 'Default Notice'), unless and until such event of default shall
have been cured or waived or ceased to exist and such acceleration shall have
been rescinded or annulled; provided such payments may not be prevented under
clause (ii) above for more than 179 days after an applicable Default Notice has
been received by the Trustee unless the Senior Indebtedness in respect of which
such event of default exists has been declared due and payable in its entirety,
in which case no such payment may be made until such acceleration has been
rescinded or annulled or such Senior Indebtedness has been paid in full. No
event of default which existed or was continuing on the date of any Default
Notice may be made the basis for the giving of a second Default Notice and only
one such Default Notice may be given in any 365-day period unless the default
which was the basis for the Default Notice shall have been cured or waived for a
period of not less than 180 days. (Article Four)
By reason of such subordination, in the event of insolvency, creditors of
the Company who are not holders of Senior Indebtedness or of the Notes may
recover less, ratably, than holders of Senior Indebtedness and may recover more,
ratably, than the Holders of the Notes.
'Senior Indebtedness' means, with respect to any Person, any of the
following (without duplication): (i) (a) any liability or obligation of the
Person for borrowed money (including, without limitation, principal of and
premium, if any, interest, fees, penalties, expenses, collection expenses, and
other obligations in respect thereof, and, to the extent permitted by applicable
law, interest accruing after the filing of a petition initiating any proceeding
under the Bankruptcy Code whether or not allowed as a claim in such proceeding),
whether or not evidenced by bonds, debentures, notes or other written
instruments, and any other liability or obligation evidenced by notes, bonds,
debentures or similar instruments (other than the Notes) whether or not
contingent, and with respect to any of the foregoing, whether outstanding on the
date of execution of the Indenture or thereafter created, incurred or assumed,
(b) any deferred payment obligation of the Person for the payment of the
purchase price of property or assets evidenced by a note or similar instrument
(excluding any obligation for accounts payable, trade payables, royalties,
advances or guarantees of minimum royalties in respect of agreements for the
acquisition, development or distribution of intellectual properties, games or
other products in the ordinary course of business recorded as deferred expenses
or current liabiities, or obligations constituting the deferred purchase price
of property or assets which is not evidenced by a note or similar instrument and
which is unsecured), (c) any Capital Lease Obligations, (d) all obligations of
the Person under interest rate and currency swaps, floors, caps, or similar
arrangements intended to fix interest rate obligations or currency fluctuation
risks, (e) all obligations of the Person evidenced by a letter of credit or any
reimbursement obligation of the Person in respect of a letter of credit and,
with respect to any of the foregoing, whether outstanding on the date of
execution of the Indenture or thereafter created, incurred or assumed (f) all
obligations of others secured by a lien to which any of the properties or assets
of the Person are subject (including, without limitation, leasehold interests
and any intangible property rights), whether or not the obligations secured
thereby have been assumed by the Person or shall otherwise be the Person's legal
obligation and, with respect to any of the foregoing, whether outstanding on the
date of execution of the Indenture or thereafter created, incurred or assumed
and (g) all obligations of others of the kinds described in the preceding
clauses (a), (b), (c), (d) or (e) assumed by or guaranteed by the Person and the
obligations of the Person under guarantees of any such obligations; and (ii) any
amendments, renewals, extensions, deferrals, modifications, refinancing and
refunding of any of the foregoing. 'Senior Indebtedness' shall not include: (i)
indebtedness that by the terms of the instrument or instruments by which such
indebtedness was created or incurred expressly provides that it (a) is junior in
right of payment to the Notes or (b) ranks pari passu, in right of payment with
the Notes, (ii) any repurchase, redemption or other obligation in respect of
Disqualified Capital Stock, (iii) any indebtedness of the Person to any
Subsidiary or to any Affiliate of the Person or any of the Subsidiaries or of
any Subsidiary or Affiliate of any Subsidiary of the Person to the Person, (iv)
any indebtedness incurred in connection with the purchase of goods, assets,
materials or services in the ordinary course of business or representing amounts
recorded as accounts payable, trade payables, royalties, advances or guarantees
of minimum royalties in respect of agreements for the acquisition, development
or distribution of intellectual properties, games or other products in the
ordinary course of business recorded as deferred expenses or current
liabilities, other current liabilities (other than for borrowed money) or
deferred revenue and deposits of the Person on the books of the Person (which
are unsecured), (v) any indebtedness of or amount owed by the Person to
employees for services rendered to the Person or in connection with the
severance of such employment, or (vi) any liability for Federal, state, local or
other taxes owing or owed by the Person.
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The Notes are effectively subordinated to all Indebtedness and other
liabilities and commitments (including trade payables and lease obligations) of
the Company's Subsidiaries. Any right of the Company to receive assets of any
such Subsidiary upon the liquidation or reorganization of any such Subsidiary
(and the consequent right of the Holders of the Notes to participate in those
assets) is effectively subordinated to the claims of that Subsidiary's
creditors, except to the extent that the Company is itself recognized as a
creditor of such Subsidiary, in which case the claims of the Company are still
subordinate to any security interest in the assets of such Subsidiary and any
indebtedness of such Subsidiary senior to that held by the Company.
The Indenture permits the incurrence of certain additional Indebtedness,
including Senior Indebtedness. At May 31, 1997, the Company's Senior
Indebtedness aggregated approximately $13.0 million, including $3.7 million of
indebtedness with respect to letters of credit and $4.4 million of obligations
under capital leases. In addition, a significant portion of the Company's trade
payables and other liabilities are liabilities of Subsidiaries of the Company
and, therefore, the Notes are effectively subordinated to all such liabilities.
The Company expects from time to time to incur additional Indebtedness,
including Senior Indebtedness to the extent permitted by the Indenture. See
Notes 11, 12, 13 and 14 of 'Notes to Consolidated Financial Statements' for a
more detailed description of the Company's outstanding obligations or
indebtedness.
OPTIONAL REDEMPTION
The Notes are redeemable at the Company's option (subject to the rights of
holders of Senior Indebtedness), in whole or from time to time in part, upon not
less than 30 nor more than 60 days' notice mailed to each Holder of the Notes to
be redeemed at such Holder's address appearing in the Note Register, on any date
on or after March 1, 2000 and prior to maturity.
The Redemption Prices (expressed as a percentage of the principal amount)
are as follows for the 12-month period beginning March 1 of the years indicated:
<TABLE>
<CAPTION>
Year Percentage
- ------------------------------------------------------------- -----------
<S> <C>
2000......................................................... 104.00%
2001......................................................... 102.00%
</TABLE>
and at maturity at 100% of principal, together in the case of any such
redemption with accrued interest to the Redemption Date (subject to the right of
Holders of record on the relevant Regular Record Date to receive interest due on
an Interest Payment Date that is on or prior to the Redemption Date). In case of
a partial redemption, selection of the Notes or portions thereof for redemption
shall be made by the Trustee pro rata and in such manner as complies with any
applicable legal requirements.
On and after any redemption date, interest will cease to accrue on the
Notes or parts thereof called for redemption as long as the Company has
deposited with the Paying Agent funds in satisfaction of the redemption price
pursuant to the Indenture.
No sinking fund is provided for the Notes.
EVENTS OF DEFAULT
The following constitute Events of Default under the Indenture:
(i) failure to pay principal of or premium, if any, on any Note when
due, whether or not such payment is prohibited by the subordination
provisions of the Indenture;
(ii) failure to pay any interest on any Note when due, continued for
30 days, whether or not such payment is prohibited by the subordination
provisions of the Indenture;
(iii) default in the payment of the Repurchase Price in respect of any
Note on the Repurchase Date therefor, whether or not such payment is
prohibited by the subordination provisions of the Indenture;
(iv) failure to perform or breach of any other covenant of the Company
in the Indenture, which continues for 60 days after written notice as
provided in the Indenture; and
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(v) certain events of bankruptcy, insolvency or reorganization of the
Company or any Significant Subsidiary. (Section 7.01)
Subject to the provisions of the Indenture relating to the duties of the
Trustee, in case an Event of Default shall occur and be continuing, the Trustee
will be under no obligation to exercise any of its rights or powers under the
Indenture at the request or direction of any of the Holders, unless such Holders
shall have offered to the Trustee reasonable indemnity. (Section 8.01) Subject
to the Trustee being offered reasonable security or indemnity against the costs,
expenses and liabilities which might be incurred by the Trustee, the Holders of
a majority in aggregate principal amount of the Outstanding Notes will have the
right by written instruction to the Trustee, to direct the time, method and
place of conducting any proceeding for any remedy available to the Trustee or
exercising any trust or power conferred on the Trustee. (Section 7.05)
If an Event of Default shall occur and be continuing, either the Trustee or
the Holders of not less than 30% in aggregate principal amount of the
Outstanding Notes may accelerate the maturity of all Notes; provided, however,
that after such acceleration, but before a judgment or decree based on
acceleration, the Holders of a majority in aggregate principal amount of the
Outstanding Notes may, under certain circumstances, rescind and annul such
acceleration if all Events of Default, other than the non-payment of accelerated
principal, have been cured or waived as provided in the Indenture. (Section
7.02) For information as to waiver of defaults, see 'Modification and Waiver'
below.
No Holder of any Note will have any right to institute any proceeding with
respect to the Indenture or for any remedy thereunder, unless (i) such Holder
shall have previously given to the Trustee written notice of a continuing Event
of Default and unless also the Holders of at least 30% in aggregate principal
amount of the Outstanding Notes shall have made written request to the Trustee
to institute proceedings, (ii) such Holder has offered to the Trustee reasonable
indemnity, (iii) the Trustee for 60 days after receipt of such notice has failed
to institute any such proceeding and (iv) no direction inconsistent with such
request shall have been given to the Trustee during such 60-day period by the
Holders of a majority in principal amount of the Outstanding Notes. (Section
7.06) However, such limitations do not apply to a suit instituted by a Holder of
a Note for enforcement of (a) payment of the principal of and premium, if any,
or interest on such Note on or after the respective due dates expressed in such
Note, (b) the right to require repurchase of such Note or (c) the right to
convert such Note in accordance with the Indenture. (Section 7.07)
The Indenture provides that the Company will deliver to the Trustee, within
90 days after the end of each fiscal year, an officers' certificate, stating as
to each signer thereof that he or she is familiar with the affairs of the
Company and whether or not to his or her knowledge the Company is in default in
the performance and observance of any of the Company's obligations under the
Indenture and if the Company shall be in default, specifying all such defaults
of which he or she has knowledge and the nature and status thereof. (Section
6.04)
CONSOLIDATION, MERGER AND SALE OF ASSETS
The Company, without the consent of the Holders of any of the Notes under
the Indenture, may consolidate with or merge into any other Person or convey,
transfer or lease its assets substantially as an entirety to any Person,
provided that (i) the successor is a Person organized under the laws of any
domestic jurisdiction; (ii) the successor Person, if other than the Company,
assumes the Company's obligations on the Notes and under the Indenture; (iii)
after giving effect to the transaction no Event of Default, and no event after
notice or lapse of time, would become an Event of Default, shall have occurred
and be continuing; (iv) the Company or the surviving person (if other than the
Company) (A) will have Consolidated Net Worth (immediately after the transaction
but prior to any purchase accounting adjustments resulting from the transaction)
greater than or equal to the Consolidated Net Worth of the Company immediately
preceding the transaction and (B) will, at the time of such transaction after
giving pro forma effect thereto as if such transaction had occurred at the
beginning of the applicable four-quarter period, be permitted to incur at least
$1.00 of additional Indebtedness pursuant to Section 6.12 of the Indenture and
(v) the Company has delivered to the Trustee an Officers' Certificate and an
Opinion of Counsel, each stating that such consolidation, merger, conveyance,
transfer or lease and, if a supplemental indenture is required in connection
with such transaction, such supplemental indenture, complies with this covenant
and that all conditions precedent herein provided for relating to such
transaction have been complied with. (Section 12.01)
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'Consolidated Net Worth' means, with respect to any Person as of any date,
the sum of (i) the consolidated equity of the common stockholders of such Person
and its consolidated Subsidiaries as of such date plus (ii) the respective
amounts reported on such Person's balance sheet as of such date with respect to
any series of preferred stock (other than Disqualified Capital Stock).
MODIFICATION AND WAIVER
Modifications and amendments of the Indenture may be made by the Company
and the Trustee with the consent of the Holders of 66 2/3% in aggregate
principal amount of the Outstanding Notes; provided, however, that no such
modification or amendment may, without consent of the Holder of each Outstanding
Note affected thereby, (i) change the stated maturity of the principal of, or
any installment of interest on any Note; (ii) reduce the principal amount of, or
the premium or interest on any Note; (iii) change the place of payment where, or
currency in which, any Note or any premium or interest thereof is payable; (iv)
impair the right to institute suit for the enforcement of any payment on or with
respect to any Note; (v) adversely affect the right to convert the Notes; (vi)
adversely affect the right to cause the Company to repurchase the Notes; (vii)
modify the subordination provisions in a manner adverse to the Holders of the
Notes; (viii) reduce the above-stated percentage of Outstanding Notes necessary
to modify or amend the Indenture; or (ix) reduce the percentage of aggregate
principal amount of Outstanding Notes necessary for waiver of compliance with
certain provisions of the Indenture or for waiver of certain defaults. (Section
11.02)
The Holders of a majority in aggregate principal amount of Outstanding
Notes may waive compliance by the Company with certain restrictive provisions of
the Indenture. (Section 7.04) The Holders of a majority in aggregate principal
amount of the Outstanding Notes may waive any past default or right under the
Indenture, except (i) a default in payment of principal, premium or interest,
(ii) the right of a Holder to redeem or convert the Note or (iii) with respect
to any covenant or provision of the Indenture that requires the consent of the
Holder of each Outstanding Note affected. (Section 7.04)
REPURCHASE AT OPTION OF HOLDERS UPON A REPURCHASE EVENT
The Indenture provides that if a Repurchase Event occurs after initial
issuance of the Notes, each Holder of the Notes shall have the right (which
right may not be waived by the Board of Directors or the Trustee) at the
Holder's option, to require the Company to repurchase all of such Holder's
Notes, or any portion thereof that is an integral multiple of $1,000, on the
date (the 'Repurchase Date') that is 45 calendar days after the date of the
Company Notice (as defined below), for cash at a price equal to 100% of the
principal amount of such Notes to be repurchased (the 'Repurchase Price'),
together with accrued interest to the Repurchase Date. (Section 6.09)
Within 15 calendar days after the occurrence of a Repurchase Event, the
Company is obligated to mail all Holders of record of the Notes a notice (the
'Company Notice') of the occurrence of such Repurchase Event and of the
repurchase right arising thereof. The Company must deliver a copy of the Company
Notice to the Trustee. To exercise the repurchase right, the Holder of such Note
must deliver on or before the fifth day preceding the Repurchase Date
irrevocable written notice to the Trustee of the Holder's exercise of such right
(except that the right of the Holders to convert such Notes shall continue until
the close of business on the last Trading Day preceding the Repurchase Date),
together with the Notes with respect to which the right is being exercised, duly
endorsed for transfer to the Company. (Section 6.09)
A Repurchase Event will be deemed to have occurred at such time after
initial issuance of the Notes if:
(i) any Person (including any syndicate or group deemed to be a
'Person' under Section 13(d)(3)of the Exchange Act), other than the
Company, any subsidiary of the Company or any current or future employee or
director benefit plan of the Company or any subsidiary of the Company or
any entity holding Capital Stock of the Company for or pursuant to the
terms of such plan, or an underwriter engaged in a firm commitment
underwriting in connection with a public offering of Capital Stock of the
Company, is or becomes the beneficial owner, directly or indirectly,
through a purchase, merger or other acquisition transaction or series of
transactions of shares of Capital Stock of the Company entitling such
Person to exercise 50% or more of the total voting power of all shares of
Capital Stock of the Company entitled to vote generally in the election of
directors;
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(ii) the Company sells or transfers all or substantially all of the
assets of the Company to another Person;
(iii) there occurs any consolidation of the Company with, or merger of
the Company into, any other Person, any merger of another Person into the
Company (other than a merger (a) which does not result in any
reclassification, conversion, exchange or cancellation of outstanding
shares of Common Stock, (b) which is effected solely to change the
jurisdiction of incorporation of the Company and results in a
reclassification, conversion or exchange of outstanding shares of Common
Stock solely into shares of Common Stock, or (c) a transaction in which the
stockholders of the Company immediately prior to such transaction owned,
directly or indirectly, immediately following such transaction, at least a
majority of the combined voting power of the outstanding voting stock of
the Company resulting from the transaction, such stock to be owned by such
stockholders in substantially the same proportion as their ownership of the
voting stock of the Company immediately prior to such transaction);
(iv) a change in the Board of Directors of the Company in which the
individuals who constituted the Board of Directors of the Company at the
beginning of the 24-month period immediately preceding such change
(together with any other director whose election by the Board of Directors
of the Company or whose nomination for election by the stockholders of the
Company was approved by a vote of at least a majority of the directors then
in office either who were directors at the beginning of such period or
whose election or nomination for election was previously so approved) cease
for any reason to constitute a majority of the directors then in office; or
(v) the Common Stock of the Company is the subject of a 'Rule 13e-3
transaction' as defined under the Exchange Act.
provided, however, that a Repurchase Event shall not be deemed to have occurred
if the closing price per share of the Common Stock for any five Trading Days
within the period of ten consecutive Trading Days ending immediately before a
Repurchase Event shall equal or exceed 110% of the Conversion Price of such
Notes in effect on each such Trading Day. A 'beneficial owner' shall be
determined in accordance with Rule 13d-3 promulgated by the Commission under the
Exchange Act, as in effect on the date of execution of the Indenture. (Sections
1.01 and 6.09)
The right to require the Company to repurchase the Notes as a result of the
occurrence of a Repurchase Event could create an event of default under Senior
Indebtedness as a result of which any repurchase could, absent a waiver, be
blocked by the subordination provisions of the Notes. The occurence of a
Repurchase Event is specifically an event of default under the Company's main
credit facility with BNY. See 'Subordination' above. Failure of the Company to
repurchase the Notes when required would result in an Event of Default with
respect to the Notes whether or not such repurchase is permitted by the
subordination provisions. The Company's ability to pay cash to the Holders of
Notes upon a repurchase may be limited by certain financial covenants contained
in the Company's credit agreement.
Rule 13e-4 under the Exchange Act requires, among other things, the
dissemination of certain information to security holders in the event of any
issuer tender offer and may apply in the event that the repurchase option
becomes available to the Holders of the Notes. The Company will comply with this
rule to the extent applicable at that time. (Section 6.09)
The repurchase feature of the Notes may in certain circumstances make more
difficult or discourage a takeover of the Company and the removal of incumbent
management. The foregoing provisions would not necessarily afford Holders of the
Notes protection in the event of highly leveraged or other transactions
involving the Company that may adversely affect Holders.
Except as described above with respect to a Repurchase Event, the Indenture
does not contain provisions permitting the Holders of the Notes to require the
Company to repurchase or redeem the Notes in the event of a takeover,
recapitalization or similar transaction. Subject to the limitation on mergers
and consolidations described above, the Company, its management or its
subsidiaries could, in the future, enter into certain transactions, including
refinancing, certain recapitalizations, acquisitions, the sale of all or
substantially all of its assets, the liquidation of the Company or similar
transactions, that would not constitute a Repurchase Event under the Indenture,
but that would increase the amount of Senior Indebtedness (or any other
Indebtedness) outstanding at such time or substantially reduce or eliminate the
Company's assets. There are certain restrictions in the Indenture on the
creation of Senior Indebtedness (and other Indebtedness), however, under certain
circumstances, the incurrence of significant amounts
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of additional indebtedness could have an adverse effect on the Company's ability
to service its indebtedness, including the Notes.
If a Repurchase Event were to occur, there is no assurance that the Company
would have sufficient funds to repurchase all Notes tendered by the Holders
thereof or to make any principal, premium, if any, or interest payments
otherwise required by the Notes.
As noted above, one of the events that constitutes a Repurchase Event under
the Indenture is a sale or other transfer of all or substantially all of the
assets of the Company. The Indenture will be governed by New York law, and the
definition under New York law of 'substantially all' of the assets of a
corporation varies according to the facts and circumstances of the transaction.
Accordingly, if the Company were to engage in a transaction in which it disposed
of less than all of its assets, a question of interpretation could arise as to
whether such disposition was of 'substantially all' of its assets and whether
the transaction was a Repurchase Event.
SATISFACTION AND DISCHARGE
The Company may, subject to certain conditions, discharge its obligations
under the Indenture while the Notes remain outstanding if (i) all outstanding
Notes will become due and payable at their scheduled maturity within one year or
(ii) all outstanding Notes are scheduled for redemption within one year, and, in
either case, the Company has deposited with the Trustee an amount sufficient to
pay and discharge all outstanding Notes on the date of their scheduled maturity
or the scheduled date of redemption. (Section 13.01)
REPORTS
In addition to complying with any applicable legal requirements, the
Company has agreed to deliver to the Holders of record, and to any beneficial
owners so requesting, annual reports containing audited consolidated financial
statements with a report thereon by the Company's independent public
accountants. (Section 8.06)
GOVERNING LAW
The Indenture and the Notes are governed by and shall be construed in
accordance with the laws of the State of New York.
INFORMATION CONCERNING THE TRUSTEE
IBJ Schroder Bank & Trust Company, New York, New York, has been appointed
Trustee, Paying Agent and Conversion Agent under the Indenture. A successor
Trustee may be appointed in accordance with the terms of the Indenture.
The Trustee's duties are set forth in the TIA, and in the Indenture. The
TIA imposes certain limitations on the right of the Trustee, in the event it
becomes a creditor of the Company, to obtain payment of claims in certain cases,
or to realize on certain property received in respect to any such claim as
security or otherwise. The Trustee will be permitted to engage in other
transactions; provided, however, if it acquires any conflicting interest within
the meaning of Section 310 of the TIA, it must generally either eliminate such
conflict or resign.
Prior to an Event of Default, the Trustee is responsible to perform only
such duties as are specifically set out in the Indenture. In case an Event of
Default shall occur (and shall not be cured), the TIA requires that the Trustee
use the degree of care of a prudent person in the conduct of its own affairs in
the exercise of its powers. Subject to such provisions, the Trustee will be
under no obligation to exercise any of its rights or powers under the Indenture
at the request of any of the Holders of Notes, unless they shall have offered to
the Trustee reasonable indemnity. (Section 8.01)
The Holders of a majority in principal amount of all outstanding Notes have
the right to direct the time, method and place of conducting any proceeding for
exercising any remedy or power available to the Trustee, provided that such
direction does not conflict with any rule of law or with the Indenture, is not
prejudicial to the rights of another Holder or the Trustee, and does not involve
the Trustee in personal liability. (Sections 7.05 and 8.01)
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MISCELLANEOUS
The Notes are fully paid and nonassessable. Holders of Notes do not have
preemptive rights. The Company has agreed to at all times reserve and keep
available out of its authorized and unissued Common Stock and/or issued shares
of Common Stock held in its treasury, solely for issuance upon the conversion of
the Notes, such number of shares of Common Stock as will from time to time be
deliverable upon the conversion of the Notes then outstanding.
DESCRIPTION OF CAPITAL STOCK
GENERAL
The following statements do not purport to be complete and are qualified in
their entirety by reference to the detailed provisions of the Company's
Certificate of Incorporation and By-Laws, each as amended, as more particularly
described below, as well as the Indenture described above.
COMMON STOCK
The Company is authorized to issue 100,000,000 shares of Common Stock, of
which 49,713,668 shares are issued and outstanding. As of May 31, 1997, options
to purchase an aggregate of 14,653,396 shares of Common Stock were outstanding
under the Plan (of which options to purchase 5,255,304 shares were exercisable
as of such date), 123,540 shares have been issued under the 1995 Restricted
Stock Plan, 290,007 shares are reserved for issuance upon exercise of options
issued other than under the Plan, and 200,000 shares are reserved for issuance
upon exercise of warrants granted to BNY. The Company has also reserved an
aggregate of 2,625,000 additional shares of Common Stock for issuance upon
exercise of warrants granted to Messrs. G. Fischbach and Scoroposki in
connection with their execution of certain security agreements. The outstanding
Common Stock is fully paid and nonassessable.
The holders of Common Stock are entitled to one vote per share for the
election of directors and with respect to all other matters submitted to a vote
of stockholders. Shares of Common Stock do not have cumulative voting rights,
which means that the holders of more than 50% of such shares voting for the
election of directors can elect 100% of the directors if they choose to do so
and, in such event, the holders of the remaining shares so voting will not be
able to elect any directors.
The holders of Common Stock are entitled to receive such dividends as may
lawfully be declared from time to time by the Board of Directors at its
discretion, subject to the priorities accorded any class of preferred stock
which may be issued, and to the restrictions under the Indenture (described
above). The holders of Common Stock have no preemptive or conversion rights, nor
are there any redemption or sinking fund rights with respect to the Common
Stock.
Upon any liquidation, dissolution, or winding up of the Company, the
holders of Common Stock are entitled to receive all assets remaining after the
payment of corporate debts and liabilities, including the Notes and any
liquidation preferences of, and unpaid dividends on, any class of preferred
stock which then may be outstanding.
PREFERRED STOCK
The Company is authorized to issue 1,000,000 shares of preferred stock, par
value $0.01 per share, none of which are currently outstanding. The Board of
Directors is empowered, without further action by the stockholders, to issue
from time to time one or more series of preferred stock (up to an aggregate of
1,000,000 shares), to fix the dividend rights, dividend rate, conversion rights,
rights and terms of redemption (including sinking fund provisions), redemption
prices, liquidation preferences, voting rights and other terms of any wholly
unissued series of preferred stock and to determine the designation of and
(subject to the aggregate limit of 1,000,000 shares) the number of shares
constituting any such unissued series. Such blanket power to issue preferred
stock could be viewed as an anti-takeover device, and might have an adverse
effect on the public stockholders. The Company has no plans to issue any
preferred stock. See 'Risk Factors--Anti Takeover Provisions.'
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Series A Preferred Stock--The Company's Board of Directors has adopted
resolutions designating 200,000 shares of Series A Preferred Stock, no par value
per share, stated value $10 per share, none of which is currently issued and
outstanding.
The Board of Directors has not designated any other series of preferred
stock, other than the Series A Preferred Stock. Pursuant to the Indenture, the
Company has agreed not to issue any Preferred Stock other than in compliance
with the restrictions described above.
SECTION 203 OF THE DELAWARE GENERAL CORPORATION LAW
Section 203 of the Delaware General Corporation Law generally restricts a
corporation from entering into certain business combinations with an interested
stockholder (defined as any person or entity that is the beneficial owner of at
least 15% of a corporation's voting stock) or its affiliates for a period of
three years after the date of the transactions in which the person became an
interested stockholder unless (i) the transaction is approved by the board of
directors of the corporation prior to such business combination, (ii) the
interested stockholder acquires 85% of the corporation's voting stock in the
same transaction in which it exceeds 15%, or (iii) the business combination is
approved by the board of directors and by a vote of two-thirds of the
outstanding voting stock not owned by the interested stockholder. The Delaware
General Corporation Law provides that a corporation may elect not to be governed
by Section 203. At present, the Company does not intend to make such an
election. Section 203 may render more difficult a change in control of the
Company or the removal of incumbent management.
TRANSFER AGENT AND REGISTRAR
American Securities Transfer, Inc., Denver, Colorado, is Transfer Agent and
Registrar for the Common Stock.
LEGAL MATTERS
Certain matters in respect of the Notes (and Shares issuable upon
conversion thereof) offered hereby will be passed upon on behalf of the Company
by Rosenman & Colin LLP, New York, New York.
EXPERTS
The Consolidated Financial Statements and schedule of Acclaim
Entertainment, Inc. and its subsidiaries as of and for the year ended August 31,
1996 have been included in this Prospectus and in the registration statement of
which it forms a part in reliance upon the report of KPMG Peat Marwick LLP
('KPMG'), independent certified public accountants, appearing elsewhere herein,
and upon the authority of said firm as experts in accounting and auditing. The
report of KPMG contains an explanatory paragraph that states that the Company's
significant loss from operations in fiscal 1996, the Company's violation of
certain loan covenants and various uncertainties including the resolution of
litigation raise substantial doubt about its ability to continue as a going
concern. The consolidated financial statements do not include any adjustments
that might result from the outcome of that uncertainty. The report also
indicates that the auditors were unable to review the selected quarterly data in
accordance with professional standards. The Consolidated Financial Statements as
of August 31, 1995 and for each of the years in the two year period ended August
31, 1995 included in this Prospectus have been audited by Grant Thornton LLP
('GT'), independent certified public accountants, as stated in their report
appearing herein. The report of GT for fiscal 1995 includes an emphasis
paragraph as to uncertainty relating to the eventual outcome of certain class
action lawsuits. See also 'Changes in and Disagreements with Accountants on
Accounting and Financial Statement Disclosure.'
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CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
On July 24, 1996, at the recommendation of its Audit Committee (the 'Audit
Committee'), the Board of Directors of the Company adopted a resolution (i) not
to retain GT as the Company's independent auditors for the fiscal year ending
August 31, 1996 and (ii) to engage KPMG as the Company's independent auditors
for the fiscal year ending August 31, 1996. GT was so advised on July 25, 1996.
The reports of GT on the Company's consolidated financial statements as of
and for the two years ended August 31, 1995 and 1994 did not contain an adverse
opinion or a disclaimer of opinion nor were they qualified or modified as to
uncertainty, audit scope or accounting principles, except that the report of GT
on the Company's financial statements for the fiscal year ended August 31, 1995
contains a modification as to uncertainty relating to the eventual outcome of
certain class action lawsuits in which the Company and certain of its officers
and directors have been named as defendants. See Note 20 of Notes to
Consolidated Financial Statements.
During the Company's two most recent fiscal years ended August 31, 1995 and
in the interim period from September 1, 1995 through July 24, 1996 there were no
disagreements with GT on any matter of accounting principles or practices,
financial statement disclosure, or auditing scope or procedure, which
disagreements, if not resolved to the satisfaction of GT, would have caused them
to make reference thereto in their report(s) on the Company's financial
statements for such fiscal year(s) or for such interim period, except:
(a) A matter, which was resolved to GT's satisfaction, in respect of
the timing of the recognition of certain revenues from nonrefundable,
recoupable exclusivity fees, which had been included in revenues for the
fourth quarter of fiscal 1995 in the October 1995 announcement by the
Company of its financial results for fiscal 1995. The Audit Committee
and/or senior management of the Company, on the one hand, and GT, on the
other hand, had several discussions in respect of such matter. The matter
was resolved by the Company revising such announced financial results to
exclude such revenues from its financial results for fiscal 1995.
(b) A matter, which was resolved to GT's satisfaction, in respect of
the balance sheet presentation of a $19 million loan from Midland Bank plc.
As of August 31, 1995, the Company did not meet a financial ratio covenant
in the loan agreement relating to such loan. The Company's senior
management and GT discussed this matter, which was resolved by the Company
reclassifying the $19 million loan from long term debt to current
liabilities.
In addition, GT proposed several audit adjustments that were not recorded
by the Company because they were considered by the Company and GT to be
immaterial to the Company's consolidated financial statements for fiscal 1995
taken as a whole.
During the Company's two most recent fiscal years ended August 31, 1995 and
the interim period from September 1, 1995 through July 24, 1996, there were no
'reportable events' as defined in Item 304(a)(1)(v) of Regulation S-K
('Regulation S-K') promulgated under the Securities Exchange Act of 1934, except
as follows:
By letter dated April 15, 1996, GT advised the Company that they had
noted certain internal control structure matters that related to
significant deficiencies in the design or operation of the Company's
internal control structure, relating to the quality and depth of financial
management, analysis of significant estimates, lack of internal audit
function and accounting for capitalized software costs, that, in their
judgment, could adversely affect the Company's ability to record, process,
summarize and report financial data consistent with the assertions of
management in the Company's financial statements.
In May 1996, KPMG was retained to conduct a review of certain internal
controls to identify and assist the Company to implement any additional
necessary steps to strengthen its internal controls.
A member of the Audit Committee and/or senior management has discussed the
subject matter of each item described above with GT, and the Company has
authorized GT to respond fully to all inquiries of KPMG concerning the subject
matter thereof.
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In response to the Company's draft Form 8-K filing presented to GT, the
Company received the following letter dated July 31, 1996 from GT which was
filed as an Exhibit to the Company's Form 8-K filed with the Securities and
Exchange Commission:
Securities and Exchange Commission
Washington, D.C. 20549
Re: Acclaim Entertainment, Inc.
File No. 0-16986
Dear Sir or Madam:
We have read Item 4 of the Form 8-K of Acclaim Entertaiment, Inc. We
believe it should be supplemented and, in part, amended to reflect the
following:
With regard to the interim period from September 1, 1995 through
July 24, 1996, we were not engaged to perform timely reviews of the
fiscal 1996 quarterly consolidated financial statements of the
Registrant. On July 17, 1996, however, we were engaged to perform a
review of the quarterly consolidated financial statements of the
Registrant for each of the first three quarters of the fiscal year
ending August 31, 1996 in respect of the Registrant's filing on Form S-3
on behalf of certain selling shareholders. On July 25, 1996, the
Registrant orally advised us of our termination as their independent
accountants. In connection with such review, certain matters, which were
still pending at the time of our termination, may have resulted in
additional disagreements and/or reportable events had we completed our
procedures. These matters included the following:
o the recognition and/or disclosure of a settlement offer
pertaining to the Lazer-Tron class action litigations.
o the recoverability asessment pertaining to excess of costs over
net assets acquired attributable to Acclaim Comics, Inc.
o the findings of the 'internal controls audit' being conducted by
KPMG Peat Marwick.
With regard to reportable events, we had issued our Internal Control
Structure/Reportable Conditions letter dated April 15, 1996 (an initial
draft of which was provided to the Registrant on January 25, 1996)
summarizing reportable conditions and recommendations which specifically
addressed the Registrant's quality and depth of financial management,
analysis of significant estimates, lack of internal audit function and
accounting for capitalized software costs. Further, the reportable
conditions discussed therein are those that we had noted as of December 8,
1995 in conjunction with our audit of the Registrant's consolidated
financial statements as of and for the year ended August 31, 1995; we have
not updated our procedures regarding such matters since that date. We have
not discussed with the Audit Committee the subject matter of our Internal
Control Structure/Reportable Conditions letter, despite our requests to the
Registrant to meet with the Audit Committee for that purpose.
With regard to the subject matter of the disagreements set forth in
Item 4 which are contained in more detail in our Report to the Audit
Committee dated April 15, 1996 (an initial draft of which was provided to
the Registrant on January 18, 1996), please be advised that we had a
telephonic discussion on December 4, 1995 with the Audit Committee
addressing only disagreements that had occurred through that date.
In connection with the Registrant's filing on Form S-3 referred to
above, we requested the Proxy Statement for the upcoming Annual
Shareholders' meeting which would be incorporated by reference in the Form
S-3, thereby forming a part of the registration statement. Professional
standards require that we read such information. We were informed by the
Registrant as recently as July 23, 1996 that the Proxy Statement was not
available for our review. On July 24, 1996, through EDGAR, we independently
obtained a copy of such requested Proxy Statement and learned that the
Registrant had filed such Proxy Statement with the Securities and Exchange
Commission on July 18, 1996. We viewed this as a restriction placed by the
Registrant on information requested by us during the conduct of our
procedures.
With regard to the Registrant's retention of KPMG Peat Marwick to
conduct an 'internal controls audit,' we did not discuss this matter with
the Registrant's Audit Committee and/or senior management.
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However, as described in our Report to the Audit Committee dated April 15,
1996 (an initial draft of which was provided to the Registrant on January
18, 1996), we were informed by management that the Registrant's legal
counsel retained KPMG Peat Marwick to assist in responding to the
Securities and Exchange Commission's Division of Enforcement. Further, we
have no knowledge as to the specific matters on which KPMG Peat Marwick was
consulted.
* * * * *
With regard to the following statements made by the Registrant in Item
4 of Form 8-K dated July 24, 1996, we have no basis for agreeing or
disagreeing with:
o the first sentence of Item 4 with respect to the July 24, 1996
Board of Directors resolution.
o the last sentence to the first paragraph of Item 4 with respect
to the Registrant's press release and any information contained
therein.
o the last sentence to the second subparagraph (b) of the third
paragraph of Item 4 with respect to the matter referred to in
such paragraph being resolved with the bank.
o the sixth paragraph of Item 4 with respect to the May 1996
retention of KPMG to conduct an 'internal controls audit.'
Very truly yours,
GRANT THORNTON LLP
In response to GT's letter of July 31, 1996, the Company notes the
following:
(a) Notwithstanding the fact that GT was not retained to perform
formal reviews of the Company's financial statements for the first, second
and third quarters of fiscal 1996, GT provided the Company with extensive
advice and consultation regarding the appropriate presentation of such
quarterly financial statements and also advised on the accounting theories
and methodologies applied; and
(b) In connection with GT's review of the Company's quarterly
financial statements for each of the first three quarters of fiscal 1996 in
respect of the Company's Registration Statement on Form S-3, GT advised the
Company on Tuesday, July 23, 1996, that it had completed its review
procedures, that there were no outstanding issues for further discussion
and that GT would release its consent in connection with the Form S-3. In
addition, on Tuesday, July 23, 1996, the Company delivered to GT its
management representation letter, which generally signifies the completion
of the review procedure. The Company delivered to GT a copy of the Proxy
Statement relating to its annual meeting of stockholders to be held on
August 7, 1996. On July 24, 1996, the Company was advised by GT that, upon
review of the Proxy Statement, GT noted that auditors had not yet been
retained for fiscal 1996 and accordingly, GT would not release its consent
unless they were appointed as the Company's auditors for fiscal 1996. GT
subsequently raised the matters discussed in GT's letter, which are
disputed by the Company as indicated above.
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TABLE OF CONTENTS TO CONSOLIDATED FINANCIAL STATEMENTS
ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Reports of Independent Auditors............................................................................ F-2
Consolidated Balance Sheets--August 31, 1996 and 1995...................................................... F-4
Statements of Consolidated Operations--Years Ended August 31, 1996, 1995 and 1994.......................... F-5
Statements of Consolidated Stockholders' Equity--Years Ended August 31, 1996, 1995 and 1994................ F-6
Statements of Consolidated Cash Flows--Years Ended August 31, 1996, 1995 and 1994.......................... F-7
Notes to Consolidated Financial Statements--Years Ended August 31, 1996, 1995 and 1994..................... F-9
Consolidated Balance Sheet--May 31,1997 (unaudited)........................................................ F-29
Statements of Consolidated Operations--Nine Months Ended May 31, 1997 and 1996 (unaudited)................. F-30
Statements of Consolidated Stockholders' Equity--Nine Months Ended May 31, 1997 (unaudited)................ F-31
Statements of Consolidated Cash Flows--Nine Months Ended May 31, 1997 and 1996 (unaudited)................. F-32
Notes to Unaudited Consolidated Financial Statements--Nine Months Ended May 31, 1997 (unaudited)........... F-33
</TABLE>
F-1
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INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Acclaim Entertainment, Inc.:
We have audited the accompanying consolidated balance sheet of Acclaim
Entertainment, Inc. and Subsidiaries as of August 31, 1996, and the related
consolidated statements of operations, stockholders' equity and cash flows for
the year then ended. In connection with our audit of the consolidated financial
statements, we also have audited the financial statement schedule for the year
ended August 31, 1996. These consolidated financial statements and financial
statement schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements and financial statement schedule based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Acclaim
Entertainment, Inc. and subsidiaries as of August 31, 1996, and the results of
their operations and their cash flows for the year ended August 31, 1996, in
conformity with generally accepted accounting principles. Also, in our opinion,
the related financial statement schedule, when considered in relation to the
basic consolidated financial statements taken as a whole, presents fairly, in
all material respects, the information set forth therein.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 2 to the
consolidated financial statements, the Company's significant loss from
operations in fiscal 1996, the Company's violation of certain loan covenants and
various uncertainties including the resolution of litigation raise substantial
doubt about its ability to continue as a going concern. Management's plans in
regard to these matters are also described in Note 2. The financial statements
do not include any adjustments that might result from the outcome of this
uncertainty.
The selected quarterly financial data in note 22 contain information that
we did not audit, and, accordingly, we do not express an opinion on that data.
We attempted but were unable to review the quarterly data in accordance with
standards established by the American Institute of Certified Public Accountants
because we believe that the Company's internal control structure policies and
procedures for the preparation of interim financial information did not provide
an adequate basis to enable us to complete such a review.
KPMG PEAT MARWICK LLP
New York, New York
December 16, 1996
F-2
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors and Stockholders,
Acclaim Entertainment, Inc.
We have audited the accompanying consolidated balance sheet of Acclaim
Entertainment, Inc. and Subsidiaries as of August 31, 1995 and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the years in the two-year period ended August 31, 1995. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Acclaim
Entertainment, Inc. and Subsidiaries as of August 31, 1995 and the results of
their operations and their cash flows for each of the years in the two-year
period ended August 31, 1995 in conformity with generally accepted accounting
principles.
We have also audited financial statement schedule II of Acclaim
Entertainment, Inc. and Subsidiaries for each of the years in the two-year
period ended August 31, 1995. In our opinion, the financial statement schedule
for such periods presents fairly, in all material respects, the information
required to be set forth therein.
As described in Note 20, the Company and certain officers have been named
as defendants in various class action claims, the outcome of which cannot
presently be determined. Accordingly, no provision for any liability that might
result upon the resolution of these matters has been made in the fiscal 1995
consolidated financial statements.
GRANT THORNTON LLP
New York, New York
December 8, 1995
F-3
<PAGE>
ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN 000S, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
AUGUST 31,
--------------------
1996 1995
-------- --------
<S> <C> <C>
ASSETS
Current assets
Cash and cash equivalents............................................................ $ 18,814 $ 44,749
Marketable equity securities......................................................... 11,278 26,503
Accounts receivable -- net........................................................... 20,478 179,311
Inventories.......................................................................... 8,052 16,015
Prepaid expenses..................................................................... 18,513 41,083
Income taxes receivable.............................................................. 54,334 14,171
Other current assets................................................................. -- 4,654
-------- --------
Total current assets............................................................ 131,469 326,486
-------- --------
Other assets
Fixed assets -- net.................................................................. 42,779 33,970
Excess of cost over net assets acquired -- net of accumulated amortization of $13,052
and $9,091, respectively............................................................ 54,939 59,837
Other assets......................................................................... 10,464 22,534
-------- --------
Total assets.................................................................... $239,651 $442,827
-------- --------
-------- --------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Trade accounts payable............................................................... $ 29,749 $ 49,072
Short-term borrowings................................................................ 5,321 4,233
Accrued expenses..................................................................... 78,506 47,017
Income taxes payable................................................................. 724 180
Current portion of long-term debt.................................................... 25,527 25,196
Obligation under capital leases -- current........................................... 1,681 333
-------- --------
Total current liabilities....................................................... 141,508 126,031
-------- --------
Long-term liabilities
Obligation under capital leases -- noncurrent........................................ 3,685 408
Other long-term liabilities.......................................................... 347 53
-------- --------
Total liabilities............................................................... 145,540 126,492
-------- --------
Minority interest....................................................................... 522 1,628
Stockholders' equity
Preferred stock, $0.01 par value; 1,000 shares authorized; None issued............... -- --
Common stock, $0.02 par value; 100,000 shares authorized; 50,041 and 46,281 shares
issued, respectively................................................................ 1,001 926
Additional paid in capital........................................................... 165,782 158,133
(Accumulated deficit), retained earnings............................................. (70,642) 153,141
Treasury stock, 348 and 273 shares, respectively..................................... (1,813) (807)
Foreign currency translation adjustment.............................................. (754) 811
Unrealized gain on marketable equity securities...................................... 15 2,503
-------- --------
Total stockholders' equity...................................................... 93,589 314,707
-------- --------
Total liabilities and stockholders' equity...................................... $239,651 $442,827
-------- --------
-------- --------
</TABLE>
See notes to consolidated financial statements.
F-4
<PAGE>
ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED OPERATIONS
(IN 000S, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
FISCAL YEAR ENDED AUGUST 31,
---------------------------------
1996 1995 1994
--------- -------- --------
<S> <C> <C> <C>
GROSS REVENUES............................................................... $ 376,024 $591,804 $520,771
Sales credits and allowances............................................... 214,079 25,081 40,015
--------- -------- --------
Net revenues............................................................... 161,945 566,723 480,756
COST OF REVENUES............................................................. 180,072 268,501 220,744
--------- -------- --------
GROSS (LOSS) PROFIT.......................................................... (18,127) 298,222 260,012
--------- -------- --------
OPERATING EXPENSES
Selling, advertising, general and administrative expenses.................. 200,440 203,930 172,099
Product development........................................................ 34,582 10,126 4,626
Operating interest......................................................... 6,417 3,957 1,979
Depreciation and amortization.............................................. 14,910 9,543 3,838
--------- -------- --------
Total operating expenses................................................... 256,349 227,556 182,542
--------- -------- --------
(Loss) earnings from operations............................................ (274,476) 70,666 77,470
--------- -------- --------
OTHER INCOME (EXPENSE)
Interest income............................................................ 3,845 2,131 1,338
Other income (expense)..................................................... 4,103 6,859 (1,143)
Interest expense........................................................... (2,339) (3,382) (670)
--------- -------- --------
(Loss) earnings before income taxes........................................ (268,867) 76,274 76,995
--------- -------- --------
(Benefit from) provision for income taxes.................................. (46,393) 31,625 31,940
--------- -------- --------
(Loss) earnings before minority interest................................... (222,474) 44,649 45,055
--------- -------- --------
Minority interest.......................................................... 1,106 (121) --
--------- -------- --------
Net (loss) earnings........................................................ $(221,368) $ 44,770 $ 45,055
--------- -------- --------
Net (loss) earnings per common and common equivalent share................. $ (4.47) $ 0.86 $ 1.00
--------- -------- --------
Weighted average number of common and common equivalent shares
outstanding............................................................. 49,515 52,300 45,150
--------- -------- --------
</TABLE>
See notes to consolidated financial statements.
F-5
<PAGE>
ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED STOCKHOLDERS' EQUITY
(IN 000S, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
PREFERRED
STOCK(1) COMMON STOCK
-------------- -------------- UNREALIZED
ISSUED ISSUED (ACCUMULATED FOREIGN GAIN (LOSS) ON
ISSUED ISSUED ADDITIONAL DEFICIT) CURRENCY MARKETABLE
-------------- -------------- PAID-IN DEFERRED RETAINED TREASURY TRANSLATION EQUITY
SHARES AMOUNT SHARES AMOUNT CAPITAL COMPENSATION EARNINGS STOCK ADJUSTMENT SECURITIES
------ ------ ------ ------ ---------- ------------ ------------ -------- ---------- --------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE AUGUST 31,
1993.................. -- -- 37,259 $ 745 $ 38,377 -- $ 61,516 $ (807) $ (2,964) --
------ ------ ------ ------ ---------- ------------ ------------ -------- ---------- --------------
Net earnings.......... -- -- -- -- -- -- 45,055 -- -- --
Issuances............. -- -- 971 19 14,981 -- -- -- -- --
Exercise of stock
options............. -- -- 1,118 23 7,435 -- -- -- -- --
Tax benefit from
exercise of stock
options............. -- -- -- -- 8,453 -- -- -- -- --
Foreign currency
translation gain.... -- -- -- -- -- -- -- -- 2,410 --
------ ------ ------ ------ ---------- ------------ ------------ -------- ---------- --------------
BALANCE AUGUST 31,
1994.................. -- -- 39,348 787 69,246 -- 106,571 (807) (554) --
------ ------ ------ ------ ---------- ------------ ------------ -------- ---------- --------------
Net earnings.......... -- -- -- -- -- -- 44,770 -- -- --
Issuances............. -- -- 5,182 104 83,659 $(12,292) -- -- -- --
Deferred compensation
expense............. -- -- -- -- -- 1,640 -- -- -- --
Exercise of stock
options............. -- -- 628 13 4,170 -- -- -- -- --
Pooling of interests
with Lazer-Tron..... -- -- 1,123 22 10,609 -- 1,800 -- -- --
Tax benefit from
exercise of stock
options............. -- -- -- -- 1,101 -- -- -- -- --
Foreign currency
translation gain.... -- -- -- -- -- -- -- -- 1,365 --
Unrealized gain on
marketable equity
securities.......... -- -- -- -- -- -- -- -- -- $2,503
------ ------ ------ ------ ---------- ------------ ------------ -------- ---------- --------------
BALANCE AUGUST 31,
1995.................. -- -- 46,281 926 168,785 (10,652) 153,141 (807) 811 2,503
------ ------ ------ ------ ---------- ------------ ------------ -------- ---------- --------------
Net loss.............. -- -- -- -- -- -- (221,368) -- -- --
Issuances of common
stock and options... -- -- 463 9 7,756 (7,765) -- -- -- --
Deferred compensation
expense............. -- -- -- -- -- 3,304 -- -- -- --
Exercise of stock
options and
warrants............ -- -- 552 11 3,711 -- -- -- -- --
Pooling of interests
with Sculptured and
Probe............... -- -- 2,745 55 (55) -- (2,415) -- -- --
Tax benefit from
exercise of stock
options............. -- -- -- -- 698 -- -- -- -- --
Purchase of treasury
stock............... -- -- -- -- -- -- -- (1,006) -- --
Foreign currency
translation loss.... -- -- -- -- -- -- -- -- (1,565) --
Unrealized loss on
marketable equity
securities.......... -- -- -- -- -- -- -- -- -- (2,488)
------ ------ ------ ------ ---------- ------------ ------------ -------- ---------- --------------
BALANCE AUGUST 31,
1996.................. -- -- 50,041 $1,001 $180,895 $(15,113) $(70,642) $(1,813) $ (754) $ 15
------ ------ ------ ------ ---------- ------------ ------------ -------- ---------- --------------
------ ------ ------ ------ ---------- ------------ ------------ -------- ---------- --------------
<CAPTION>
TOTAL
--------
<S> <C>
BALANCE AUGUST 31,
1993.................. $ 96,867
--------
Net earnings.......... 45,055
Issuances............. 15,000
Exercise of stock
options............. 7,458
Tax benefit from
exercise of stock
options............. 8,453
Foreign currency
translation gain.... 2,410
--------
BALANCE AUGUST 31,
1994.................. 175,243
--------
Net earnings.......... 44,770
Issuances............. 71,471
Deferred compensation
expense............. 1,640
Exercise of stock
options............. 4,183
Pooling of interests
with Lazer-Tron..... 12,431
Tax benefit from
exercise of stock
options............. 1,101
Foreign currency
translation gain.... 1,365
Unrealized gain on
marketable equity
securities.......... 2,503
--------
BALANCE AUGUST 31,
1995.................. 314,707
--------
Net loss.............. (221,368)
Issuances of common
stock and options... --
Deferred compensation
expense............. 3,304
Exercise of stock
options and
warrants............ 3,722
Pooling of interests
with Sculptured and
Probe............... (2,415)
Tax benefit from
exercise of stock
options............. 698
Purchase of treasury
stock............... (1,006)
Foreign currency
translation loss.... (1,565)
Unrealized loss on
marketable equity
securities.......... (2,488)
--------
BALANCE AUGUST 31,
1996.................. $ 93,589
--------
--------
</TABLE>
- ------------------
(1) The Company is authorized to issue 1,000 shares of preferred stock at a par
value of $0.01 per share, none of which shares is presently issued and
outstanding.
F-6
<PAGE>
ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED CASH FLOWS
(IN 000S, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
FISCAL YEAR ENDED AUGUST 31,
-----------------------------------
1996 1995 1994
--------- --------- ---------
<S> <C> <C> <C>
CASH FLOWS (USED IN) PROVIDED BY OPERATING ACTIVITIES:
Cash received from customers............................................. $ 331,101 $ 614,526 $ 499,663
Cash paid to suppliers and employees..................................... (383,209) (594,457) (439,034)
Interest received........................................................ 3,845 2,131 1,338
Interest paid............................................................ (8,756) (7,339) (2,649)
Income taxes received (paid)............................................. 18,719 (22,127) (30,236)
--------- --------- ---------
Net cash (used in) provided by operating activities................. (38,300) (7,266) 29,082
--------- --------- ---------
CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES:
Acquisition of subsidiaries, net......................................... 7,912 1,743 (47,805)
Investment in marketable securities...................................... -- -- (10,375)
Sales of marketable securities........................................... 14,599 57,160 8,314
Acquisition of fixed assets, excluding capital leases.................... (13,488) (29,862) (10,195)
Disposal of fixed assets................................................. 133 284 15
Acquisition of other assets.............................................. (1,731) (2,919) (2,954)
--------- --------- ---------
Net cash provided by (used in) investing activities................. 7,425 26,406 (63,000)
--------- --------- ---------
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES:
Proceeds from term loan.................................................. -- -- 40,000
Proceeds from mortgage................................................... 6,676 -- --
Payment of mortgage...................................................... (223) (1,342) (87)
Proceeds from short-term bank loans...................................... 15,873 11,304 14,278
Payment of short-term bank loans......................................... (14,337) (8,769) (20,313)
Exercise of stock options................................................ 3,722 4,183 7,458
Payment of obligation under capital leases............................... (496) (292) (156)
Issuance of common stock................................................. 4 1,398 --
Payment of long-term debt................................................ (6,196) (16,046) --
--------- --------- ---------
Net cash provided by (used in) financing activities................. 5,023 (9,564) 41,180
--------- --------- ---------
Effect of exchange rate changes on cash.................................. (83) 497 1,669
--------- --------- ---------
Net (decrease) increase in cash.......................................... (25,935) 10,073 8,931
Cash at beginning of year................................................ 44,749 34,676 25,745
--------- --------- ---------
Cash at end of year...................................................... $ 18,814 $ 44,749 $ 34,676
--------- --------- ---------
</TABLE>
See notes to consolidated financial statements.
F-7
<PAGE>
ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES--(CONTINUED)
STATEMENTS OF CONSOLIDATED CASH FLOWS
(IN 000S, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
FISCAL YEAR ENDED AUGUST 31,
-----------------------------------
1996 1995 1994
--------- --------- ---------
RECONCILIATION OF NET (LOSS) EARNINGS TO NET CASH (USED IN) PROVIDED BY
OPERATING ACTIVITIES:
<S> <C> <C> <C>
Net (loss) earnings...................................................... $(221,368) $ 44,770 $ 45,055
--------- --------- ---------
ADJUSTMENTS TO RECONCILE NET (LOSS) EARNINGS TO NET CASH (USED IN) PROVIDED
BY OPERATING ACTIVITIES:
Depreciation and amortization............................................ 14,910 9,543 3,838
(Gain) loss on sale of marketable securities............................. (3,690) (5,968) 135
Provision for returns and discounts...................................... 214,079 25,081 40,015
Deferred taxes........................................................... 4,264 8,610 (3,571)
Minority interest in net earnings of consolidated subsidiary............. (1,106) (121) --
Deferred compensation expense............................................ 3,304 1,640 --
Non-cash inventory charges............................................... 25,753 -- --
Non-cash royalty charges................................................. 30,432 -- --
Other non-cash charges................................................... 1,577 1,751 32
Change in assets and liabilities, net of effects of acquisitions:
(Increase) in accounts receivable..................................... (28,123) (35,754) (99,249)
(Increase) decrease in inventories.................................... (17,842) 1,298 8,643
Decrease (increase) in prepaid expenses............................... 6,759 (17,345) (954)
(Increase) decrease in other current assets........................... (19) (8,813) 2,111
(Decrease) increase in trade accounts payable......................... (21,046) (23,031) 10,940
(Decrease) increase in accrued expenses............................... (14,612) 580 13,147
(Decrease) increase in income taxes payable........................... (31,572) (9,507) 8,940
--------- --------- ---------
Total adjustments..................................................... 183,068 (52,036) (15,973)
--------- --------- ---------
Net cash (used in) provided by operating activities........................ $ (38,300) $ (7,266) $ 29,082
--------- --------- ---------
--------- --------- ---------
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Acquisition of equipment under capital leases............................ $ 4,631 $ 91 $ 377
</TABLE>
In fiscal 1995, the Company purchased all of the capital stock of Iguana
Entertainment, Inc. for $5,513, net of cash received. In connection with the
acquisition, liabilities assumed were as follows:
<TABLE>
<S> <C>
Fair value of assets acquired....................................................... $ 9,179
Cash paid for the capital stock..................................................... (5,513)
-------
Liabilities assumed................................................................. $ 3,666
-------
-------
</TABLE>
In fiscal 1995, the Company issued 4,349 shares of its common stock, valued
at $71,472 in exchange for 3,403 Class A common shares of Telecommunications,
Inc.
In fiscal 1994, the Company purchased all of the capital stock of Acclaim
Comics for $62,805, net of cash received. In connection with the acquisition,
liabilities assumed were as follows:
<TABLE>
<S> <C>
Fair value of assets acquired...................................................... $ 67,478
Cash paid for the capital stock.................................................... (50,588)
Fair market value of common stock issued........................................... (15,000)
--------
Liabilities assumed................................................................ $ 1,890
--------
--------
</TABLE>
See notes to consolidated financial statements.
F-8
<PAGE>
ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FISCAL YEARS ENDED AUGUST 31, 1996, 1995 AND 1994
(IN 000S, EXCEPT PER SHARE DATA)
1. BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
A. Business
Acclaim Entertainment, Inc. and its subsidiaries ('Acclaim' or the
'Company') is a mass market entertainment company whose principal business to
date has been publishing and distributing interactive entertainment software.
The Company also develops and publishes comic books, markets its motion capture
technology and studio services and distributes coin-operated, location-based
ticket redemption games and coin-operated video arcade games.
B. Principles of Consolidation
The consolidated financial statements include the accounts of Acclaim and
its majority-owned subsidiaries. All material intercompany balances and
transactions have been eliminated.
C. Cash Equivalents
The Company considers all highly liquid investments with a maturity of
three months or less when purchased to be cash equivalents.
D. Marketable Equity Securities
The Company determines the appropriate classification of debt and equity
securities at the time of purchase and reevaluates such designation as of each
balance sheet date. Securities are classified as held-to-maturity when the
Company has the intent and ability to hold the securities to maturity.
Held-to-maturity securities are stated at cost and investment income is included
in earnings. The Company classifies certain highly liquid securities as trading
securities. Trading securities are stated at fair value and unrealized holding
gains and losses are included in income. Securities that are not classified as
held-to-maturity or trading are classified as available-for-sale.
Available-for-sale securities are carried at fair value, with the unrealized
holding gains and losses, net of tax, reported as a separate component of
stockholders' equity. The cost of securities sold is based on the specific
identification method.
E. Inventories
Inventories are stated at the lower of FIFO cost (first-in, first-out) or
market and consist principally of finished goods.
F. Prepaid Royalties
Royalty advances represent advance payments made to independent software
developers and licensors of intellectual properties. All such payments are
recoupable against future royalties in excess of minimum nonrefundable advances
made in respect of software licensed under the terms of the agreements. Prepaid
royalties are expensed as selling expenses at contractual royalty rates based on
actual net product sales. That portion of prepaid royalties deemed unlikely to
be recovered through product sales is charged to selling expenses. Royalty
advances are classified as current and noncurrent assets based on estimated net
product sales within the next year.
G. Fixed Assets
Property and equipment are recorded at cost. Depreciation is provided using
the straight-line method over the estimated useful lives of the assets, or,
where applicable, the terms of the respective leases, whichever is shorter. The
asset values of capitalized leases are included in fixed assets and the
associated liabilities are reflected as obligations under capital leases.
F-9
<PAGE>
ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FISCAL YEARS ENDED AUGUST 31, 1996, 1995 AND 1994
(IN 000S, EXCEPT PER SHARE DATA)
1. BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
H. Excess of Cost Over Net Assets Acquired
Excess of cost over net assets acquired is being amortized on the
straight-line basis over periods ranging from five to twenty years (See note 5).
It is the Company's policy to evaluate and recognize an impairment of goodwill
if it is probable that the recorded amounts are in excess of anticipated
undiscounted future cash flows.
I. Net Revenues
Revenues are recorded when products are shipped to customers. The Company
is generally not contractually obligated to accept returns, except for defective
product. However, the Company permits its customers to return or exchange
product and may provide price protection on products unsold by a customer.
Revenue is recorded net of an allowance for estimated returns, price concessions
and other discounts. Such allowance is reflected as a reduction to accounts
receivable when the Company expects to grant credits for such items; otherwise,
it is reflected as a liability. The Company also recognizes revenue from
sub-licensing of its intellectual properties. Such revenues are recognized under
royalty agreements when the Company fulfills all of its obligations in
accordance with such agreements.
J. Income Taxes
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be realized or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.
K. Foreign Currency Translations
Assets and liabilities of foreign operations are translated at rates of
exchange at the end of the period, while results of operations are translated at
average exchange rates in effect for the period. Unrealized gains and losses
from the translation of foreign assets and liabilities are classified as a
separate component of stockholders' equity. Included in other income (expense)
are realized gains and (losses) from foreign currency transactions of $2,917,
($2,832), $5,092, ($4,576) and $2,610 ($3,336) in fiscal 1996, 1995, and 1994,
respectively. The Company does not enter into material foreign currency hedging
transactions.
L. Financial Instruments
Statement of Financial Accounting Standards No. 107, 'Disclosure About Fair
Value of Financial Instruments', requires disclosure of the fair value of
certain financial instruments. As of August 31, 1996 and 1995, the fair value of
financial instruments (cash and equivalents, receivables, trade accounts
payable, short-term borrowings and certain other liabilities) approximates book
value due to the short maturity of these instruments. The Company is unable to
determine the fair value of its term loan and mortgage note since they are in
default.
M. 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
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Among the more significant estimates included in these
F-10
<PAGE>
ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FISCAL YEARS ENDED AUGUST 31, 1996, 1995 AND 1994
(IN 000S, EXCEPT PER SHARE DATA)
1. BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
financial statements are the estimated allowances for returns and discounts, the
estimated valuation of inventory and the recoverability of advance royalty
payments and goodwill. Actual results could differ from those estimates.
N. Reclassifications
Certain reclassifications were made to prior period amounts to conform to
the current period presentation format.
2. LIQUIDITY
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. The Company's
significant loss from operations in fiscal 1996, the uncertainty whether the
Company's products in development will be 'hits', the Company's default of
certain loan financial covenants related to its bank financings and uncertainty
regarding the resolution of litigation, including various class action lawsuits,
raise substantial doubt about the Company's ability to continue as a going
concern. The consolidated financial statements do not include any adjustments
that might arise from the outcome of this uncertainty.
The Company believed that the majority of its software revenues in fiscal
1996 would be derived from 16-bit software sales. However, the 16-bit software
market matured much more rapidly than anticipated by the Company (See note 3)
and the Company's 32-bit and PC software sales in fiscal 1996 were materially
insufficient to offset the decline in sales of 16-bit software. Due to these
factors and the increased fixed operating costs primarily attributable to the
acquisition of software development studios, the Company's results of operations
and liquidity in fiscal 1996 were materially adversely affected. Short-term
liquidity concerns were alleviated in November 1996 when the Company received an
income tax refund of approximately $54,000 related to the carryback of its loss
for fiscal 1996. The Company, to enhance its long-term liquidity, has
significantly reduced the number of its personnel and is also evaluating various
alternatives, including a capital infusion, the sale of certain assets and
renegotiating debt covenants and repayment terms related to its long-term debt.
However, the Company's future long-term liquidity will be materially dependent
on its ability to develop and market new software products that achieve
widespread market acceptance for use with the hardware platforms that dominate
the market.
3. SPECIAL CARTRIDGE VIDEO CHARGE (UNAUDITED)
In fiscal 1996 the Company's revenues were adversely affected due to new
hardware platform introductions and the resulting shift from demand for 16-bit
software to 32- and 64-bit software and PC software compatible with the new
hardware systems. Due to the relatively longer development period relating to
16-bit and 32-bit software products, the Company's strategic decisions to
support certain 16-bit and portable hardware systems and develop certain
software products were made well in advance of the time it became apparent that
the transition period commenced.
In addition, in fiscal 1996, the Company did not release 'hits' for
hardware platforms with significant installed bases, as it had in prior years
and offered concessions (such as returns and discounts) to its customers at
higher than anticipated levels in order to manage 16-bit software inventory
levels. Finally, the Company exited the 16-bit and portable software markets in
April 1996.
As a result, the Company recorded a special cartridge video charge in the
second quarter of fiscal 1996 of $48,947 to adjust accounts receivable and
inventories to their estimated net realizable values. Due to the
F-11
<PAGE>
ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FISCAL YEARS ENDED AUGUST 31, 1996, 1995 AND 1994
(IN 000S, EXCEPT PER SHARE DATA)
3. SPECIAL CARTRIDGE VIDEO CHARGE (UNAUDITED)--(CONTINUED)
continued and accelerated deterioration of the 16-bit and portable cartridge
business throughout 1996, the Company revised its estimates in the fourth
quarter of fiscal 1996 and recorded an additional charge of $65,031, primarily
to adjust accounts receivable and inventory to their revised estimated net
realizable values. The total charge of $113,978 for the year ended August 31,
1996 consists of provisions of approximately $90,524 and $23,455, respectively,
to adjust accounts receivable and inventories related to 16-bit and portable
Software to their estimated net realizable values subsequent to the Company's
decision to exit such software market and is reflected as sales returns and
allowances and in cost of sales, respectively, in the statement of consolidated
operations.
The following presents the effect of the special cartridge video charge
upon net revenues and cost of revenues:
<TABLE>
<CAPTION>
1996
----------
<S> <C>
Gross revenues............................................................................ $ 376,024
Sales credits and allowances.............................................................. 123,555
----------
252,469
Special cartridge video charge............................................................ 90,524
----------
Net revenues.............................................................................. $ 161,945
----------
Cost of revenues.......................................................................... $ 156,617
Special cartridge video charge............................................................ 23,455
----------
$ 180,072
----------
Gross loss................................................................................ $ (18,127)
----------
</TABLE>
4. LICENSE AGREEMENTS
The Company has various license agreements with Nintendo Co., Ltd. (Japan)
(Nintendo Co., Ltd. and its subsidiary, Nintendo of America, Inc., are
collectively herein referred to as 'Nintendo') pursuant to which it has the
nonexclusive right to utilize the 'Nintendo' name and its proprietary
information and technology in order to develop and market interactive
entertainment software ('Software') for use with various 8-bit, 16-bit and
portable Nintendo platforms in various territories throughout the world. The
Company also has an agreement with Nintendo to develop and market one N64
Software title in North America. The license agreements with Nintendo for the
different platforms expire at various times.
In April 1992, the Company entered into an agreement with Sega Enterprises
Ltd. ('Sega'), pursuant to which the Company received the nonexclusive right to
utilize the 'Sega' name and its proprietary information and technology in order
to develop and distribute software titles for use with various Sega platforms.
The Company exercised its option to extend the Sega Agreement, which agreement,
as amended, expired in December 1995. The Company is currently negotiating a new
agreement with Sega. In the interim, the Company and Sega are continuing to
operate under the terms of the expired Sega Agreement, and with respect to the
Sega Saturn hardware platform are operating under an oral agreement. The Company
believes that the impact, if any, of a new agreement with Sega will not have a
material adverse effect on its financial condition or results of operations.
In December 1994, the Company entered into an agreement with Sony Computer
Entertainment of America ('SCE') pursuant to which the Company received the
nonexclusive right to utilize its proprietary information and technology in
order to develop and distribute Software titles for use with the Sony
PlayStation(Trademark) for a four year period expiring in December 1998.
F-12
<PAGE>
ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FISCAL YEARS ENDED AUGUST 31, 1996, 1995 AND 1994
(IN 000S, EXCEPT PER SHARE DATA)
5. ACQUISITIONS
Sculptured Software, Inc.
On October 10, 1995, the Company acquired all the issued and outstanding
stock of Sculptured Software Inc., a software developer pursuant to an Agreement
and Plan of Merger dated October 9, 1995 for 1,013 shares of the Company's
common stock.
The acquisition was accounted for as a pooling of interests and
accordingly, the Company's financial statements for the year ended August 31,
1996 include the results of Sculptured. Prior period financial statements were
not restated as the acquisition had an immaterial effect upon previously
reported revenue and net income of the consolidated entities.
Probe Entertainment Ltd.
On October 16, 1995, the Company acquired all the issued and outstanding
stock of Probe Entertainment Ltd., a software developer pursuant to an Agreement
and Plan of Merger dated October 10, 1995 for 1,732 shares of the Company's
common stock.
The acquisition was accounted for as a pooling of interests and,
accordingly, the Company's financial statements for the year ended August 31,
1996 include the results of Probe. Prior period financial statements were not
restated as the acquisition had an immaterial effect upon previously reported
revenue and net income of the consolidated entities.
Iguana Entertainment, Inc.
On January 4, 1995, the Company acquired all the issued and outstanding
common stock of Iguana Entertainment, Inc., developers of interactive video
games, pursuant to the terms of an Agreement and Plan of Merger dated December
20, 1994. The acquisition was accounted for as a purchase. Accordingly, the
operating results of Iguana are included in the Statements of Consolidated
Operations from the acquisition date. The acquired assets and liabilities have
been recorded at their estimated fair values at the date of acquisition.
In consideration for the Iguana stock, the Company paid $5,000 in cash. The
total cost of the acquisition was $7,342, (which includes direct acquisition
costs) of which $2,357 was allocated to identifiable net tangible assets. The
remaining balance of $4,985 represents the excess of the purchase price over the
fair value of the net assets acquired, which is being amortized on a
straight-line basis over five years.
Proforma results of operations, assuming the acquisition had been made at
the beginning of each year presented, would not be materially different from the
consolidated results reported.
Lazer-Tron Corporation
On August 31, 1995, the Company acquired all the issued and outstanding
common stock of Lazer-Tron Corporation, a developer and manufacturer of
coin-operated redemption games pursuant to an Agreement and Plan of Merger dated
March 22, 1995. Under the terms of the agreement, Lazer-Tron shareholders
received .314 of a share of the Company's common stock for each Lazer-Tron
share. Accordingly, the Company issued 1,123 shares of its common stock for all
the outstanding shares of Lazer-Tron common stock. Additionally, outstanding
options and warrants to acquire Lazer-Tron stock were converted to options and
warrants to acquire 318 shares of the Company's common stock.
The acquisition was accounted for as a pooling of interests and,
accordingly, the Company's financial statements for the year ended August 31,
1995 have been restated to include the results of Lazer-Tron. Prior
F-13
<PAGE>
ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FISCAL YEARS ENDED AUGUST 31, 1996, 1995 AND 1994
(IN 000S, EXCEPT PER SHARE DATA)
5. ACQUISITIONS--(CONTINUED)
period financial statements were not restated as the acquisition had an
immaterial effect upon previously reported revenue and net income of the
consolidated entities.
Acclaim Comics
On July 29, 1994, the Company acquired all the issued and outstanding
common stock of Acclaim Comics (formerly Voyager Communications Inc.), publisher
of Valiant Comics, pursuant to the terms of an Agreement and Plan of Merger
dated April 30, 1994. The acquisition was accounted for as a purchase.
Accordingly, the operating results of Acclaim Comics are included in the
Statements of Consolidated Operations from the acquisition date. The acquired
assets and liabilities have been recorded at their estimated fair values at the
date of acquisition.
In consideration for the Acclaim Comics' stock, the Company paid $65,000
comprised of (i) $50,000 in cash and (ii) 971 shares of the common stock of the
Company. The total cost of the acquisition was $65,588 (which includes direct
acquisition costs) of which $9,505 was allocated to identifiable net tangible
assets. The remaining balance of $56,083 represents the excess of the purchase
price over the fair value of the net assets acquired, which was being amortized
on a straight-line basis over forty years. During the fourth quarter of fiscal
1996, based on current conditions in the comic book industry, the Company
reduced the estimated remaining life of the goodwill related to Acclaim Comics
to twenty years, which increased the related amortization expense by
approximately $300. In connection with the acquisition, Acclaim Comics obtained
a $40,000 term loan. (See note 13.)
The following unaudited combined pro forma information shows the results of
operations for the year ended August 31, 1994 as though the purchase of Acclaim
Comics had been made at the beginning of that fiscal year.
<TABLE>
<S> <C>
Net sales................................................................................... $504,436
Net earnings................................................................................ 47,695
Net earnings per share...................................................................... 1.04
</TABLE>
The pro forma results of operations are not necessarily indicative of the
actual results of operations that would have occurred had the purchase been made
at the beginning of the period, or of results which may occur in the future.
6. MARKETABLE EQUITY SECURITIES
Marketable equity securities at August 31, 1996 and 1995 consisted
primarily of Class A Common Shares of Tele-Communications, Inc. Such shares have
been classified as 'available for sale' securities and accordingly are stated at
fair market value. Unrealized holding gains of $15 and $2,503 (net of income
taxes of $11 and $1,784 at August 31, 1996 and 1995, respectively) at August 31,
1996 and 1995, respectively, are classified as a separate component of
stockholders' equity. In fiscal 1996 and 1995, other income includes realized
gains from the sale of marketable equity securities of $3,690 and $5,968
respectively.
On October 19, 1994, Acclaim Cable Holdings, Inc. a wholly-owned subsidiary
of the Company, entered into a Partnership Agreement (the 'Partnership
Agreement') with TCI GameCo Ventures, Inc., an indirect wholly-owned subsidiary
of Tele-Communications, Inc. ('TCI'), for the creation of a Delaware limited
partnership (the 'Joint Venture'), the interests in which are indirectly held
65% by the Company and 35% by TCI. The Company and TCI are currently
reconsidering the viability of the Joint Venture.
In connection with the execution of the Partnership Agreement, the Company
entered into an Exchange Agreement (the 'Exchange Agreement') with TCI and TCI
GameCo Holdings, Inc. ('TCI Sub'), pursuant to
F-14
<PAGE>
ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FISCAL YEARS ENDED AUGUST 31, 1996, 1995 AND 1994
(IN 000S, EXCEPT PER SHARE DATA)
6. MARKETABLE EQUITY SECURITIES--(CONTINUED)
which the Company issued and sold to TCI Sub 4,349 shares of the Company's
common stock in exchange for 3,403 shares of Class A Common Stock of TCI.
7. ACCOUNTS RECEIVABLE
Accounts receivable are comprised of the following:
<TABLE>
<CAPTION>
AUGUST 31,
--------------------
1996 1995
------- ---------
<S> <C> <C>
Receivables assigned to factor................................................... $55,099 $ 155,782
Less advances from factor........................................................ 23,487 37,082
------- ---------
Due from factor................................................................ 31,612 118,700
Unfactored accounts receivable................................................... 12,031 33,093
Accounts receivable -- foreign................................................... 20,229 41,743
Other receivables................................................................ 5,472 5,410
Allowances for returns and discounts............................................. (48,866) (19,635)
------- ---------
$20,478 $ 179,311
------- ---------
------- ---------
</TABLE>
Pursuant to a factoring agreement, the Company's principal bank acts as its
factor for the majority of its North American receivables, which are assigned on
a pre-approved basis. At August 31, 1996, the factoring charge amounted to 0.25%
of the receivables assigned. The Company's obligations to the bank are
collateralized by all of the Company's and its North American subsidiaries'
accounts receivable, inventories and equipment. The advances for factored
receivables are pursuant to a revolving credit and security agreement, which
expires on January 31, 1999, in the maximum amount of $70 million. Pursuant to
the terms of the agreement, which can be cancelled by either party upon 90 days
written notice prior to the end of the term, the Company is required to maintain
specified levels of working capital and tangible net worth, among other
financial covenants.
The Company draws down working capital advances and opens letters of credit
(up to an aggregate maximum of $20 million) against the facility in amounts
determined on a formula based on factored receivables, inventory and cost of
imported goods under outstanding letters of credit. Interest was charged at the
bank's prime lending rate (8.25% at August 31, 1996) per annum on such advances.
Effective November 8, 1996, interest is charged at the bank's prime lending rate
plus one percent per annum on such advances. As of August 31, 1996, the Company
was in default of certain financial covenants under its revolving credit
facility, which defaults have been waived by the lender. The Company is also in
default of the prohibitions on having a 'going concern' paragraph in the audit
report on its financial statements under the revolving credit facility and the
term loan.
Pursuant to the terms of certain distribution, warehouse and credit and
collection agreements, certain of the Company's foreign accounts receivable are
due from certain distributors. These receivables are not collateralized and as a
result management periodically monitors the financial condition of these
distributors. No additional credit risk beyond amounts provided for collection
losses is believed inherent in the Company's accounts receivable. At August 31,
1996 and 1995, the balance due from a distributor was approximately 19% and 19%
of accounts receivable foreign, respectively.
F-15
<PAGE>
ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FISCAL YEARS ENDED AUGUST 31, 1996, 1995 AND 1994
(IN 000S, EXCEPT PER SHARE DATA)
8. PREPAID EXPENSES
Prepaid expenses are comprised of the following:
<TABLE>
<CAPTION>
AUGUST 31,
--------------------
1996 1995
------- ---------
<S> <C> <C>
Royalty advances.................................................................. $ 6,783 $25,640
Prepaid advertising costs......................................................... 2,868 6,292
Other prepaid expenses............................................................ 8,862 9,151
------- ---------
$18,513 $41,083
------- ---------
------- ---------
</TABLE>
Prepaid advertising costs consist principally of advance payments in
respect of television and other media advertising. Advertising expenses are
charged to income as incurred.
9. FIXED ASSETS
The major classes of fixed assets are as follows:
<TABLE>
<CAPTION>
AUGUST 31,
---------------------
1996 1995
-------- ---------
<S> <C> <C>
Buildings and improvements....................................................... $ 24,724 $21,351
Furniture, fixtures and equipment................................................ 34,490 19,608
Automotive equipment............................................................. 1,680 1,368
-------- ---------
60,894 42,327
Less: accumulated depreciation................................................... (18,115) (8,357)
-------- ---------
$ 42,779 $33,970
-------- ---------
-------- ---------
</TABLE>
The estimated useful lives of these assets are:
<TABLE>
<S> <C>
Buildings and improvements.......................................................... 1 to 20 years
Furniture, fixtures and equipment................................................... 1 to 7 years
Automotive equipment................................................................ 3 to 5 years
</TABLE>
F-16
<PAGE>
ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FISCAL YEARS ENDED AUGUST 31, 1996, 1995 AND 1994
(IN 000S, EXCEPT PER SHARE DATA)
10. OTHER ASSETS
Other assets are comprised of the following:
<TABLE>
<CAPTION>
AUGUST 31,
------------------
1996 1995
------- -------
<S> <C> <C>
Royalty advances.................................................................. $ 5,255 $ 5,000
Investments....................................................................... 1,000 4,000
Other assets...................................................................... 4,209 13,534
------- -------
$10,464 $22,534
------- -------
------- -------
</TABLE>
11. SHORT-TERM BORROWINGS
Short-term borrowings at August 31, 1996 and 1995 consisted of notes
payable to banks in Japan of $3,671 and $4,233, respectively, and $1,650
outstanding under lines of credit with two domestic banks at August 31, 1996.
The notes payable to banks in Japan are short-term, maturing within 90 days
and are collateralized by inward letters of credit from distributors. The
average annual interest rate applicable to the bank loans for the year ended
August 31, 1996 was approximately 2%. Such agreement also provides that the bank
has the right to offset cash of the Company collected under the inward letters
of credit and deposited with it against the associated short-term notes.
The credit agreement with one domestic bank provides for borrowings of up
to $2,000 for general working capital purposes and is due on demand. Borrowings
under the agreement bear interest at the bank's prime rate plus one percent
(9.25% at August 31, 1996) and are based upon a percentage of eligible accounts
receivable. The balance at August 31, 1996 was $1,300 which was repaid in
December, 1996.
A revolving line of credit agreement with the other domestic bank provides
for borrowings of up to $500 and is renewable yearly with interest charged at
one and one-half percent above the bank's prime rate (9.75% at August 31, 1996).
The balance at August 31, 1996 was $350.
12. ACCRUED EXPENSES
Accrued expenses are comprised of the following:
<TABLE>
<CAPTION>
AUGUST 31,
------------------
1996 1995
------- -------
<S> <C> <C>
Accrued royalties payable......................................................... $28,090 $18,712
Accrued selling expenses and sales allowances..................................... 30,804 8,957
Accrued payroll and payroll taxes................................................. 2,229 5,750
Other accrued taxes............................................................... 4,290 3,606
Other accrued expenses............................................................ 13,093 9,992
------- -------
$78,506 $47,017
------- -------
------- -------
</TABLE>
F-17
<PAGE>
ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FISCAL YEARS ENDED AUGUST 31, 1996, 1995 AND 1994
(IN 000S, EXCEPT PER SHARE DATA)
13. LONG-TERM DEBT
Long-term debt consists of the following:
<TABLE>
<CAPTION>
AUGUST 31,
------------------
1996 1995
------- -------
<S> <C> <C>
(A) Term loan..................................................................... $19,000 $25,000
(B) Mortgage note................................................................. 6,527 --
Other............................................................................. -- 196
------- -------
25,527 25,196
Less: current portion............................................................. 25,527 25,196
$ -- $ --
------- -------
------- -------
</TABLE>
(A) In conjunction with the acquisition of Acclaim Comics, Inc., Acclaim
Comics entered into a term loan guaranteed by the Company and collateralized by
all the assets of Acclaim Comics, which bears interest based on LIBOR (5.5625%
at August 31, 1996) plus 2.5% and was due and payable on January 29, 1996. On
April 14, 1995, Acclaim Comics repaid $15,000 and exercised its option to extend
the loan for an additional four and one-half year period, payable in quarterly
installments of $1,500 through July 1998 and $1,750 through July 1999, at an
interest rate of LIBOR plus 2.5%. The loan contains covenants which require the
maintenance of certain financial ratios, restrict encumbrance of assets and
limit the payment of dividends by the Company and Acclaim Comics.
(B) The mortgage note bears interest at the bank's prime lending rate
(8.25% at August 1996) and is payable in quarterly installments that commenced
March 1, 1996. The principal amount is payable in quarterly installments that
commenced on May 1, 1996. On March 27, 2003, the unpaid principal sum of $3,559,
together with all accrued and unpaid interest, will be due and payable. The
mortgage note is collateralized by a building (Corporate Headquarters) with a
carrying value of approximately $17,425.
As of August 31, 1996, the Company has been advised by the lenders of the
aforementioned long term debt that events of default have occurred and are
continuing under clauses of the respective lending agreements regarding certain
financial ratio requirements and prohibitions on cross defaults with other
facilities. Although interest and principal payments continue to be made on a
timely basis, the lenders have advised that they reserve the right to take any
and all actions including the option of accelerating and/or demanding immediate
repayment of the obligations. Accordingly, the debt has been classified as
current. As of August 31, 1995, the term loan was also classified as a current
liability due to a covenant, with which the Company was not in compliance, that
was revised but not yet effective. The Company is currently discussing
additional modifications with all of its lenders. The Company expects that the
modifications to its term loan and mortgage will include an immediate paydown of
a portion of the loan and accelerated payment terms for the balance.
F-18
<PAGE>
ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FISCAL YEARS ENDED AUGUST 31, 1996, 1995 AND 1994
(IN 000S, EXCEPT PER SHARE DATA)
14. OBLIGATIONS UNDER CAPITAL AND OPERATING LEASES
The Company is committed under various capital leases for automotive and
computer equipment expiring at various dates through 2006. Future minimum
payments required under such leases are as follows:
<TABLE>
<CAPTION>
YEARS ENDING
AUGUST 31,
- -----------------------------------------------------------------------------------------------
<S> <C>
1997........................................................................................... $2,108
1998........................................................................................... 2,116
1999........................................................................................... 1,248
2000........................................................................................... 348
2001........................................................................................... 264
Thereafter..................................................................................... 400
------
Total minimum lease payments................................................................... 6,484
Less: amount representing interest............................................................. 1,118
Present value of net minimum lease payments.................................................... $5,366
------
------
</TABLE>
The present value of net minimum lease payments is reflected in the balance
sheet as current and noncurrent obligations under capital leases of $1,681 and
$3,685, respectively.
The Company has operating leases for rental space and equipment which
expire on various dates through 2006. The leases provide for contingent rentals
based upon escalation clauses. Future minimum rental payments required under
such leases are as follows:
<TABLE>
<CAPTION>
YEARS ENDING
AUGUST 31,
- -----------------------------------------------------------------------------------------------
<S> <C>
1997........................................................................................... $3,836
1998........................................................................................... 3,375
1999........................................................................................... 2,965
2000........................................................................................... 2,580
2001........................................................................................... 2,246
Thereafter..................................................................................... 4,698
------
Total minimum operating lease payments......................................................... 19,700
------
------
</TABLE>
15. (BENEFIT FROM) PROVISION FOR INCOME TAXES
During fiscal 1994, the Company adopted Statement of Financial Accounting
Standards No. 109, Accounting for Income Taxes. The cumulative effect of the
accounting change was not material.
F-19
<PAGE>
ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FISCAL YEARS ENDED AUGUST 31, 1996, 1995 AND 1994
(IN 000S, EXCEPT PER SHARE DATA)
15. (BENEFIT FROM) PROVISION FOR INCOME TAXES--(CONTINUED)
The (recovery of) provision for income taxes consists of the following:
<TABLE>
<CAPTION>
1996 1995 1994
-------- ------- -------
<S> <C> <C> <C>
Current:
Federal............................................................. $(52,808) $20,131 $21,382
Foreign............................................................. 1,453 (457) 991
State............................................................... -- 2,240 4,685
-------- ------- -------
(51,355) 21,914 27,058
-------- ------- -------
Deferred:
Federal............................................................. 4,264 8,880 (3,551)
Foreign............................................................. -- (270) (20)
-------- ------- -------
4,264 8,610 (3,571)
-------- ------- -------
Charge in lieu of income taxes........................................ 698 1,101 8,453
-------- ------- -------
Total income tax provision (benefit)............................. $(46,393) $31,625 $31,940
-------- ------- -------
</TABLE>
The charge in lieu of income taxes relates to the tax benefit arising from
disqualifying dispositions of employee stock options.
A reconciliation of the federal statutory income tax rate with the
effective income tax rate follows:
<TABLE>
<CAPTION>
1996 1995 1994
----- ---- ----
<S> <C> <C> <C>
Statutory tax rate............................................................. (35.0)% 35.0% 35.0%
State income taxes, net of federal income tax benefit.......................... -- 2.2 3.6
Increase in valuation allowance................................................ 12.2 -- --
Net operating loss carryback benefit at less than statutory rate............... 4.2 -- --
Nondeductible expenses......................................................... 0.9 2.1 1.0
Foreign tax rate differential, net of foreign tax credits...................... 0.1 0.2 1.3
Other.......................................................................... 0.3 2.0 0.6
----- ---- ----
Effective income tax rate................................................. (17.3)% 41.5% 41.5%
----- ---- ----
----- ---- ----
</TABLE>
The tax effects of temporary differences that give rise to the deferred tax
assets and deferred tax liabilities recorded on the consolidated balance sheets
as of August 31, 1996 and 1995 are as follows:
<TABLE>
<CAPTION>
1996 1995
------------------------- -------------------------
DEFERRED DEFERRED
DEFERRED TAX DEFERRED TAX
TAX ASSETS LIABILITIES TAX ASSETS LIABILITIES
---------- ----------- ---------- -----------
<S> <C> <C> <C> <C>
Reserves and allowances............................................ $ 13,711 -- $1,662 --
Investment in subsidiary........................................... 2,879 -- 3,664 --
Accrued expenses................................................... 1,750 -- -- --
Federal net operating loss carryforwards........................... 8,750 -- -- --
Unrealized gains on marketable securities.......................... -- -- -- $ 1,784
Foreign net operating loss carryforwards........................... 5,644 -- 1,059 --
Other.............................................................. 806 $75 692 43
---------- --- ---------- -----------
33,540 75 7,077 1,827
Valuation allowance................................................ 33,465 -- 548 --
---------- --- ---------- -----------
$ 75 $75 $6,529 $ 1,827
---------- --- ---------- -----------
---------- --- ---------- -----------
</TABLE>
F-20
<PAGE>
ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FISCAL YEARS ENDED AUGUST 31, 1996, 1995 AND 1994
(IN 000S, EXCEPT PER SHARE DATA)
15. (BENEFIT FROM) PROVISION FOR INCOME TAXES--(CONTINUED)
As of August 31, 1996, the Company has a U.S. tax net operating loss
carryforward of approximately $25,000 expiring in fiscal 2011. At August 31,
1996 the Company has provided a valuation allowance of $33,465 against its net
deferred tax assets due to the Company's recent pre-tax losses and lack of
significant offsetting objective evidence.
At August 31, 1995, one of the Company's foreign subsidiaries had unused
tax benefits of $548 related to foreign net operating loss carryforwards. A
valuation allowance of $548 has been recognized to offset the related deferred
tax asset due to the uncertainty of realizing the benefit of the loss
carryforwards.
Deferred tax assets of $2,259 are classified as other current assets at
August 31, 1995. During fiscal 1995, additional tax benefits of $1,187
attributable to Acclaim Comics were recorded as a reduction of the excess cost
over the net assets acquired.
A provision for additional taxes on income which would become payable upon
the repatriation of the earnings from its foreign subsidiaries has not been
provided since, upon repatriation, the tax consequences of such distributions
would be substantially offset by available foreign tax credits.
16. (LOSS) EARNINGS PER COMMON SHARE AND COMMON SHARE EQUIVALENTS
(Loss) earnings per common share and common share equivalents are computed
by dividing net earnings by the weighted average number of common shares and
dilutive common share equivalents (stock options and warrants) outstanding. The
weighted average number of common shares and common share equivalents used in
computing net (loss) earnings per common share for the years ended August 31,
1996, 1995 and 1994 were 49,515, 52,300 and 45,150, respectively.
17. STOCK OPTION PLAN
The Company has a stock option plan which, as amended, provides for the
grant of up to 15,000 shares of its common stock to employees, directors and
consultants. The exercise price per share of all incentive stock options
heretofore granted has been the market price, or 110% thereof for certain
employees, or, for non-incentive options, not less than 85% of market price, of
the Company's common stock on the date of grant. Generally, outstanding options
become exercisable evenly over a three year period from the date of grant
(although this may be accelerated due to retirement or death). Outstanding
options must generally be exercised within ten years from the date of grant or,
with respect to incentive options, within five years from the date of grant for
certain employees. The 1988 Stock Option Plan terminates in May 1998. At August
31, 1996, options to purchase approximately 5,980 shares were exercisable and
options to purchase 128 shares were available for future grant under the 1988
stock option plan.
F-21
<PAGE>
ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FISCAL YEARS ENDED AUGUST 31, 1996, 1995 AND 1994
(IN 000S, EXCEPT PER SHARE DATA)
17. STOCK OPTION PLAN--(CONTINUED)
Transactions are summarized as follows:
<TABLE>
<CAPTION>
SHARES UNDER OPTION
------------------------------------------
EXERCISE
INCENTIVE NON-INCENTIVE PRICE
--------- ------------- ------------
<S> <C> <C> <C>
Outstanding, August 31, 1993.................................. 3,595 5,062 $ 0.89-21.33
--------- ------------- ------------
Granted....................................................... 864 2,303 $13.25-25.25
Exercised..................................................... (451) (635) $ 1.95-11.17
Cancelled..................................................... (450) (1,726) $ 1.95-25.25
--------- ------------- ------------
Outstanding, August 31, 1994.................................. 3,558 5,004 $ 0.89-21.75
--------- ------------- ------------
Conversion of Lazer-Tron Options.............................. 108 27 $ 5.41-40.61
Granted....................................................... 1,596 2,861 $13.75-24.00
Exercised..................................................... (464) (43) $ 1.95-17.92
Cancelled..................................................... (427) (2,022) $ 3.92-20.63
--------- ------------- ------------
Outstanding, August 31, 1995.................................. 4,371 5,827 $ 0.89-40.61
--------- ------------- ------------
Granted....................................................... 1,239 2,799 $ 6.38-24.75
Exercised..................................................... (384) (95) $ 0.89-17.92
Cancelled..................................................... (241) (1,234) $ 1.95-26.88
--------- ------------- ------------
Outstanding, August 31, 1996.................................. 4,985 7,297 $ 1.95-37.42
--------- ------------- ------------
--------- ------------- ------------
</TABLE>
In addition, options to purchase 37 shares of common stock at $4.17 per
share, 37 shares of common stock at $5.67 per share, 37 shares of common stock
at $4.58 per share, 56 shares of common stock at $2.08 per share, 150 shares of
common stock at $2.04 per share, 11 shares of common stock at $3.92 per share,
19 shares of common stock at $13.25 per share, 56 shares of common stock at $16
per share and 250 shares of common stock at $13.25 per share were granted
outside the 1988 Stock Option Plan and remain outstanding at August 31, 1996.
In October of 1995, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 123, 'Accounting for Stock-based
Compensation,' which must be adopted by the Company in fiscal 1997. The Company
has elected not to implement the fair value based accounting method for employee
stock options, but has elected to disclose, commencing in fiscal 1997, the pro
forma net income and earnings per share as if such method had been used to
account for stock-based compensation cost as described in the Statement.
18. EQUITY
At August 31, 1996 and 1995, 2,625 stock warrants were outstanding and
exercisable. The stock warrants entitle the holders thereof to purchase 1,500
shares of common stock at $2.42 per share and 1,125 shares of common stock at
$3.00 per share. The stock warrants expire in 2001.
In addition, outstanding stock warrants to purchase shares of Lazer-Tron
Corporation (See note 5) were converted into warrants entitling the holders
thereof to purchase 17 shares of common stock at $30.57 per share at August 31,
1996 and 1995, 40 shares of common stock at $9.55 per share at August 31, 1996
and 1995 and 105 shares of common stock at $15.92 per share at August 31, 1995.
In addition, certain of such warrants entitle the holders thereof to receive
warrants to purchase 20 shares of common stock at $15.92 per share at August 31,
1996 and 1995. These warrants expire at various times through 1998.
Deferred compensation at August 31, 1996 and 1995 included $8,194 and
$10,652, respectively, which represents escrowed common stock on behalf of
certain executives pursuant to employment agreements. The
F-22
<PAGE>
ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FISCAL YEARS ENDED AUGUST 31, 1996, 1995 AND 1994
(IN 000S, EXCEPT PER SHARE DATA)
18. EQUITY--(CONTINUED)
common stock is ratably released from escrow and the fair value of the common
stock is recorded as expense when earned over the five-year term of the
agreements, and are recoverable by the Company if the executive's employment
with the Company is terminated upon the occurrence of certain events specified
in the respective employment agreements.
In fiscal 1996 the Company issued 463 shares of restricted common stock to
employees. The fair value of the common stock issued of $4,990 is being expensed
when earned over the five-year period that the restrictions lapse. If employment
with the Company is terminated by the employee, any remaining restricted shares
will be returned to the Company. Deferred compensation includes $4,576 at August
31, 1996 related to such restricted stock awards.
Also included in deferred compensation at August 31, 1996 is $2,343 related
to grants of stock options with exercise prices less than the fair value of the
Company's common stock on the date of grant. Total deferred compensation was
$2,775, which will be expensed at varying amounts through 1999.
19. MAJOR SUPPLIERS AND CUSTOMERS AND RELATED PARTY TRANSACTIONS
A. Major Suppliers and Customers
The Company is substantially dependent on Nintendo as the sole manufacturer
of N64, SNES and Game Boy hardware and a significant portion of the Software for
those platforms and as the sole licensor of the proprietary information and the
technology needed to develop the Software for those platforms; on Sega as the
sole manufacturer of Saturn, Genesis, Master System, Game Gear and Sega CD
hardware and a portion of Software for those platforms and as the sole licensor
of the proprietary information and the technology needed to develop Software for
those platforms; and on Sony as the sole manufacturer of PlayStation hardware
and all of the Software for that platform. In fiscal years 1996, 1995 and 1994,
the Company derived 29%, 47% and 45% of its gross revenues, respectively, from
sales of Nintendo-compatible products, in fiscal years 1996, 1995 and 1994, the
Company derived 36%, 46%, and 55% of its gross revenues, respectively, from
sales of Sega-compatible products and in fiscal year 1996 the Company derived
19% of its gross revenues, from sales of Sony-compatible products.
The Company markets its products primarily to mass merchandise companies,
large retail toy store chains, department stores and specialty stores. No one
customer accounted for more than 10% of revenues for the year ended August 31,
1996. Sales to one customer represented 11% and 12% of revenues for the years
ended August 31, 1995 and 1994, respectively.
B. Related Party Transactions
Sales commissions are payable to two companies owned or controlled by one
of the Company's principal stockholders for sales obtained by these companies.
These commissions amounted to approximately $515, $2,249 and $3,657 for the
years ended August 31, 1996, 1995 and 1994, respectively, of which $1 and $458
are included in accrued expenses at August 31, 1996 and 1995, respectively.
20. COMMITMENTS AND CONTINGENCIES
(a) In December 1995, actions were filed against the Company and several of
its directors and/or executive officers. The plaintiffs, on behalf of a class of
the Company's stockholders, claim unspecified damages arising from the Company's
December 4, 1995 announcement that it revised results for the fiscal year ended
August 31, 1995 to reflect a decision to defer $18 million of revenues and $10.5
million of net income previously reported on October 17, 1995 for the fiscal
year ended August 31, 1995. The actions were consolidated into a class action
F-23
<PAGE>
ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FISCAL YEARS ENDED AUGUST 31, 1996, 1995 AND 1994
(IN 000S, EXCEPT PER SHARE DATA)
20. COMMITMENTS AND CONTINGENCIES--(CONTINUED)
entitled In re: Acclaim Ent. Shareholder Litigation, 95 Civ. 4979 (E.D.N.Y.)
(TCP). The consolidated complaint was served on defendants on or about June 14,
1996, and a corrected consolidated complaint was served on or about July 10,
1996. Defendants' have answered the complaint and have produced documents. No
depositions have taken place to date in this action. The Company has Directors'
and Officers' liability insurance which may cover some portion of the liability,
if any, resulting from these actions. The ultimate outcome of the litigation
cannot presently be determined. Accordingly, no provision for any liability that
may result upon adjudication has been recognized in the accompanying
consolidated financial statements.
(b) The Company and certain of its directors and/or executive officers were
also sued in an action (the 'Campbell Action') filed in December 1995 in the
United States District Court in the Northern District of California. The
plaintiffs in the Campbell Action, on behalf of former Lazer-Tron stockholders,
claim unspecified damages arising from alleged violations of the anti-fraud
provisions of the federal securities laws relating to, among other things, (i)
the Company's October 17, 1995 announcement of its results of operations for the
fiscal year ended August 31, 1995, which was subsequently revised by the
Company's December 4, 1995 announcement reflecting a decision to defer $18
million of revenues and $10.5 million of net income previously reported for the
fiscal year ended August 31, 1995 and (ii) the alleged misleading nature of
prior public disclosures and announcements made by the Company. In addition, in
the Campbell Action, the plaintiffs also allege certain common law causes of
action. The Campbell Action has been transferred to the United States District
Court for the Southern District of New York for consolidation with the action
described in note 20(a). Additionally, actions may be brought against the
Company and its officers and directors arising from the matters described above.
The Company has Directors' and Officers' liability insurance which may cover a
portion of the liability, if any, resulting from the Campbell Action. The
ultimate outcome of the litigation cannot presently be determined. Accordingly,
no provision for any liability that may result upon adjudication has been
recognized in the accompanying financial statements.
(c) By summons and complaint dated December 11, 1995, certain of the
Company's directors and/or executive officers were named as defendants, and the
Company was named as a nominal defendant, in a shareholder derivative action in
the Supreme Court of the State of New York, County of Nassau (the 'Derivative
Action'). The Derivative Action was brought on behalf of the Company (as nominal
defendant), alleging that the individual defendants violated their fiduciary
duties to the Company in connection with the Company's revision of its revenues
for the fiscal year ended August 31, 1995 (as described in detail in note 20
(a)). Plaintiff alleges that the individual defendants (1) breached their duty
of candor, (2) caused the Company to waste corporate assets, and (3) mismanaged
the Company, and, accordingly, seeks unspecified damages. Plaintiffs withdrew
their complaint and filed an amended complaint. The parties have briefed
defendants' motion to dismiss based on plaintiffs' failure to make a proper
demand. The Company has Directors' and Officers' liability insurance which may
cover some portion of the liability, if any, resulting from the Derivative
Action. The ultimate outcome of the litigation cannot presently be determined.
Accordingly, no provision for any liability that may result upon adjudication
has been recognized in the accompanying financial statements.
(d) The Securities and Exchange Commission has issued orders directing a
private investigation relating to, among other things, the Company's earnings
estimate for fiscal 1995 and its decision in the second quarter of fiscal 1996
to exit the 16-bit portable and cartridge market. The Company has been and
intends to continue to fully cooperate with the Commission in its investigation.
(e) The New York State Department of Taxation and Finance (the
'Department') has been conducting a field audit of the Company with respect to
franchise tax liability for its fiscal years ended August 31, 1989, 1990 and
1991. The Company has recently been informed that the Department has made
preliminary findings that a stock license fee (plus interest and penalties) of
approximately $1,933, relating to the Company's outstanding capital stock as of
1989, is due to the State. The Company is contesting the fee and a petition
denying liability has
F-24
<PAGE>
ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FISCAL YEARS ENDED AUGUST 31, 1996, 1995 AND 1994
(IN 000S, EXCEPT PER SHARE DATA)
20. COMMITMENTS AND CONTINGENCIES--(CONTINUED)
been filed. The Company believes that it has defenses and based on advice from
legal counsel, the ultimate outcome of this audit will not have a material
adverse effect on the Company.
(f) The Company's subsidiary, Lazer-Tron, was sued in an action in the
Superior Court of the State of California, County of Alameda, Eastern Division.
In addition, certain directors and officers of Lazer-Tron have been named as
defendants in an action pending in the Superior Court of the State of
California, County of Alameda. In addition, certain directors and/or executive
officers of Lazer-Tron have been named as defendants in another action in the
Superior Court of the State of California, County of Alameda. The plaintiffs, on
behalf of a class of Lazer-Tron's stockholders, claim damages based on
allegations that, as a result of lack of due diligence by the named defendants
in fully investigating the proposed acquisition by the Company of Lazer-Tron,
the defendants breached their fiduciary duties to Lazer-Tron's shareholders.
These two actions have been consolidated. The court certified a class in the
consolidated action. Lazer-Tron and the Company intend to defend these actions
vigorously. Management believes, based on the allegations stated in the
complaints, discovery proceedings to date, preliminary settlement discussions
and advice from its legal counsel, that the ultimate outcome of these actions
will not have a material adverse effect on the Company.
(g) In April, 1994, the Company and its executive officers were sued in
four actions regarding its agreement with WMS Industries Inc. ('WMS'). The WMS
actions were consolidated and on July 21, 1994, the plaintiffs served a second
consolidated amended class action complaint entitled In re Acclaim
Entertainment, Inc., Securities Litigation (CV 94 1501). The plaintiffs, on
behalf of a class of the Company's stockholders, claim damages arising from the
Company's alleged failure to comply with the disclosure requirements of the
securities laws in respect of the Company's relationship with WMS and the status
of negotiations on the renewal of a license agreement with WMS, pursuant to
which WMS granted the Company a right of first refusal to create software for
'computer games', 'home video games' and 'handheld game machines' based on
arcade games released by WMS through March 21, 1995. The plaintiffs allege that,
by no later than January 12, 1994, the Company knew or should have known that
(i) it was likely that the license agreement with WMS would not be renewed, (ii)
the nonrenewal of the license agreement would have a material adverse impact on
the Company, (iii) any joint venture or other agreement between WMS and the
Company that might be entered into in the future, however unlikely that may be,
would be on terms substantially less advantageous to the Company than the
license agreement and (iv) statements by the Company's representative that
rumors relating to the nonrenewal of the license agreement were
'unsubstantiated' and that talks between the Company and WMS were continuing,
were materially false and misleading. Accordingly, the plaintiffs claim that the
defendants should have disclosed the likely nonrenewal of the license agreement.
Discovery in the WMS Actions is almost complete, and the parties have moved for
summary judgment. In addition, plaintiffs have moved to expand the class period.
Defendants have opposed the motion. The Company believes the lawsuit is without
merit and lacks any basis in fact, intends to defend the WMS Actions vigorously,
and has asked for permission to move for summary judgment in its favor. The
Company has also asserted a third-party action against its insurance company,
Mt. Hawley Insurance Company ('Mt. Hawley') based on Mt. Hawley's disclaimer of
coverage for liability which may result from the WMS Actions and for fees and
expenses incurred in connection with the defense of the WMS Actions. The
ultimate outcome of the litigation cannot presently be determined. Accordingly,
no provision for any liability that may result upon adjudication has been
recognized in the accompanying consolidated financial statements.
(h) The Company is also party to various other litigations arising in the
course of its business, the resolution of none of which, the Company believes,
will have a material adverse effect on the Company's liquidity or Results of
Operations.
F-25
<PAGE>
ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FISCAL YEARS ENDED AUGUST 31, 1996, 1995 AND 1994
(IN 000S, EXCEPT PER SHARE DATA)
20. COMMITMENTS AND CONTINGENCIES--(CONTINUED)
(i) At August 31, 1996, the Company and its subsidiaries had outstanding
letters of credit aggregating approximately $3,100 for the purchase of
merchandise. The Company's subsidiaries had independent facilities totalling
approximately $45,000 with various banks at August 31, 1996.
(j) Trade accounts payable include $3,100 and $22,000 at August 31, 1996
and 1995, respectively, which were collateralized under outstanding letters of
credit.
(k) The Company has established an Employee Savings Plan (the 'Plan')
effective January 1, 1995, which qualifies as a deferred salary arrangement
under Section 401(k) of the Internal Revenue Code. The Plan is available to all
U.S. employees who meet the eligibility requirements. Under the Plan,
participating employees may elect to defer a portion of their pretax earnings,
up to the maximum allowed by the Internal Revenue Service (up to the lessor of
15% of compensation or $9,240 for calendar year 1996). All amounts vest
immediately. Generally, the Plan assets in a participant's account will be
distributed to a participant or his or her beneficiaries upon termination of
employment, retirement, disability or death. All Plan administrative fees are
paid by the Company.
The Company does not provide its employees any other post retirement or
post employment benefits, except discretionary severance payments upon
termination of employment.
At August 31, 1996, the Company recorded severance costs of $5,000,
included in other accrued expenses.
(l) The Company has entered into employment agreements with certain of its
directors and officers which provide for annual bonus payments based on
consolidated income before income taxes, in addition to their base compensation.
21. OPERATIONS IN GEOGRAPHIC AREAS
The Company is primarily engaged in one industry segment, the development,
marketing and distribution of Software products. The following information sets
forth geographic information on the Company's net revenues, (loss) earnings from
operations and identifiable assets.
<TABLE>
<CAPTION>
UNITED STATES EUROPE JAPAN OTHER ELIMINATIONS CONSOLIDATED
------------- ------- ------- ------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Year ended August 31, 1996:
Sales to unaffiliated customers......... $ 57,742 $86,043 $14,945 $ 3,215 -- $ 161,945
Transfers between geographic areas...... 6,368 -- -- 91 $ (6,459) --
------------- ------- ------- ------- ------------ ------------
Total net revenues...................... $ 64,110 $86,043 $14,945 $ 3,306 $ (6,459) $ 161,945
------------- ------- ------- ------- ------------ ------------
(Loss) earnings from operations......... $(281,159) $ 6,041 $ 1,369 $ (727) $ -- $ (274,476)
------------- ------- ------- ------- ------------ ------------
Identifiable Assets at August 31,
1996.................................. $ 204,749 $23,415 $ 9,442 $ 2,045 $ -- $ 239,651
------------- ------- ------- ------- ------------ ------------
Year ended August 31, 1995:
Sales to unaffiliated customers......... $ 428,868 $95,556 $27,274 $15,025 $ -- $ 566,723
Transfers between geographic areas...... 11,388 102 -- -- (11,490) --
------------- ------- ------- ------- ------------ ------------
Total net revenues...................... $ 440,256 $95,658 $27,274 $15,025 $(11,490) $ 566,723
------------- ------- ------- ------- ------------ ------------
Earnings from operations................ $ 45,457 $17,732 $ 1,872 $ 5,605 $ -- $ 70,666
------------- ------- ------- ------- ------------ ------------
Identifiable Assets at August 31,
1995.................................. $ 410,873 $19,259 $10,462 $ 2,233 $ -- $ 442,827
------------- ------- ------- ------- ------------ ------------
Year ended August 31, 1994:
Sales to unaffiliated customers......... $ 367,271 $78,878 $17,338 $17,269 $ -- $ 480,756
Transfers between geographic areas...... 11,057 333 11,728 -- (23,118) --
------------- ------- ------- ------- ------------ ------------
Total net revenues...................... $ 378,328 $79,211 $29,066 $17,269 $(23,118) $ 480,756
------------- ------- ------- ------- ------------ ------------
Earnings from operations................ $ 56,295 $ 9,438 $ 4,425 $ 7,312 $ -- $ 77,470
------------- ------- ------- ------- ------------ ------------
Identifiable Assets at August 31,
1994.................................. $ 295,649 $32,982 $ 5,292 $ 1,955 $ -- $ 335,878
------------- ------- ------- ------- ------------ ------------
------------- ------- ------- ------- ------------ ------------
</TABLE>
F-26
<PAGE>
ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FISCAL YEARS ENDED AUGUST 31, 1996, 1995 AND 1994
(IN 000S, EXCEPT PER SHARE DATA)
21. OPERATIONS IN GEOGRAPHIC AREAS--(CONTINUED)
Export sales from the U.S. have been insignificant during each of the years
in the three year period ended August 31, 1996.
22. QUARTERLY FINANCIAL DATA (UNAUDITED)
During the second half of fiscal 1996, the deterioration of the 16-bit
cartridge and portable software market accelerated. Retail inventories were
higher than anticipated and the Company's sales of its 16-bit products, as well
as its other software products, continued to require more retail incentives,
including price concessions. As a result, the Company's financial statements in
the fourth quarter include several adjustments to accrue additional sales
credits and allowances, reduce inventory to its net realizable value and write
off prepaid royalties. The Company also accrued the costs associated with a
reduction in its work force and to increase goodwill amortization. On a pre-tax
basis, these fourth quarter adjustments are as follows:
<TABLE>
<S> <C>
Adjustments to estimated net realizable value of 16-bit cartridge and portable
software accounts receivable and inventory...................................... $ 65,000
Adjustments to estimated net realizable value of other accounts receivable and
inventory....................................................................... 29,000
Write-offs of prepaid royalties................................................... 31,000
Write-off of capitalized software costs........................................... 8,000
Provision for severance costs..................................................... 5,000
Accelerated amortization of goodwill.............................................. 300
--------
$138,300
--------
--------
</TABLE>
A portion of these adjustments relate to prior quarters. However, the
Company was unable to determine a reasonable method to allocate the adjustments
since a combination of customer retail sales practices, sales concessions
originating outside the Company's financial reporting process and changing
16-bit and portable software market conditions make more accurate estimates of
the period in which these charges belong impractical to determine.
F-27
<PAGE>
ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FISCAL YEARS ENDED AUGUST 31, 1996, 1995 AND 1994
(IN 000S, EXCEPT PER SHARE DATA)
22. QUARTERLY FINANCIAL DATA (UNAUDITED)--(CONTINUED)
The following table sets forth certain quarterly financial information for
fiscal 1996:
<TABLE>
<CAPTION>
QUARTER ENDED
-----------------------------------------------------
NOVEMBER 30, FEBRUARY 29, MAY 31, AUGUST 31,
1995 1996 1996 1996 TOTAL
------------ ------------ ------- ---------- --------
<S> <C> <C> <C> <C> <C>
Gross Revenues................................... $154,162 $104,377 $66,310 $ 51,175 $376,024
Sales credits and allowances..................... 19,715 *86,451 3,671 *104,242 214,079
------------ ------------ ------- ---------- --------
Net revenues..................................... 134,447 17,926 62,639 (53,067) 161,945
Cost of revenues................................. 75,863 *54,553 24,456 *25,200 180,072
Net (loss) earnings.............................. 595 (55,771) (3,968) (162,224) (221,368)
Net (loss) earnings per share.................... $ 0.01 $ (1.12) $ (0.08) $ (3.28) $ (4.47)
</TABLE>
- ------------------
* Includes amounts relating to the special cartridge video charge as follows:
<TABLE>
<CAPTION>
QUARTER ENDED
(IN MILLIONS)
--------------------------
FEBRUARY 29, AUGUST 31,
1996 1996 TOTAL
------------ ---------- ------
<S> <C> <C> <C>
Sales credits and allowances........................................ $ 28.8 $ 61.7 $ 90.5
Cost of revenues.................................................... 20.1 3.3 23.4
------ ---------- ------
$ 48.9 $ 65.0 $113.9
</TABLE>
The following table sets forth certain quarterly financial information for
fiscal 1995:
<TABLE>
<CAPTION>
QUARTER ENDED
------------------------------------------------------
NOVEMBER 30, FEBRUARY 29, MAY 31, AUGUST 31,
1994 1995 1995 1995 TOTAL
------------ ------------ -------- ---------- --------
<S> <C> <C> <C> <C> <C>
Net revenues.................................... $164,304 $161,273 $107,654 $ 133,492 $566,723
Cost of revenues................................ 77,665 73,456 53,792 63,588 268,501
Net earnings.................................... 15,958 13,856 8,855 6,101 44,770
Net earnings per share.......................... $ 0.34 $ 0.28 $ 0.17 $ 0.11 $ 0.86
</TABLE>
The sum of the quarterly net earnings per share amounts do not equal the
annual amount reported, as per share amounts are computed independently for each
quarter and for the twelve months based on the weighted average common and
common equivalent shares outstanding in each such period.
F-28
<PAGE>
ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(IN 000S, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
MAY 31,
1997
-----------
(UNAUDITED)
<S> <C>
ASSETS
Current assets
Cash and cash equivalents....................................................................... $ 46,043
Accounts receivable -- net...................................................................... 23,740
Inventories..................................................................................... 3,626
Prepaid expenses................................................................................ 14,853
-----------
Total current assets.......................................................................... 88,262
-----------
Fixed assets -- net............................................................................. 36,985
Excess of cost over net assets acquired -- net.................................................. 24,075
Other assets.................................................................................... 10,605
-----------
Total assets.................................................................................. $ 159,927
-----------
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Current liabilities
Trade accounts payable.......................................................................... $ 18,044
Short-term borrowings........................................................................... 5,550
Accrued expenses................................................................................ 82,701
Income taxes payable............................................................................ 3,177
Current portion of long-term debt............................................................... 1,168
Obligation under capital leases--current........................................................ 1,824
-----------
Total current liabilities..................................................................... 112,464
-----------
Long-term liabilities
Long-term debt.................................................................................. 52,835
Obligation under capital leases--noncurrent..................................................... 2,529
-----------
Total liabilities............................................................................. 167,828
-----------
Minority interest............................................................................... (714)
Stockholders' deficiency
Preferred stock, $0.01 par value; 1,000 shares authorized; None issued........................ --
Common stock, $0.02 par value; 100,000 shares
authorized; 50,121 shares issued........................................................... 1,002
Additional paid-in capital.................................................................... 172,514
Accumulated deficit........................................................................... (176,188)
Treasury stock, 474 shares.................................................................... (2,904)
Foreign currency translation adjustment....................................................... (1,611)
-----------
Total stockholders' deficiency............................................................. (7,187)
-----------
Total liabilities and stockholders' deficiency............................................. $ 159,927
-----------
-----------
</TABLE>
See notes to unaudited consolidated financial statements.
F-29
<PAGE>
ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED OPERATIONS
(UNAUDITED AND IN 000S, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED MAY
MAY 31, 31,
-------------------- ----------------------
1997 1996 1997 1996
-------- -------- --------- ---------
<S> <C> <C> <C> <C>
NET REVENUES................................................... $ 41,616 $ 62,639 $ 147,264 $ 215,012
COST OF REVENUES............................................... $ 25,466 25,806 78,019 162,522
-------- -------- --------- ---------
GROSS PROFIT................................................... 16,150 36,833 69,245 52,490
-------- -------- --------- ---------
OPERATING EXPENSES
Selling, advertising, general and administrative expenses.... 28,476 30,791 90,732 111,184
Research and development expenses............................ 6,621 7,155 23,588 18,559
Operating interest........................................... 417 2,150 1,625 5,255
Depreciation and amortization................................ 4,394 3,671 12,554 10,867
Goodwill writedown........................................... 25,200 -- 25,200 --
Litigation settlements....................................... 8,300 -- 8,300 --
Downsizing charge............................................ 10,000 -- 10,000 --
-------- -------- --------- ---------
Total operating expenses.................................. 83,408 43,767 171,999 145,865
-------- -------- --------- ---------
(LOSS) FROM OPERATIONS......................................... (67,258) (6,934) (102,754) (93,375)
-------- -------- --------- ---------
OTHER (EXPENSE) INCOME (2,316) 930 (3,608) 5,463
-------- -------- --------- ---------
(LOSS) BEFORE INCOME TAXES..................................... (69,574) (6,004) (106,362) (87,912)
-------- -------- --------- ---------
Provision (benefit) for income taxes........................... 805 (1,800) 426 (28,260)
-------- -------- --------- ---------
NET (LOSS) BEFORE MINORITY INTEREST............................ (70,379) (4,204) (106,788) (59,652)
Minority interest.............................................. (675) (236) (1,242) (508)
-------- -------- --------- ---------
Net (loss)..................................................... $(69,704) $ (3,968) $(105,546) $ (59,144)
-------- -------- --------- ---------
Net (loss) per common and common equivalent share.............. $ (1.40) $ (0.08) $ (2.13) $ (1.20)
-------- -------- --------- ---------
Weighted average number of common and common equivalent shares
outstanding.................................................. 49,645 49,940 49,645 49,360
-------- -------- --------- ---------
</TABLE>
See notes to unaudited consolidated financial statements.
F-30
<PAGE>
ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED STOCKHOLDERS' EQUITY
(UNAUDITED AND IN 000S, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
PREFERRED
STOCK(1) COMMON STOCK UNREALIZED
-------------- -------------- (ACCUMULATED FOREIGN GAIN (LOSS) ON
ISSUED ISSUED ADDITIONAL DEFICIT) CURRENCY MARKETABLE
PAID-IN DEFERRED RETAINED TREASURY TRANSLATION EQUITY
SHARES AMOUNT SHARES AMOUNT CAPITAL COMPENSATION EARNINGS STOCK ADJUSTMENT SECURITIES
------ ------ ------ ------ ---------- ------------ ------------ -------- ---------- --------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance August 31,
1995.................. -- -- 46,281 $ 926 $168,785 $(10,652) $ 153,141 $ (807 ) $ 811 $2,503
------ ------ ---------- ------------ ------------ -------- ---------- ------
Net Loss............... -- -- -- -- -- -- (221,368) -- -- --
Issuance of Common
Stock and Options..... -- -- 463 9 7,756 (7,765) -- -- -- --
Deferred compensation
expense............... -- -- -- -- -- 3,304 -- -- -- --
Exercise of Stock
Options and
Warrants.............. -- -- 552 11 3,711 -- -- -- -- --
Pooling of Interests
with Sculptured and
Probe................. -- -- 2,745 55 (55) -- (2,415) -- -- --
Tax Benefit from
Exercise of Stock
Options............... -- -- -- -- 698 -- -- -- -- --
Purchase of Treasury
Stock................. -- -- -- -- -- -- -- (1,006 ) -- --
Foreign Currency
Translation Loss...... -- -- -- -- -- -- -- -- (1,565) --
Unrealized Loss on
Marketable Equity
Securities............ -- -- -- -- -- -- -- -- -- (2,488)
------ ------ ---------- ------------ ------------ -------- ---------- ------
Balance August 31,
1996.................. -- -- 50,041 1,001 180,895 (15,113) (70,642) (1,813 ) (754) 15
------ ------ ---------- ------------ ------------ -------- ---------- ------
Net Loss............... -- -- -- -- -- -- (105,546) -- -- --
Deferred compensation
expense............... -- -- -- -- -- 5,275 -- -- -- --
Exercise of Stock
Options............... -- -- 80 1 169 -- -- -- -- --
Issuance of Warrants
and Options........... -- -- -- -- 722 566 -- -- -- --
Purchase of Treasury
Stock................. -- -- -- -- -- -- -- (1,091 ) -- --
Foreign Currency
Translation Loss...... -- -- -- -- -- -- -- -- (857) --
Unrealized Loss on
Marketable Equity
Securities............ -- -- -- -- -- -- -- -- -- (15)
------ ------ ---------- ------------ ------------ -------- ---------- ------
Balance May 31, 1997... -- -- 50,121 $1,002 $181,786 $ (9,272) $ (176,188) $(2,904 ) $ (1,611) --
------ ------ ---------- ------------ ------------ -------- ---------- ------
<CAPTION>
TOTAL
--------
<S> <C>
Balance August 31,
1995.................. $314,707
--------
Net Loss............... (221,368)
Issuance of Common
Stock and Options..... --
Deferred compensation
expense............... 3,304
Exercise of Stock
Options and
Warrants.............. 3,722
Pooling of Interests
with Sculptured and
Probe................. (2,415)
Tax Benefit from
Exercise of Stock
Options............... 698
Purchase of Treasury
Stock................. (1,006)
Foreign Currency
Translation Loss...... (1,565)
Unrealized Loss on
Marketable Equity
Securities............ (2,488)
--------
Balance August 31,
1996.................. 93,589
--------
Net Loss............... (105,546)
Deferred compensation
expense............... 5,275
Exercise of Stock
Options............... 170
Issuance of Warrants
and Options........... 1,288
Purchase of Treasury
Stock................. (1,091)
Foreign Currency
Translation Loss...... (857)
Unrealized Loss on
Marketable Equity
Securities............ (15)
--------
Balance May 31, 1997... $ (7,187)
--------
</TABLE>
- ------------------
(1) The Company is authorized to issue 1,000 shares of preferred stock at a par
value of $0.01 per share, none of which shares is presently issued and
outstanding.
See notes to unaudited consolidated financial statements.
F-31
<PAGE>
ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED CASH FLOWS
(UNAUDITED AND IN 000S, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
MAY 31,
----------------------
1997 1996
--------- ---------
<S> <C> <C>
CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES
Cash received from customers............................................................ $ 165,654 $ 419,862
Cash paid to suppliers and employees.................................................... (230,489) (438,691)
Interest received....................................................................... 1,606 2,935
Interest paid........................................................................... (4,698) (6,966)
Income taxes refunded (paid)............................................................ 56,955 (2,394)
--------- ---------
Net cash (used in) operating activities............................................... (10,972) (25,254)
--------- ---------
CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES
Acquisition/Divestiture of subsidiaries, net............................................ 6,964 7,912
Sale of marketable equity securities.................................................... 10,240 14,643
Acquisition of fixed assets, excluding capital leases................................... (3,620) (11,204)
Acquisition of other assets............................................................. (382) (2,068)
Other investing activities.............................................................. -- 212
--------- ---------
Net cash provided by investing activities............................................. 13,202 9,495
--------- ---------
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES
Proceeds from Convertible Subordinated Notes............................................ 47,400 --
Proceeds from short-term borrowings..................................................... 12,827 12,947
Repayment of short-term borrowings...................................................... (12,657) (14,286)
Proceeds from mortgage.................................................................. -- 6,676
Payment of mortgage..................................................................... (2,524) (111)
Issuance of common stock................................................................ -- 4
Exercise of stock options............................................................... 170 3,502
Payment of obligation under capital leases.............................................. (1,513) (166)
Payment of long-term debt............................................................... (19,000) (4,613)
Other financing activities.............................................................. 460 127
--------- ---------
Net cash provided by financing activities............................................... 25,163 4,080
--------- ---------
Effect of exchange rate changes on cash................................................. (164) (1,285)
--------- ---------
Net increase (decrease) in cash......................................................... 27,229 (12,964)
Cash and cash equivalents at beginning of period........................................ 18,814 44,749
--------- ---------
Cash and cash equivalents at end of period.............................................. $ 46,043 $ 31,785
--------- ---------
RECONCILIATION OF NET (LOSS) TO NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES
Net (loss).............................................................................. $(105,546) $ (59,144)
--------- ---------
Adjustments to reconcile net (loss) to net cash provided by (used in) operating
activities:
Depreciation and amortization......................................................... 37,754 10,867
Loss (gain) on sale of marketable equity securities................................... 1,010 (3,684)
Provision for returns and discounts................................................... 23,440 109,837
Deferred income taxes................................................................. -- (7,022)
Minority interest in net earnings of consolidated subsidiary.......................... (1,242) (508)
Deferred compensation expense......................................................... 5,275 2,294
Non-cash royalty charges.............................................................. 7,750 2,221
Litigation settlements................................................................ 8,300 --
Other non-cash items.................................................................. 248 173
Change in assets and liabilities:
(Increase) in accounts receivable................................................... (20,543) (4,668)
Decrease (Increase) in inventories.................................................. 1,377 (3,127)
(Increase) in prepaid expenses...................................................... (2,688) (3,836)
Decrease in other current assets.................................................... 330 1,288
(Decrease) in trade accounts payable................................................ (11,666) (14,280)
(Decrease) in accrued expenses...................................................... (12,231) (32,026)
(Decrease) in income taxes payable.................................................. -- (23,639)
Decrease in income taxes receivable................................................. 57,460 --
--------- ---------
Total adjustments................................................................... 94,574 33,890
--------- ---------
Net cash (used in) provided by operating activities................................... $ (10,972) $ (25,254)
--------- ---------
</TABLE>
See notes to unaudited consolidated financial statements.
F-32
<PAGE>
ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED MAY 31, 1997
(IN 000S, EXCEPT PER SHARE DATA)
1. INTERIM PERIOD REPORTING
The data contained in these financial statements are unaudited and are
subject to year-end adjustments; however, in the opinion of management, all
known adjustments (which consist only of normal recurring accruals) have been
made to present fairly the consolidated operating results for the unaudited
periods.
Adjustments in the fourth quarter of fiscal 1996, on a pre-tax basis,
aggregated $138,300, a portion of which related to prior quarters. Accordingly,
for comparative quarterly purposes, during fiscal 1997, the 1996 quarterly
operating results may not necessarily be indicative of the results of operations
for such quarterly periods if those year-end adjustments could have been
allocated to the respective quarters.
2. LIQUIDITY
The accompanying consolidated financial statements have been prepared
assuming that Acclaim Entertainment, Inc. ('Acclaim'), together with its
subsidiaries (Acclaim and its subsidiaries are collectively hereinafter referred
to as the 'Company'), will continue as a going concern. The Company's
significant losses from operations in fiscal 1996 and in the nine months ended
May 31, 1997, the uncertainty as to whether the Company's products in
development will achieve commercial success, the uncertainty in respect of the
on-going support of the Company's principal bank and uncertainty regarding the
resolution of litigations, including various class action lawsuits, raise
substantial doubt about the Company's ability to continue as a going concern.
The consolidated financial statements do not include any adjustments that might
arise from the outcome of this uncertainty.
3. ACQUISITIONS AND DIVESTITURE
On October 9, 1995, the Company acquired Sculptured Software, Inc.
('Sculptured') and, on October 16, 1995, the Company acquired Probe
Entertainment Limited ('Probe'). Sculptured and Probe are developers of
interactive video games. Both acquisitions were accounted for as poolings of
interests and were effected through the exchange of an aggregate of 2,745 shares
of common stock, par value $0.02 per share (the 'Common Stock'), of the Company
for all the issued and outstanding shares of Sculptured and Probe. The Company's
consolidated financial statements for fiscal 1996 include the results of
Sculptured and Probe.
On March 5, 1997, the Company completed the sale of substantially all of
the assets and certain liabilities of Acclaim Redemption Games, Inc., formerly
Lazer-Tron Corporation, for $6,000 in cash.
4. ACCOUNTS RECEIVABLE
Accounts receivable are comprised of the following:
<TABLE>
<CAPTION>
MAY 31, AUGUST 31,
1997 1996
------- ----------
<S> <C> <C>
Receivables assigned to factor................................................... $16,934 $ 55,099
Less advances from factor........................................................ 841 23,487
------- ----------
Due from factor.................................................................. 16,093 31,612
Unfactored accounts receivable................................................... 4,549 12,031
Accounts receivable -- foreign................................................... 21,781 20,229
Other receivables................................................................ 3,352 5,472
Allowances for returns and discounts............................................. (22,035) (48,866)
------- ----------
$23,740 $ 20,478
------- ----------
------- ----------
</TABLE>
Pursuant to a factoring agreement, the Company's principal bank acts as its
factor for the majority of its North American receivables, which are assigned on
a pre-approved basis. At May 31, 1997, the factoring charge
F-33
<PAGE>
ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NINE MONTHS ENDED MAY 31, 1997
(IN 000S, EXCEPT PER SHARE DATA)
4. ACCOUNTS RECEIVABLE--(CONTINUED)
amounted to 0.25% of the receivables assigned. The Company's obligations to the
bank are collateralized by all of the Company's and its North American
subsidiaries' accounts receivable, inventories and equipment. The advances for
factored receivables are made pursuant to a revolving credit and security
agreement, which expires on January 31, 2000.
The Company draws down working capital advances and opens letters of credit
(up to an aggregate maximum of $20,000) against the facility in amounts
determined on a formula based on factored receivables, inventory and cost of
imported goods under outstanding letters of credit. Effective November 8, 1996,
interest is charged at the bank's prime lending rate (8.5% at May 31, 1997) plus
one percent per annum on such advances.
As of August 31, 1996 and November 30, 1996, the Company was in default of
various financial and other covenants under its revolving credit facility,
including the prohibition on having a 'going concern' paragraph in the fiscal
1996 auditors' report on its financial statements. The lender waived these past
defaults, conditioned upon the Company receiving at least $46,000 in net
proceeds from the issuance of the Convertible Subordinated Notes described more
fully in Note 5. On February 26, 1997, the Company received net proceeds of
$47,400 from the issuance of such Notes. The Company is current in its payment
obligations under the revolving credit facility. Pursuant to the terms of the
agreement, which can be cancelled by either party upon 90 days' notice prior to
the end of the term, the Company is required to maintain specified levels of
working capital and tangible net worth and may not incur losses in excess of
specified amounts, among other covenants.
As of May 31, 1997, the Company was in default of certain covenants under
its agreement with the lender, which default was waived by the lender. The
Company is currently negotiating revised financial covenants for future periods
with the lender. Subsequent to May 31, 1997, the Company was in default under
its agreement with the lender arising from the delivery to the lender of certain
financial projections, which default was waived by the lender through July 18,
1997. The Company anticipates that such default will be waived permanently upon
the delivery by the Company to the lender of new projections in connection with
the negotiation of revised financial covenants.
In connection with the establishment of a research and development joint
venture, the Company was in default of certain covenants under its agreement
with the lender, which default has been waived through July 31, 1997 subject to
the Company's delivery to the lender of certain documents and collateral.
Sales credits and allowances for the three months ended May 31, 1997 and
1996 were $6,887 and $3,671, respectively, and for the nine months ended May 31,
1997 and 1996 were $23,440 and $109,837 respectively.
5. LONG TERM DEBT
Long-term debt consists of the following:
<TABLE>
<CAPTION>
MAY 31, AUGUST 31,
1997 1996
------- ----------
<S> <C> <C>
(A) 10% Convertible Subordinated Notes due 2002.................................. $50,000 $ --
(B) Term Loan.................................................................... -- 19,000
(C) Mortgage note................................................................ 4,003 6,527
------- ----------
54,003 25,527
------- ----------
Less: current portion......................................................... 1,168 25,527
------- ----------
$52,835 $ --
------- ----------
------- ----------
</TABLE>
(A) In February 1997, the Company issued $50,000 of unsecured 10%
Convertible Subordinated Notes (the 'Notes') due March 1, 2002 with interest
payable semiannually commencing September 1, 1997. The Notes
F-34
<PAGE>
ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NINE MONTHS ENDED MAY 31, 1997
(IN 000S, EXCEPT PER SHARE DATA)
5. LONG TERM DEBT--(CONTINUED)
were sold at par with proceeds to the Company of $47,400, net of expenses. The
indenture governing the Notes contains covenants that, among other things,
substantially limit the Company's ability to incur additional indebtedness,
issue preferred stock, pay dividends and make certain other payments. The Notes
are convertible into shares of Common Stock at any time after April 26, 1997 and
prior to maturity, unless previously redeemed, at a conversion price of $5.18
per share, subject to adjustment under certain conditions. The Notes are
redeemable, in whole or in part, at the option of the Company (subject to the
rights of holders of senior indebtedness) at 104% of the principal balance at
any time on or after March 1, 2000 through February 28, 2001 and at 102% of the
principal balance thereafter to maturity.
(B) In conjunction with the acquisition of Acclaim Comics, Inc., in July
1994, Acclaim Comics entered into a term loan guaranteed by the Company which
bore interest at a rate of LIBOR plus 2.5%. The Company used $16,000 of the
proceeds from the issuance of the Notes to pay the remaining outstanding balance
of the term loan.
(C) Interest on the mortgage note, which, until April 30, 1997, was charged
at the bank's prime lending rate and is currently charged at the bank's prime
lending rate (8.5% at May 31, 1997) plus one percent per annum, is payable in
quarterly installments that commenced on March 1, 1996.
The principal amount is payable in quarterly installments that commenced on
May 1, 1996. The mortgage note is collateralized by a building (Corporate
Headquarters) with a carrying value of approximately $16,647.
As of August 31, 1996 and November 30, 1996, the Company was in default of
various financial and other covenants with the mortgage lender. The mortgage
lender waived these past defaults, conditioned upon the mortgage lender
receiving $2,000 from the net proceeds from the issuance of the Notes and the
Company accelerating payment terms on the balance of the loan. The Company used
$2,000 of the proceeds from the issuance of the Notes to repay a portion of the
mortgage note and is obligated to make an additional accelerated payment of $500
payable over nine months in addition to quarterly payments of $181 payable until
February 1, 2002, when the principal balance on the mortgage note is due.
6. STOCK OPTIONS
On October 28, 1996, the Company granted options to purchase an aggregate
of 5,055 shares of Common Stock at an exercise price of $3.94 per share, the
market value of the Common Stock on such date, to certain employees, other than
directors, which options were granted in lieu of previously granted options
whose exercise price was higher than $3.94. The vesting period for the new
options was identical to that of the old options and commenced on October 28,
1996, the grant date.
On February 26, 1997, the Company granted options to purchase an aggregate
of 4,100 shares of Common Stock at an exercise price of $4.88 per share, the
market value of the Common Stock on such date, to certain employees and
directors, subject to stockholder approval of an amendment to increase the
number of shares subject to the 1988 Stock Option Plan.
On April 30, 1997, the Company (i) granted options to purchase an aggregate
of 255 shares of Common Stock at an exercise price of $3.38 per share, the
market value of the Common Stock on such date, to certain employees, and (ii)
granted options to purchase an aggregate of 3,621 shares of Common Stock at an
exercise price of $3.38 per share to certain employees, other than directors,
which options were granted in lieu of previously granted options whose exercise
price was higher than $3.38. The new grants were made subject to stockholder
approval of an amendement to increase the number of shares subject to the 1988
Stock Option Plan. The vesting period for the new options was identical to that
of the old options and commenced on April 30, 1997, the grant date.
F-35
<PAGE>
ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NINE MONTHS ENDED MAY 31, 1997
(IN 000S, EXCEPT PER SHARE DATA)
7. OPERATING EXPENSES
In May 1997, the Company effected a downsizing and put into place a plan to
effect substantial cost reductions. Severance charges and other costs related to
the downsizing and proposed cost reductions of approximately $10 million were
recorded in the third quarter of fiscal 1997. Management believes that the
Company will realize operating expense reductions resulting therefrom commencing
in the fourth quarter of fiscal 1997.
Since the Company's acquisition of Acclaim Comics in July 1994, Acclaim
Comics has not achieved the sales and earnings projections prepared at the time
of acquisition primarily due to the steady decrease in demand for comic books.
Accordingly, Acclaim Comics recorded losses in fiscal 1995 and 1996, which were
insignificant in relation to the Company's overall operating results. In fiscal
1996, the Company reduced the life of the goodwill relating to the acquisition
of Acclaim Comics from 40 years to 20 years, and continues to evaluate the
recoverability of such goodwill based on projected undiscounted cash flows over
the remaining amortization period of the goodwill.
Due to continuing operating losses by Acclaim Comics in the first nine
months of fiscal 1997, management's assessment of the current state of the comic
book industry, the longer-than-expected period of time required to ramp up
various new product introductions and management's current projections for
Acclaim Comics' operations, management believes that there is an impairment in
the carrying value of the goodwill relating to the acquisition of Acclaim
Comics. Accordingly, the Company recorded a write-down of $25.2 million of
goodwill in the quarter ended May 31, 1997 to reduce the carrying value of the
goodwill associated with Acclaim Comics to the related forecasted undiscounted
cash flows.
Goodwill recoverability was based on projected undiscounted cash flows over
19 years, which represents the remaining life of the goodwill as of May 31,
1997, based on historical actual results adjusted for recently introduced
products. The Company believes that the projected future results are the most
likely scenario.
In conjunction with certain litigations for which the settlement obligation
is currently probable and estimable (see 'Risk Factors--Litigation' and 'Legal
Proceedings'), the Company recorded a primarily noncash charge of $8.3 million
in the quarter ended May 31, 1997. No assurance can be given that the Company
will not be required to record additional material charges in future periods in
conjunction with the various litigations to which the Company is a party.
F-36
<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS IN CONNECTION WITH THE OFFER
CONTAINED HEREIN OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR
MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED BY THE COMPANY. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL
OR THE SOLICITATION OF AN OFFER TO BUY ANY SECURITY OTHER THAN THOSE TO WHICH IT
RELATES, NOR DOES IT CONSTITUTE AN OFFER TO SELL, OR THE SOLICITATION OF AN
OFFER TO BUY, TO ANY PERSON IN ANY JURISDICTION IN WHICH SUCH OFFER OR
SOLICITATION IS NOT AUTHORIZED, OR IN WHICH THE PERSON MAKING SUCH OFFER OR
SOLICITATION IS NOT QUALIFIED TO DO SO, OR TO ANY PERSON TO WHOM IT IS UNLAWFUL
TO MAKE SUCH OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR
ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION
THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE
HEREOF OR THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME
SUBSEQUENT TO THE DATE HEREOF.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Special Note Regarding Forward-Looking
Statements................................... 3
Available Information.......................... 3
Summary........................................ 4
Risk Factors................................... 9
Market Price of and Dividends on the Company's
Common Equity and Related Stockholder
Matters...................................... 21
Use of Proceeds................................ 21
Capitalization................................. 22
Selected Financial Information................. 23
Management's Discussion and Analysis of
Financial Condition and Results of
Operations................................... 24
Business....................................... 32
Legal Proceedings.............................. 40
Management..................................... 43
Security Ownership of Certain Beneficial Owners
and Management............................... 49
Certain Relationships and Related
Transactions................................. 51
Selling Securityholders........................ 52
Plan of Distribution........................... 53
Description of Notes........................... 54
Description of Capital Stock................... 66
Legal Matters.................................. 67
Experts........................................ 67
Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure....... 68
Financial Statements........................... F-1
</TABLE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
ACCLAIM ENTERTAINMENT, INC.
$50,000,000
10% CONVERTIBLE SUBORDINATED
NOTES DUE 2002
-----------------------
PROSPECTUS
-----------------------
SEPTEMBER 22, 1997
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
