<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-------------------
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
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<S> <C>
FOR QUARTER ENDED: JUNE 30, 1996 COMMISSION FILE NUMBER: 0-19463
</TABLE>
SPECTRUM HOLOBYTE, INC.
Exact Name of registrant as specified in its charter
<TABLE>
<S> <C>
DELAWARE 52-1728656
(State or other jurisdiction of (IRS Employer Identification
Incorporation or organization) Number)
2490 MARINER SQUARE LOOP, SUITE 100, ALAMEDA,
CA 94501
(Address of Principal Executive Offices) (Zip Code)
</TABLE>
(510) 522-3584
Registrant's telephone number, including area code
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No __
26,138,466 shares of Common Stock were outstanding as of June 30, 1996.
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SPECTRUM HOLOBYTE, INC.
TABLE OF CONTENTS
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PAGE
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<S> <C> <C>
PART I -- FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Balance Sheets at June 30, 1996 and March 31, 1996................................. 3
Consolidated Statements of Operations for the three months ended June 30, 1996 and 1995......... 4
Consolidated Statements of Cash Flows for the three months ended June 30, 1996 and 1995......... 5
Notes to Consolidated Financial Statements...................................................... 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS........... 9
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS............................................................................... 21
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K................................................................ 21
SIGNATURES................................................................................................. 23
EXHIBITS................................................................................................... 24
</TABLE>
2
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PART I -- FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
SPECTRUM HOLOBYTE, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
ASSETS
<TABLE>
<CAPTION>
JUNE 30, MARCH 31,
1996 1996
------------ ------------
<S> <C> <C>
(UNAUDITED)
Current assets:
Cash and cash equivalents........................................................... $ 39,549 $ 35,369
Accounts receivable, less allowances of $9,656 and $9,179........................... 6,362 9,718
Inventories......................................................................... 3,423 3,673
Prepaid royalties................................................................... 2,810 2,126
Other current assets................................................................ 1,983 2,133
------------ ------------
Total current assets.............................................................. 54,127 53,019
Property and equipment, net......................................................... 5,625 5,670
Goodwill, net....................................................................... 743 818
Investments......................................................................... 6,742 4,300
Other assets........................................................................ 1,516 2,115
------------ ------------
$ 68,753 $ 65,922
------------ ------------
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Notes and borrowings under lines of credit.......................................... $ -- $ 504
Accounts payable.................................................................... 4,662 5,694
Salaries, wages and related accruals................................................ 3,560 3,909
Royalties payable................................................................... 1,575 1,703
Current portion of capital lease obligations........................................ 300 431
Other current liabilities........................................................... 4,994 5,093
------------ ------------
Total current liabilities......................................................... 15,091 17,334
Capital lease obligations........................................................... 347 384
Other liabilities................................................................... 1,212 1,238
Long-term debt...................................................................... 35,145 50,000
------------ ------------
Total liabilities................................................................. 51,795 68,956
Redeemable preferred stock, $0.001 par value, 4,000,000 Series A shares issued and
outstanding, redemption and liquidation amount of $5,050 and $4,980................ 5,881 5,881
Stockholders' equity (deficit):
Preferred stock, $0.001 par value, 9,000,000 shares authorized (of which 4,000,000
shares have been designated Series A):
750,000 Series B convertible shares issued and outstanding at June 30, 1996...... 1 --
1,168,860 Series B-1 convertible shares issued and outstanding at June 30, 1996... 1 --
Common stock, $0.001 par value, 40,000,000 shares authorized, 26,138,466 and
24,282,813 shares issued and outstanding........................................... 26 24
Additional paid-in-capital.......................................................... 141,521 119,923
Accumulated deficit................................................................. (129,971) (128,456)
Foreign currency translation adjustment............................................. (501) (406)
------------ ------------
Total stockholders' equity (deficit).............................................. 11,077 (8,915)
------------ ------------
$ 68,753 $ 65,922
------------ ------------
------------ ------------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL
STATEMENTS.
3
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SPECTRUM HOLOBYTE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
JUNE 30,
--------------------
1996 1995
--------- ---------
<S> <C> <C>
Net revenue................................................................................ $ 13,072 $ 16,929
Cost of revenue............................................................................ 4,899 7,703
--------- ---------
Gross profit............................................................................. 8,173 9,226
Operating expenses:
Sales and marketing...................................................................... 4,582 6,043
General and administrative............................................................... 3,672 3,944
Research and development................................................................. 5,688 8,267
--------- ---------
Total operating expenses............................................................... 13,942 18,254
--------- ---------
Operating loss............................................................................. (5,769) (9,028)
Interest expense, net...................................................................... (481) (189)
Other income (expense), net................................................................ 2,067 (181)
--------- ---------
Loss before extraordinary item............................................................. (4,183) (9,398)
Extraordinary item (note 4).............................................................. 2,668 --
--------- ---------
Net loss................................................................................... $ (1,515) $ (9,398)
--------- ---------
--------- ---------
Per share computation:
Loss before extraordinary item........................................................... $ (0.18) $ (0.42)
Extraordinary item....................................................................... 0.11 --
--------- ---------
Net loss................................................................................. $ (0.07) $ (0.42)
--------- ---------
--------- ---------
Weighted average number of shares used in the per share computation........................ 24,384 22,659
--------- ---------
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</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL
STATEMENTS.
4
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SPECTRUM HOLOBYTE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
JUNE 30,
--------------------
1996 1995
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<S> <C> <C>
Cash flows from operating activities:
Net loss................................................................................. $ (1,515) $ (9,398)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization.......................................................... 906 811
Equity interest in investment losses................................................... 23 --
Gain on the sale of investment in FASA................................................. (1,895) --
Extraordinary gain on the extinguishment of debt....................................... (2,668) --
Changes in assets and liabilities:
Accounts receivable.................................................................. 3,356 (667)
Inventories.......................................................................... 250 (668)
Prepaid royalties.................................................................... (684) (56)
Other current assets................................................................. 400 1,033
Other assets......................................................................... 7 (713)
Accounts payable..................................................................... (840) (1,406)
Salaries, wages and related accruals................................................. (349) 1,253
Royalties payable.................................................................... (128) 1,104
Other current liabilities............................................................ (99) 292
Other liabilities.................................................................... (26) (529)
--------- ---------
Net cash used in operating activities.............................................. (3,262) (8,944)
Cash flows from investing activities:
Acquisitions of property and equipment, net.............................................. (715) (961)
Acquisition of German distributor........................................................ (820) --
Investment in Virtual World Entertainment Group, Inc..................................... (570) --
Proceeds from the sale of investment in FASA............................................. 570 --
--------- ---------
Net cash used in investing activities.................................................. (1,535) (961)
Cash flows from financing activities:
Proceeds from issuance of common stock, net of issuance costs............................ 9,744 12,564
Borrowings under notes and lines of credit............................................... -- 751
Repayments under notes and lines of credit............................................... (504) (2,877)
Principal payments on capital lease obligations.......................................... (168) (192)
--------- ---------
Net cash provided by financing activities.............................................. 9,072 10,246
Effect of exchange rate changes on cash................................................ (95) (29)
--------- ---------
Increase in cash and cash equivalents................................................ 4,180 312
Cash and cash equivalents at beginning of period........................................... 35,369 7,723
--------- ---------
Cash and cash equivalents at end of period................................................. $ 39,549 $ 8,035
--------- ---------
--------- ---------
Supplemental disclosures of cash flow information:
Cash paid for interest................................................................... $ 19 $ 303
Cash paid for taxes...................................................................... 2 --
Supplemental schedule of non-cash investing and financing activities:
Capital lease obligations incurred..................................................... $ -- $ 305
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL
STATEMENTS.
5
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SPECTRUM HOLOBYTE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1. BASIS OF PRESENTATION
The consolidated financial statements are the unaudited historical financial
statements of Spectrum HoloByte, Inc. and subsidiaries (the "Company") and
reflect all adjustments (consisting only of normal recurring accruals) that, in
the opinion of management, are necessary for a fair presentation of interim
period results.
The results of operations for the current interim period are not necessarily
indicative of results to be expected for the entire current year or other future
interim periods.
The consolidated financial statements should be read in conjunction with the
financial statements and notes thereto included in the Company's Annual Report
on Form 10-K for the fiscal year ended March 31, 1996, as filed with the
Securities and Exchange Commission on June 28, 1996. The March 31, 1996
consolidated balance sheet included herein was derived from audited financial
statements, but does not include all disclosures, including notes, required by
generally accepted accounting principles.
Effective in fiscal 1997, the Company changed its fiscal quarter from the
Sunday nearest to the last day of the quarter to the last day of the calendar
quarter. The impact of this change on the results for the quarter ended June 30,
1996 was not material.
Certain reclassifications have been made to the prior period consolidated
financial statements to conform to current period presentation. These
reclassifications had no effect on previously reported net losses or
stockholders' equity (deficit).
NOTE 2. ACQUISITIONS AND INVESTMENTS
OT SPORTS
The Company entered into a Limited Liability Company ("LLC") agreement with
Capital Cities/ ABC, Inc. ("ABC") effective July 1, 1995. The LLC (subsequently
named "OT Sports") was formed for the purpose of developing a sports-based line
of products.
In May 1996, the Company sold its interest in OT Sports to ABC. Under the
terms of the agreement, the Company received a note for $250,000 which is due
upon the first product shipment of OT Sports (but no later than December 31,
1996). The Company is not obligated to make future contributions to OT Sports.
FASA AND VIRTUAL WORLD
In fiscal 1995 and 1996, the Company invested a total of $1.5 million in
FASA Interactive Technologies, Inc. ("FASA"). This investment was accounted for
by the Company under the cost method of accounting.
In June 1996, the Company sold its investment in FASA to FASA for
approximately $3.4 million. The Company received cash of $600,000 and a $2.8
million note bearing interest at a rate of 6% per annum and due June 2001. A
gain of $1.9 million was recorded on the sale of this investment.
Proceeds from the sale of this investment were reinvested in Virtual World
Entertainment Group, Inc. ("VWEG"), a corporation formed for the purpose of
acquiring Virtual World Entertainment, Inc., a developer and operator of
location-based entertainment, and FASA, a developer of entertainment software
for PC and next-generation console platforms. The investment in VWEG is being
accounted for under the cost method of accounting.
6
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SPECTRUM HOLOBYTE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 2. ACQUISITIONS AND INVESTMENTS (CONTINUED)
GERMAN DISTRIBUTOR
In June 1996, the Company entered into an agreement to acquire certain net
assets of a German distributor of computer software games for DM1.2 million
(approximately $0.8 million). The transaction is being accounted for under the
equity method of accounting. During the quarter ended June 30, 1996, the Company
recognized equity losses related to this investment of approximately $23,000.
These losses are included in "Other income (expense), net" in the accompanying
consolidated statement of operations.
NOTE 3. INVENTORIES
Inventories are stated at the lower of cost or market on a first-in,
first-out (FIFO) basis, net of allowances for write-downs. Inventories at June
30, 1996 and March 31, 1996 consisted of (IN THOUSANDS):
<TABLE>
<CAPTION>
JUNE 30, MARCH 31,
1996 1996
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<S> <C> <C>
Raw materials and work in process....................................... $ 1,348 $ 705
Finished goods.......................................................... 2,075 2,968
--------- -----------
$ 3,423 $ 3,673
--------- -----------
--------- -----------
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NOTE 4. LONG-TERM DEBT
In June 1996, the Company exchanged 1,918,860 shares of Series B and Series
B-1 preferred stock (Note 5) for subordinated notes with a face value of
approximately $14.9 million. An extraordinary gain of approximately $2.7 million
was realized on the retirement of the long-term debt.
In July 1996, the Company repurchased subordinated notes with a face value
of $4.0 million for approximately $2.8 million. An extraordinary gain of
approximately $1.0 million was realized on the retirement of the long-term debt.
NOTE 5. ISSUANCE OF CONVERTIBLE PREFERRED STOCK
In June 1996, the Company issued 750,000 shares of Series B and 1,168,860
shares of Series B-1 convertible preferred stock in exchange for the retirement
of subordinated notes with a face value of approximately $14.9 million. Both the
Series B and Series B-1 preferred stock are convertible into an equivalent
number of common shares. Dividends on the Series B and Series B-1 preferred
shares are non-cumulative and non-accruing, and shall be paid only at such time
and such rate as determined by the Board of Directors. As of June 30, 1996, no
dividends had been declared. Subject to the liquidation preference of the Series
A preferred shares, the Series B and Series B-1 convertible preferred stock have
a liquidation preference of $8.00 per share and $7.57 per share, respectively,
plus all declared but unpaid dividends.
NOTE 6. ISSUANCE OF COMMON STOCK
In June 1996, the Company completed a private placement of 1,818,367 shares
of common stock which generated approximately $9.7 million in proceeds, after
discounts, commissions and other issuance costs.
7
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SPECTRUM HOLOBYTE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 7. CANCELLATION AND RE-GRANT OF STOCK OPTIONS
In June 1996, the Board of Directors of the Company approved the
cancellation and re-grant of all outstanding stock options granted to current
employees. The re-granted options have an exercise price of $5.375 per share. As
of July 26, 1996 (the expiration date for the re-grant offer), 1,927,408 options
were canceled and re-granted.
NOTE 8. LICENSE AGREEMENT WITH MITSUI & CO.
In April 1996, the Company's wholly-owned Japanese subsidiary ("Spectrum
Japan") granted an exclusive license to Mitsui & Co., Ltd. ("Mitsui") for the
localization, manufacturing, marketing and distribution of certain Company
titles in Japan. The Company received an up-front license fee of approximately
$300,000, and will earn royalties based upon revenue generated by Mitsui during
the three-year term of the agreement. In connection with the license agreement,
Spectrum Japan subcontracted all of its employees to Mitsui and largely
discontinued its operations. During the quarter ended June 30, 1996, the Company
recognized net revenue of $406,000 related to the license agreement.
NOTE 9. NET LOSS PER SHARE
Net loss per share has been computed by dividing the net loss by the
weighted average number of common shares outstanding during the period. For the
quarters ended June 30, 1996 and 1995, cumulative preferred dividends on Series
A preferred stock of $70,000 have been added to the net loss in the computation
of net loss per share. Common stock equivalents are excluded from the
computations of net losses per share as their effect would be antidilutive.
8
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SPECTRUM HOLOBYTE, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following information should be read in conjunction with the
consolidated historical financial information and the notes thereto included in
Item 1 of this Quarterly Report and Management's Discussion and Analysis of
Financial Condition and Results of Operations contained in the Company's Annual
Report on Form 10-K for the fiscal year ended March 31, 1996, as filed with the
Securities and Exchange Commission on June 28, 1996.
This Form 10-Q contains forward looking statements which involve risks and
uncertainties. The Company may, from time to time, make oral forward-looking
statements. The factors discussed in "Risk Factors" below are important factors
that could cause actual results to differ materially from those projected in any
such forward-looking statements.
OVERVIEW
Spectrum HoloByte, Inc. (the "Company") derives revenue primarily from
publishing and distributing entertainment software. This software is generally
published by the Company for the following platforms:
- Personal computer platforms ("PC"), primarily on Compact-Disc
Read-Only-Memory ("CD-ROM").
- Next-generation videogame consoles.
In addition, the Company generates revenue from the licensing of its
products to third-party publishers and the distribution of affiliated label
products published by third parties. The Company has terminated its U.S.
affiliated label agreements, other than with FASA, and is currently generating
only limited affiliated label revenue in Europe.
The Company operates in North America and Europe, and generates revenue in
other territories based primarily upon the licensing of its products to
third-party publishers. During the first quarter of fiscal 1997, the Company
granted an exclusive license to Mitsui & Co. ("Mitsui") for the localization,
manufacturing, marketing and distribution of certain Company titles in Japan and
largely discontinued its internal Japanese operations.
See additional discussion below in "Risk Factors".
OPERATING RESULTS
Consolidated net revenue generated in North America and the rest of the
world for the three-month periods ended June 30, 1996 and 1995 consisted of the
following (DOLLARS IN THOUSANDS):
<TABLE>
<CAPTION>
NET REVENUE % OF TOTAL
-------------------- --------------------
1996 1995 % CHANGE 1996 1995
--------- --------- ----------- --------- ---------
<S> <C> <C> <C> <C> <C>
North America.................................... $ 7,245 $ 11,131 -34.9% 55.4% 65.8%
International.................................... 5,827 5,798 0.5% 44.6% 34.2%
--------- --------- --------- ---------
Consolidated............................... $ 13,072 $ 16,929 -22.8% 100.0% 100.0%
--------- --------- --------- ---------
--------- --------- --------- ---------
</TABLE>
In the first quarter of fiscal 1997 the Company released two new PlayStation
products, TOP GUN: FIRE AT WILL (which shipped only in the U.S.) and GUNSHIP
2000 (which shipped only in Europe). Back-catalog sales, driven in large part by
sales of SID MEIER'S CIVILIZATION II, accounted for 68% of North American net
revenue. The decline in North American net revenue as compared to the first
quarter of fiscal 1996 is due primarily to a decrease in revenue generated from
new titles introduced in North America during the quarter. The Company released
five titles, including two affiliated label titles, in North America in the
first quarter of fiscal 1996 (including STAR TREK: THE NEXT GENERATION "A FINAL
9
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SPECTRUM HOLOBYTE, INC.
UNITY") which contributed $5.9 million in North American net revenue. In the
first quarter of fiscal 1997, the Company's one North American release, TOP GUN:
FIRE AT WILL, contributed $2.3 million in net revenue.
Net revenue in the first quarter of fiscal 1997 as compared with the same
period in the prior year was also negatively affected by a percentage increase
in the Company's reserves for returns and markdowns. Management believes these
reserves are adequate based on historical experience and its current estimate of
potential returns and allowances. Although the Company believes its reserves are
adequate, and although the Company's agreements with certain customers place
certain limits on product returns, the Company could be forced to accept
substantial product returns to maintain its relationships with retailers and its
access to distribution channels. In addition, although it is not the Company's
policy, the Company may in certain circumstances be forced to grant markdown
allowances to certain customers which could have a material adverse effect on
the Company's revenue and gross profits.
The following table sets forth the components of net revenue and gross
profit in thousands of dollars and as a percentage of net revenue for the
three-month periods ended June 30, 1996 and 1995 (DOLLARS IN THOUSANDS):
<TABLE>
<CAPTION>
NET REVENUE % OF TOTAL
-------------------- --------------------
1996 1995 % CHANGE 1996 1995
--------- --------- ----------- --------- ---------
<S> <C> <C> <C> <C> <C>
PC-CD ROM........................................ $ 8,939 $ 14,053 -36.4% 68.3% 83.0%
PlayStation ("PSX").............................. 2,621 -- -- 20.1% --
Floppy disk/Cartridge............................ -- 2,257 -100.0% -- 13.3%
Licensing/OEM.................................... 1,512 619 144.0% 11.6% 3.7%
--------- --------- --------- ---------
Consolidated............................... $ 13,072 $ 16,929 -22.8% 100.0% 100.0%
--------- --------- --------- ---------
--------- --------- --------- ---------
Gross profit..................................... $ 8,173 $ 9,226 11.4% 62.5% 54.5%
--------- --------- --------- ---------
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</TABLE>
The Company has released three PlayStation products to-date, including two
in the June 1996 quarter (TOP GUN: FIRE AT WILL in the U.S. and GUNSHIP 2000 in
Europe). The decrease in the amount and percentage of revenue generated from
PC-CD ROM products is a result of no new PC-CD ROM product releases in the June
1996 quarter as compared to five PC-CD ROM product releases in the same quarter
of the prior year. In addition, PC-CD ROM affiliated label products distributed
by the Company generated less than 1% of net revenue in the first quarter of
fiscal 1997 as compared to approximately 10% of net revenue in the first quarter
of fiscal 1996. Due to a shift in the entertainment software market towards
multimedia CD and next-generation products, the Company is no longer developing
or selling floppy disk/cartridge products. The increase in licensing/OEM net
revenue is due principally to a more focused effort to license the Company's
back-catalog titles and due to approximately $406,000 in license fees received
from Mitsui during the June 1996 quarter.
The increase in gross profit as a percent of net revenue in the first
quarter of fiscal 1997 as compared to the same period in fiscal 1996 was due
principally to the strong sales of SID MEIER'S CIVILIZATION II. Also
contributing to the increase were a shift away from lower-margin, affiliated
label products and an increased emphasis on licensing programs. Partially
offsetting the increase in gross profit was the shipment of the lower-margin
PlayStation titles in the first quarter of fiscal 1997. The Company believes
that gross profit in future periods will continue to be impacted by high royalty
rates, cost of goods associated with next-generation products and competitive
pricing pressures.
In order to sustain revenue in future periods, it will be important that the
Company release new, full multimedia titles in accordance with its development
schedule, that those new titles achieve
10
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SPECTRUM HOLOBYTE, INC.
market acceptance and that the Company generate substantial revenue from sales
of back-catalog products. The Company has not been able to consistently
accomplish this in the past, and there can be no assurance that the Company will
be successful in achieving this objective in the future.
The following table sets forth operating expenses and interest and other
income (expense) for the three-month periods ended June 30, 1996 and 1995
(DOLLARS IN THOUSANDS):
<TABLE>
<CAPTION>
% OF NET REVENUE
COSTS AND EXPENSES
-------------------- --------------------
1996 1995 % CHANGE 1996 1995
--------- --------- ------------- --------- ---------
<S> <C> <C> <C> <C> <C>
Sales and marketing............................ $ 4,582 $ 6,043 -24.2% 35.1% 35.7%
General and administrative..................... 3,672 3,944 -6.9% 28.1% 23.3%
Research and development....................... 5,688 8,267 -31.2% 43.5% 48.8%
--------- --------- --------- ---------
Total operating expenses..................... $ 13,942 $ 18,254 -23.6% 106.7% 107.8%
--------- --------- --------- ---------
--------- --------- --------- ---------
Interest and other income (expense)............ $ 1,586 $ (370) -- 12.1% -2.2%
--------- --------- --------- ---------
--------- --------- --------- ---------
</TABLE>
The decrease in sales and marketing expense in the first quarter of fiscal
1997 as compared to the same period in the prior year is a result of the
reorganization of the Company's domestic marketing and sales functions, a
reduction in distributor and retailer cooperative marketing costs, and lower
variable marketing spending. The decrease in variable marketing expense is
primarily due to the introduction of fewer new titles and that prior year's
spending include the release of STAR TREK: THE NEXT GENERATION "A FINAL UNITY."
General and administrative expenses decreased in the first quarter of fiscal
1997 as compared to the same period in fiscal 1996 primarily due to reductions
in finance and administration personnel at the Company's Hunt Valley facility, a
decrease in legal and accounting fees and a reduction in recruiting costs.
Partially offsetting this decrease was an increased bad debt provision of
$750,000 due to concerns regarding the credit-worthiness of certain domestic
distributors.
The decrease in research and development expenses in the first quarter of
fiscal 1997 as compared to the same period in the prior year was due to a $1.5
million charge in fiscal 1996 related to the write-off of development advances
of discontinued products, and a $400,000 reduction in outside labor costs, which
in the prior year mostly related to the development of STAR TREK: THE NEXT
GENERATION "A FINAL UNITY."
The increase in interest and other income (expense) in the first quarter of
fiscal 1997 relates primarily to a $1.9 million gain from the sale of the
Company's investment in FASA.
LIQUIDITY AND CAPITAL RESOURCES
On October 2, 1995, the Company completed a private offering of $50 million
face value Convertible Subordinated Notes (the "Notes") pursuant to Rule 144A of
the Securities Act of 1933. The Notes, which bear interest at the rate of 6 1/2
percent per annum, will mature on September 15, 2002, and are convertible into
shares of the Company's common stock at any time after 60 days following the
latest date of original issuance through maturity, unless previously redeemed or
repurchased, at a conversion price of $15.84 per share (subject to adjustment
for certain events). The Notes may be redeemed at the option of the Company
subsequent to September 17, 1998, in whole or in part, at various declining
redemption prices from 103.7% to 100% of the face value of the Notes, together
with accrued interest thereon. The Notes may also be redeemed at the option of
the holder at 100% of the face value of the Notes upon the occurrence of certain
events. Net proceeds to the Company approximated $48.0 million, after discounts,
commissions and other issuance costs. See "Risk Factors -- Significant
Leverage."
11
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SPECTRUM HOLOBYTE, INC.
In June 1996, the Company exchanged 1,918,860 shares of Series B and Series
B-1 convertible preferred stock for Notes with a face value of $14.9 million. In
July 1996, the Company repurchased Notes with a face value of $4.0 million for
cash of approximately $2.8 million.
In the first and second quarters of fiscal 1996, the Company completed
private equity placements of 1,497,414 shares of common stock which generated
approximately $19.4 million in proceeds, after issuance costs. In June 1996, the
Company completed a private placement of 1,818,367 shares of common stock which
generated approximately $9.7 million in proceeds, after issuance costs.
The Company has historically maintained revolving credit facilities in both
the United States ("U.S. Facility") and the United Kingdom ("UK Facility").
During the third quarter of fiscal 1996, both of these facilities expired and
all outstanding borrowings were repaid in full. In the fourth quarter of fiscal
1996, the Company renegotiated the UK Facility. This renegotiated UK Facility
consists of an overdraft/line of credit facility based upon qualifying
receivables and certain other bank requirements for amounts up to a maximum
credit limit of approximately $2.7 million, and bears interest at the rate of
2.75% over the bank's base rate. This renegotiated UK Facility expires August
30, 1996. The Company is currently reevaluating its alternatives with respect to
reestablishing the U.S. Facility and extending the term of the UK Facility.
There can be no assurances, however, that the Company will be able to accomplish
these objectives in the future, or that any additional available facilities will
be on acceptable terms.
Cash increased approximately $4.2 million during the three-month period
ended June 30, 1996. The net loss generated during the quarter was funded
primarily from the equity financing and a reduction in net receivables. A
portion of the cash generated from these activities was used to repurchase
subordinated notes, acquire certain net assets of the German distributor, and
repay borrowings under lines of credit.
RISK FACTORS
THE FOLLOWING RISK FACTORS SHOULD BE CAREFULLY CONSIDERED IN EVALUATING THE
COMPANY AND ITS BUSINESS PROSPECTS.
CONTINUING LOSSES. The Company reported a net loss for the quarter ended
June 30, 1996 of $1.5 million, or $.07 per share. The Company had net losses of
approximately $39.8 million, $18.1 million and $58.5 million for fiscal 1996,
1995 and 1994, respectively. Since the Merger with MicroProse in December 1993,
the Company has not been able to achieve profitability on an annual basis. There
can be no assurance that any of the Company's business strategies and tactics
will be successful or that the Company will be able to achieve or sustain
profitability.
SIGNIFICANT LEVERAGE. As of June 30, 1996, the Company had outstanding
indebtedness for borrowed funds of approximately $35.1 million, cumulative
manditorily redeemable preferred stock of $5.9 million, and certain additional
indebtedness. This substantial leverage will have several important consequences
for the Company's future operations, including the following: (i) a substantial
portion of the Company's cash flows from operations will be dedicated to the
payment of interest on, and principal of, its indebtedness; (ii) the Company's
ability to obtain additional financing in the future for capital expenditures,
acquisitions, general corporate purposes or other purposes may be impaired; and
(iii) the Company's ability to withstand competitive pressures, adverse economic
conditions and adverse changes in governmental regulations and to make
acquisitions or otherwise take advantage of significant business opportunities
that may arise may be negatively impacted.
The Company in the future may enter into lines of credit or other borrowing
arrangements, any of which would add to the total outstanding indebtedness of
the Company. The Company's ability to meet its debt service obligations and to
reduce its total indebtedness will be dependent upon the Company's future
performance, which will be subject to financial, business and other factors
affecting the operations of the Company, many of which are beyond its control.
If the Company is unable to generate sufficient cash flow from operations in the
future to service its debt, it may be required to
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convert or refinance all or a portion of such debt, including the Notes (see
below), or to obtain additional financing. However, there can be no assurance
that any refinancing would be possible or that any additional financing could be
obtained. See "Risk Factors -- Nasdaq Listing".
NASDAQ LISTING. The Company was notified by the Nasdaq Stock Market
("Nasdaq") that the Company was no longer in compliance with the net tangible
assets requirement of the National Association of Securities Dealers' ByLaws for
listing on the Nasdaq National Market. Nasdaq granted the Company a temporary
exemption from the net tangible assets requirement. The exemption required that
the Company achieve compliance with the listing on or before July 12, 1996.
In the first quarter of fiscal 1997, management implemented tactics to
achieve compliance with the net tangible assets listing requirement. The Company
raised $9.7 million of additional equity, and exchanged approximately $14.9
million in principal amount of convertible bonds for Series B and Series B-1
convertible preferred stock. These actions, among others, enabled the Company to
regain compliance with the Nasdaq National Market listing requirements as of the
end of the fiscal quarter ended June 30, 1996. There can be no assurance that
the Company will be able to maintain compliance with the listing requirements of
the Nasdaq National Market in the future. If the Company is unable to maintain
compliance, it may qualify for listing under the Nasdaq SmallCap Market. If for
any reason the Company is unable to achieve and maintain compliance with the
SmallCap listing requirements and is delisted from both the Nasdaq National
Market and the Nasdaq SmallCap Market, the holders of the Company's 6 1/2%
Convertible Subordinated Notes Due 2002 (the "Notes") would be entitled to
require the Company to repurchase all or any portion of such holders' Notes for
cash at a price equal to the principal amount plus accrued interest. In such
event, the Company's business, results of operations and financial condition
would be materially and adversely affected.
FLUCTUATIONS IN OPERATING RESULTS; SEASONALITY. The Company's operating
results have varied significantly in the past, and are expected to vary
significantly in the future. This variability is a result of factors such as: 1)
the degree of market acceptance of the Company's products, 2) the introduction
of products competitive with those of the Company, 3) the timing and market
acceptance of new hardware and software product introductions, 4) the
commencement of volume shipments of significant new products, 5) the size and
rate of growth of the consumer software market, 6) development and promotional
expenses relating to the introduction of new products or new versions of
existing products, 7) product returns and markdowns, 8) changes in pricing
policies by the Company and its competitors, 9) the accuracy of retailers'
forecasts of consumer demand, 10) the timing of orders from major customers, 11)
order cancellations, 12) delays of shipment, and 13) write-offs of advance
royalty payments. Because a majority of the unit sales for a product typically
occurs in the first 90 to 120 days following the introduction of the product,
the Company's revenue may increase significantly in a period in which a major
product introduction occurs and may decline in following periods or in periods
in which there are no major product introductions. The Company's expenses are
based, in part, on expected future revenue. Certain overhead and product
development 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. In certain past
periods the Company's revenue or operating results were below the expectations
of, and certain new products were not introduced when anticipated by, public
market analysts and investors. These circumstances could recur in future
periods, and in such event, the prices of the Company's common stock and Notes
would likely be materially and adversely affected.
The entertainment software business 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
and increases in the third calendar quarter. This seasonal pattern is due
primarily to the increased demand for entertainment software products during the
year-end holiday buying season. The Company's net revenue, however, varies
significantly and is largely
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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 net revenue and operating results will continue to fluctuate
significantly in the future.
STRATEGIC RESTRUCTURING. In fiscal 1996 and early fiscal 1997, the Company
undertook a strategic restructuring with the goals of better integrating the
operations of Spectrum HoloByte and MicroProse, streamlining product development
efforts and reducing operating costs. Certain domestic operations were
streamlined and consolidated in California, including marketing, operations,
customer support, finance and product planning. The Company largely discontinued
its Japanese operations, and entered into an exclusive three-year distribution
agreement in Japan which is expected to generate royalties in future periods.
The Company's domestic affiliated label programs were largely terminated and the
number of products being published and actively marketed was significantly
reduced in order to focus the Company's sales and distribution efforts. As a
result of these changes, the Company has improved operating efficiencies,
reduced headcount and reduced operating costs. There can be no assurance,
however, that the Company will be successful in meeting the objectives of this
restructuring. Furthermore, as a result of reducing the number of the Company's
products, there can be no assurance that the Company's expected revenue will be
sufficient to generate operating profits.
DEPENDENCE ON NEW PRODUCT INTRODUCTIONS; PRODUCT DELAYS. A significant
portion of the Company's fiscal year revenue is generated by products introduced
during that fiscal year. The Company depends on both the timely introduction of
successful new products or sequels to existing products to replace declining
revenue from older products and continued revenue from back-catalog products. If
for any reason revenue from new products or other activities fails to replace
declining revenue from existing products, or if revenue from back-catalog titles
declines significantly, the Company's business, operating results and financial
condition may be materially and adversely affected. In order to maintain or grow
its current revenue levels, the Company believes it will be necessary to develop
or obtain rights to new products that achieve market acceptance, are developed
for the appropriate platforms, are introduced in a timely manner and are able to
sustain market acceptance. The Company is continuing to devote considerable
resources toward the development of new products and has secured rights to
intellectual properties owned by third parties. As is typical in the industry,
while the Company maintains internally developed release schedules, there can be
no assurance that new products under development will be released on schedule or
at all, or that any such products will generate significant revenue.
Historically, the Company has frequently missed product release schedules. To
the extent that major new products are not released on schedule, both net
revenue and gross profit are likely to be adversely affected. In addition, as
access to distribution channels and retail shelf space becomes increasingly
competitive, the Company's ability to produce and bring to market new and
compelling products in a timely fashion plays an increasingly important role in
the Company's ability to retain adequate access to these channels.
The Company's current production schedules contemplate that the Company will
commence shipments of a number of new products in fiscal 1997. As with any
software product, however, until all aspects of the development and initial
distribution of a game are completed, there can be no assurance of its release
date. Release dates will vary depending on quality assurance testing and other
development factors. If the Company were unable to commence volume shipments of
a significant new product during the scheduled quarter, the Company's revenue
and earnings would likely be materially and adversely affected in that quarter.
In the past, the Company has experienced significant delays in the introduction
of certain new products. It is likely in the future that 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 products and on the Company's business, operating results and financial
condition, particularly in the quarter in which such products were scheduled to
be introduced.
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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 products with more sophisticated and
elaborate multimedia features and as new platforms and technologies are
supported. At the same time, the introduction of new technologies and
competitive products, the increase in competition for retail shelf space among
software products and other factors may cause the effective lives of the
Company's products to become shorter and the Company's ability to introduce new
products on a timely basis to become increasingly important. As the Company
intends to focus its resources on a smaller number of titles, its exposure to
the risks of delays of any one title will increase.
UNCERTAINTY OF MARKET ACCEPTANCE; UNPREDICTABLE PRODUCT LIFE
CYCLES. Consumer preferences for entertainment software products are
continually and rapidly changing and are extremely difficult to predict. Few
entertainment software products achieve sustained market acceptance, for
example, beyond one holiday buying season. There can be no assurance that new
products introduced by the Company will achieve any significant degree of market
acceptance, or that acceptance, if achieved, will be sustained for any
significant period. Further, there can be no assurance that such products will
not be subject to changes in consumer preferences or that product life cycles
will be sufficient to permit the Company to recover development and other
associated costs. In addition, sales of any single title of the Company's
entertainment software products will decline over time. A majority of the unit
sales for a product typically occurs in the first 90 to 120 days after the
product is introduced. Therefore, the Company cannot rely on the sales of
current products to sustain its business in the future. Failure of new products
or platforms to achieve or sustain market acceptance would have a material and
adverse effect on the Company's business, operating results and financial
condition. In addition, the Company does not carry significant inventory of its
new products. As a result, significant production delays would have a material
and adverse effect on the Company's business and operating results. Further, if
demand for a particular product is greater than anticipated, the Company may not
have sufficient inventory to meet customer demands.
LITIGATION. On July 9, 1996, a lawsuit entitled Acclaim Entertainment, Inc.
v. Spectrum HoloByte California, Inc., No. 96-2462 WHO, was filed in the United
Stated District Court for the Northern District of California, but not served
upon the Company or its subsidiary, Microprose Software, which is also named as
a defendant. The Complaint alleges various causes of action related to an
exclusive license Acclaim Entertainment, Inc. ("Acclaim") allegedly holds from
Wizards of the Coast, Inc. ("WOTC"), to develop certain computer game products.
Acclaim alleges that its license is being infringed by a computer game being
developed by the Company. The Company also holds an exclusive license from WOTC,
and believes that all of its computer game development, which has been disclosed
to the licensor, has been within the scope of its license. The Company is
hopeful that this matter will be resolved without the serving of the Complaint;
however, should the Complaint be served, the Company intends to deny all
liability, and to vigorously defend against the lawsuit. However, in the event
the Company should not prevail in the lawsuit filed by Acclaim, the Company may
not be able to ship or sell certain of its products and may be required to pay
damages to Acclaim, both of which would have a material adverse effect on the
business, operating results and financial condition of the Company.
COMPETITION. The entertainment software industry is intensely competitive
and in the process of consolidation. 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 competes primarily with other developers of PC
entertainment and video game entertainment software. Significant competitors of
the Company in the entertainment software industry include Electronic Arts,
Sierra On-Line, Lucas Arts, Interplay, GT Interactive, Maxis, Acclaim
Entertainment, and Broderbund Software, along with Virgin Interactive in Europe.
Additionally, the entry and participation of new industries and companies,
including diversified entertainment companies, in markets in which the Company
competes may adversely
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SPECTRUM HOLOBYTE, INC.
affect the Company's performance in such markets. The availability of
significant financial resources has become a major competitive factor in the
entertainment software industry, principally as a result of the technical
sophistication of advanced multimedia computer game products requiring
substantial investments in research and development and the increasing need to
license products and rights to use other intellectual properties from third
parties. Also, competitors with large product lines and popular titles typically
have greater leverage with retailers and distributors and other customers who
may be willing to promote titles with less consumer appeal in return for access
to such competitors' most popular titles.
The Company believes that large diversified entertainment, cable and
telecommunications companies, in addition to large software companies such as
Microsoft, are increasing their focus on the interactive entertainment market,
which will result in greater competition for the Company. 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 and adverse effect on the Company's business, financial condition and
operating results. There can be no assurance that the Company will be able to
compete successfully against current or future competitors or that competitive
pressures faced by the Company will not materially and adversely affect its
business, operating results and financial condition.
Retailers of the Company's products typically have a limited amount of shelf
space and promotional resources, and there is intense competition among consumer
software producers for adequate levels of shelf space and promotional support
from retailers. To the extent that the number of consumer software products and
computer platforms increases, this competition for shelf space may intensify.
Due to increased competition for limited shelf space, retailers and distributors
are increasingly in a better position to negotiate favorable terms of sale,
including price discounts and product return policies. Retailers often require
software publishers to pay fees in exchange for preferred shelf space. The
Company's products constitute a relatively small percentage of a retailer's
sales volume, and there can be no assurance that retailers will continue to
purchase the Company's products or provide the Company's products with adequate
levels of shelf space and promotional support.
As more consumers own multimedia PCs, the distribution channels for
entertainment software have changed, and are expected to continue to change, to
increasingly depend on mass merchandisers to reach the broader market. There can
be no assurance that the Company will make this transition successfully. In
addition, while this trend has increased the number of distribution channels, it
has intensified competition for shelf space because these new channels generally
carry only top-selling titles. In addition, other types of retail outlets and
methods of product distribution, such as online services and the Internet, may
become important in the future, and it will be important for the Company to gain
access to these channels of distribution. There can be no assurance that the
Company will gain such access or that the Company's access will allow the
Company to maintain its historical levels of sales volume.
CONCENTRATION OF CUSTOMER BASE; RISK OF CUSTOMER BUSINESS FAILURE; PRODUCT
RETURNS. The Company principally sells its products to retailers and
distributors, who in turn resell the products to consumers. During the quarter
ended June 30, 1996, sales to the top ten such customers represented
approximately 52% of the Company's net revenue. Sales are typically made on
credit, with terms that vary depending upon the customer and the nature of the
product. The Company does not hold collateral to secure payment. Retailers and
distributors compete in a volatile industry and are subject to the risk of
business failure. Certain of the Company's distributors have recently
experienced financial difficulties and the Company has increased its reserves
accordingly. However, the business failure of a significant distributor or
customer could have a material and adverse effect on the Company's business,
operating results and financial condition.
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The Company is exposed to the risk of product returns from distributors and
retailers. The Company currently maintains a stock balancing policy that allows
distributors and retailers to return products subject to certain conditions. The
Company provides reserves for returns that it believes are adequate, and the
Company's agreements with various customers place certain limits on product
returns. However, new product introductions by the Company or its competitors,
or changes in consumer demand from that anticipated, could cause customers to
seek to return inventory to the Company. Due to the unpredictability of consumer
demand and the uncertainties associated with a rapidly changing market, there
can be no assurance that the Company or its customers will be able to forecast
demand accurately. Consistent with industry trends, the Company has accepted
substantial increased product returns and markdowns on products in the last
fiscal year and the Company could continue to be forced to accept such returns
and markdowns in the distribution channel to maintain its relationships with
retailers and its access to distribution channels. These returns and markdowns
are likely to increase in periods in which the Company does not have a
significant number of new product introductions. Any significant amount of
product returns or markdowns could have a material and adverse effect on the
Company's business, operating results and financial condition.
DEPENDENCE UPON STRATEGIC RELATIONSHIPS. The Company's business strategy
relies to a significant extent on its strategic relationships with other
companies and on its alliances with key developers. There can be no assurance
that these relationships will be successful or that the Company will continue to
maintain and develop strategic relationships, or that licenses between the
Company and any third party will be renewed or extended at their expiration
dates. For example, the Company's licenses from Paramount Pictures Corporation
for the STAR TREK: THE NEXT GENERATION property expire on December 31, 1998, and
for the TOP GUN property on April 30, 1998. In addition, these agreements may be
terminated at Paramount's option in the event that the Company fails to meet
certain specified milestone dates. The Company's failure to renew or extend a
key license or maintain its strategic relationships could materially and
adversely affect the Company's business, operating results and financial
condition. In addition, under certain key license agreements, the Company must
obtain approval on a timely basis from the licensor in order to market products
it develops under the license. There can be no assurance that the Company will
obtain such approval, and failure to do so could have a material and adverse
effect on the Company's operating results, financial condition and business
prospects.
CHANGES IN TECHNOLOGY AND PRODUCT PLATFORMS. The market for entertainment
software, including entertainment software platforms, is undergoing rapid
technological change. As a result, the Company must continually anticipate and
adapt its products to emerging platforms and evolving consumer preferences. The
introduction of new platforms and technologies can render existing products
obsolete and unmarketable. Development of entertainment software products for
new hardware platforms requires substantial investments in research and
development for technologies such as enhanced sound, digitized speech, music and
video and requires the Company to anticipate and develop products for those
platforms that will ultimately be successful. Such research and development
efforts, which generally require 12 to 24 months, must occur well in advance of
the release of new platforms in order to introduce products on a timely basis
following the release of such platforms. In addition, the Company expects that
the trend toward more complex multimedia products and increasing product
development costs will continue for the foreseeable future.
Although the Company intends to develop and market games for certain
advanced and emerging platforms, these development and marketing efforts may
require greater financial and technical resources than those currently possessed
by the Company. In addition, there can be no assurance that the platforms for
which the Company develops products will achieve market acceptance and, as a
result, there can be no assurance that the Company's development efforts with
respect to such new platforms will lead to marketable products or products that
generate sufficient revenue to offset research and development costs incurred in
connection with their development. There can be no
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SPECTRUM HOLOBYTE, INC.
assurance that the Company will be successful in developing and marketing
products for new platforms. Failure to develop products for new platforms that
achieve significant market acceptance may have a material and adverse effect on
the Company's business, operating results and financial condition. The Company
is developing games that may be played interactively over on-line services and
the Internet, but there can be no assurance that the market for networked
videogame play will evolve or develop as anticipated. Consumer preferences
change continually and are extremely difficult to predict. Even if a market for
networked videogame play develops, no assurance can be given that the Company's
products will meet the requirements of such market and achieve market
acceptance.
The Company is heavily dependent on the success of the entertainment
softwares developed for use on the PC. However, there are multiple, competing
and incompatible formats being introduced in this new market. PlayStation, Sega
Saturn, 3DO Multiplayer and Nintendo's Ultra 64 are currently available. There
can be no assurance that the Company's strategy of developing primarily for the
PC or the other platforms the Company chooses to support ultimately will be
successful. The development, marketing and distribution of products for game
consoles the Company chooses to support will involve substantial investment and
risks. The Company believes that the principal target audience for game consoles
may be younger than the Company's traditional customers, and there can be no
assurance that the Company's products will be successful with this different
audience. In addition, the Company anticipates that products in the game console
market will require substantially greater expenditures for marketing,
advertising and inventory buildup, often before the market acceptance of a
product is known. Inventory will be two or more times more expensive as a result
of license fees that are required to be prepaid to the manufacturers of the
hardware platforms. Further, game console products will be sold through channels
that overlap with, but are somewhat different from, the retail channels
currently utilized by the Company, and the Company will be competing in
distribution against much larger organizations with greater financial resources.
There can be no assurance that the Company will be successful in marketing and
distributing software for game consoles.
RISK OF SOFTWARE ERRORS OR FAILURES. Software products as complex as those
offered by the Company may contain undetected errors when first introduced or
when new versions are released. In the past, the Company has discovered software
errors in certain of its product offerings after their introduction and has
experienced delays or lost revenue during the period required to correct these
errors. The Company's products must maintain compatibility with certain
hardware, software and accessories. Any changes that result in incompatibility
could result in significant product returns and customer service costs. In
particular, the PC hardware environment is characterized by a wide variety of
nonstandard peripherals (such as sound and graphics cards) and configurations
that make prerelease testing for programming or compatibility errors very
difficult and time consuming. There can be no assurance that, despite testing by
the Company, errors will not be found in new products or releases after
commencement of commercial shipments, resulting in loss of or delay in market
acceptance, which could have a material and adverse effect on the Company's
business, operating results and financial condition. The risk of undetected
product errors can be expected to increase as products and their development
processes become more complex and as growing competition leads to increased
pressure to reduce time to market.
DEPENDENCE ON KEY PERSONNEL; MANAGEMENT CHANGES. The Company's future
success depends in large part on the continued service of its key product
development, technical and management personnel and on its ability to continue
to attract, motivate and retain highly qualified employees, including additional
management personnel. The loss of certain key employees could have a material
and adverse effect on the Company's business. In addition, the Company depends
on teams of programmers, game designers and artists. Competition for these
skilled employees is intense, and the loss of the services of key development
personnel could have a material and adverse effect upon the Company's current
business, new product development efforts and prospects. Sid Meier, the
Company's former Executive Vice President of Product Development, resigned in
May 1996. He will continue as a consultant until the completion of MAGIC: THE
GATHERING. Since January 1, 1996, the
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Company has hired a Senior Vice President of Sales, Senior Vice President of
Operations, and Senior Vice President of Marketing, and intends to hire other
senior management positions including a new Senior Vice President of Development
Studios and a new Chief Financial Officer. The Company has also hired a
financial consultant to advise the Chief Executive Officer on financial
planning, controls and reporting structures. The Chief Executive Officer and
other officers and senior managers of the Company can be expected to expend
significant time and effort in the transition process as new officers assume
their positions with the Company and become integrated into the Company, its
operations and its culture. There can be no assurance that qualified personnel
can be readily identified and hired wherever necessary, that any new personnel
will be successfully integrated into the Company, its operations and culture, or
that new personnel, if hired, will improve the Company's business, operations or
operating results. The Company does not currently have key person life insurance
on any employees.
USE OF INDEPENDENT SOFTWARE DEVELOPERS. In addition to marketing internally
developed software, the Company also markets entertainment software created by
independent software developers. The cost to retain independent developers is
increasing in the form of guaranteed advances and royalties. Additionally, the
Company has less control over the scheduling and the quality of work of
independent contractors than that of its own employees. Furthermore, the
Company's agreements to publish and market certain independent software
developers' titles will terminate after specified dates unless renewed. The
Company's business and future operating results will depend in part on the
Company's continued ability to attract and maintain relationships with skilled
independent software developers, and to enter into and renew product development
agreements with such developers. There can be no assurance that the Company will
be able to maintain such relationships or enter into and renew such agreements.
INTERNATIONAL REVENUE. International net revenue represented approximately
45%, 49%, and 29% of the Company's net revenue for the first quarter of fiscal
1997, and for fiscal years ended March 31, 1996 and 1995, respectively. The
Company expects that international net revenue will continue to account for a
significant portion of its net revenue in future periods. International revenue
is 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 does not
believe exposure to foreign currency losses is 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 substantial
costs and experience delays in localizing its products, and there can be no
assurance that any localized product will ever generate significant revenue.
These or other factors could have a material and adverse effect on the Company's
future international revenues and, consequently, on the Company's business,
operating results and financial condition.
RECOVERY OF PREPAID ROYALTIES AND GUARANTEES. The Company, from time to
time, enters into agreements with licensors of intellectual property and
developers of games that involve advance payments of royalties and guaranteed
minimum royalty payments. If the sales volumes of products subject to such
arrangements are not sufficient to recover such advances and guarantees, the
Company will be required to write-off unrecovered portions of such payments. The
Company has been required to write-off a material portion of these advances in
past fiscal quarters and, if the Company must write-off additional portions of
such advances or ultimately accrue for the guarantees, its results of operations
may be materially and adversely affected.
INTELLECTUAL PROPERTY. The Company regards the software that it owns or
licenses as proprietary and 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
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agreements. There can be no assurance that these measures will be sufficient to
protect the Company's intellectual property rights against infringement. The
Company owns or licenses various trademarks and copyrights. However, the Company
has no license agreements with the end users of its products and does not copy
protect its software. Rather, the Company relies on the copyright laws to
prevent unauthorized distribution of its software. Existing copyright laws
afford only limited protection. It may be possible for unauthorized parties to
copy the Company's products or to reverse engineer or otherwise obtain and use
information that the Company regards as proprietary. Policing unauthorized 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 parties. As the number of
entertainment software products in the industry increases, the Company believes
that software increasingly will become the subject of claims that such software
infringes upon the rights of others. From time to time, the Company has received
communications from parties asserting that features or content of certain of its
products may infringe upon intellectual property rights of such parties. The
Company believes such claims have been without merit. 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 against the Company will not result in costly litigation or require the
Company to license the intellectual property rights of parties. There can be no
assurance that such licenses will be available on reasonable terms or at all.
VOLATILITY OF PRICE OF STOCK AND NOTES. There has been a history of
significant volatility in the market prices of companies engaged in the
entertainment software industry, including the Company. It is likely that the
market price of the Company's common stock will continue to be highly volatile
and the price of the Company's Notes will also be subject to such fluctuations.
Factors such as the timing and market acceptance of new product introductions by
the Company, the introduction of new 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 entertainment software industry may have a
significant impact on the market price of the Company's common stock and Notes.
In the past, the Company has experienced fluctuations in its operating results,
and it is likely that in some future quarter the Company's revenue or operating
results will be below the expectations of, and certain new products will not be
introduced when anticipated by, public market analysts and investors. In such
event, the price of the Company's common stock would likely be materially
adversely affected. Volatility in the price of the Company's common stock,
changes in prevailing interest rates and changes in perceptions of the Company's
creditworthiness may in the future adversely affect the price of the Notes.
20
<PAGE>
SPECTRUM HOLOBYTE, INC.
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On July 9, 1996, a lawsuit entitled Acclaim Entertainment, Inc. v. Spectrum
HoloByte California, Inc., No. 96-2462 WHO, was filed in the United States
District Court for the Northern District of California, but not served upon the
Company or its subsidiary, Microprose Software, which is also named as a
defendant. The Complaint alleges various causes of action related to an
exclusive license Acclaim allegedly holds from WOTC, to develop certain computer
game products. Acclaim alleges that its license is being infringed by a computer
game being develped by the Company. The Company also holds an exclusive license
from WOTC, and believes that all of its computer game development, which has
been disclosed to the licensor, has been within the scope of its license. The
Company is hopeful that this matter will be resolved without the serving of the
Complaint; however, should the Complaint be served, the Company intends to deny
all liability, and to vigorously defend against the lawsuit. However, in the
event the Company should not prevail in the lawsuit filed by Acclaim, the
Company may not be able to ship or sell certain of its products and may be
required to pay damages to Acclaim, both of which would have a material adverse
effect on the business, operating results, and financial condition of the
Company.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) THE FOLLOWING EXHIBITS ARE FILED HEREWITH:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- --------- -----------------------------------------------------------------------------------------------
<C> <S>
3.1+ Certificate of Incorporation of the Registrant
3.2+ Bylaws of Registrant
4.1+ Specimen Common Stock Certificate of the Registrant
4.2+ Warrants issuable to the Grotech Investors and Corporate Venture Partners, L.P., dated as of
October 17, 1991
4.3+ Form of Warrant issuable to Paragon Investors, dated July 1992
4.4+ Form of Warrant, issued to Ince & Co. (incorporated by reference to Exhibit 2.3 of Spectrum
HoloByte, Inc.'s Quarterly Report on Form 10-Q, File No. 0-19463, filed on December 31, 1994)
4.5+ Registration Rights Agreement, dated June 12, 1995 by and among Spectrum HoloByte, Inc. and
Stephen Barcia and Maria Barcia (incorporated by reference to Exhibit 2.3 of Spectrum
HoloByte, Inc.'s Current Report on Form 8-K, File No. 0-19463, filed on June 27, 1995)
4.6+ Registration Rights Agreement, dated as of May 16, 1995, by and among Spectrum HoloByte, Inc.
and IPWEL LTD (incorporated by reference to Exhibit 4.7 of Spectrum HoloByte, Inc.'s
Registration on Form S-3, File No. 33-94580, filed October 24, 1995)
4.7+ Registration Rights Agreement, dated as of May 16, 1995, by and among Spectrum HoloByte, Inc.
and GFL Advantage Fund Limited (incorporated by reference to Exhibit 4.8 of Spectrum HoloByte,
Inc.'s Registration on Form S-3, File No. 33-94580, filed October 24, 1995)
4.8+ Registration Rights Agreement, dated as of August 28, 1995, by and among Spectrum HoloByte,
Inc. and GFL Advantage Fund Limited (incorporated by reference to Exhibit 4.9 of Spectrum
HoloByte, Inc.'s Registration on Form S-3, File No. 33-94580, filed October 24, 1995)
</TABLE>
21
<PAGE>
SPECTRUM HOLOBYTE, INC.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- --------- -----------------------------------------------------------------------------------------------
<C> <S>
4.9+ Registration Rights Agreement, dated as of June 27, 1995, by and among Spectrum HoloByte, Inc.
and Banque Scandinave en Suisse (incorporated by reference to Exhibit 4.10 of Spectrum
HoloByte, Inc.'s Registration on Form S-3, File No. 33-94580, filed October 24, 1995)
4.10+ Registration Rights Agreement, dated as of August 25, 1995, by and among Spectrum HoloByte,
Inc. and PJP International, Ltd. (incorporated by reference to Exhibit 4.11 of Spectrum
HoloByte, Inc.'s Registration on Form S-3, File No. 33-94580, filed October 24, 1995)
4.11+ Registration Rights Agreement, dated as of May 16, 1995, by and among Spectrum HoloByte, Inc.
and Tanner, Owen & Co. Incorporated (incorporated by reference to Exhibit 4.12 of Spectrum
HoloByte, Inc.'s Registration on Form S-3, File No. 33-94580, filed October 24, 1995)
4.12+ Registration Rights Agreement, dated as of September 6, 1995, by and among Spectrum HoloByte,
Inc. and Tanner, Owen & Co. Incorporated (incorporated by reference to Exhibit 4.13 of
Spectrum HoloByte, Inc.'s Registration on Form S-3, File No. 33-94580, filed October 24, 1995)
4.13+ Indenture, dated as of September 15, 1995, between Spectrum HoloByte, Inc. and Chemical Trust
Company of California (incorporated by reference to Exhibit 3 of Spectrum HoloByte, Inc.'s
Current Report on Form 8-K, File No. 0-19463, filed October 17, 1995)
4.14+ Registration Rights Agreement, dated as of September 26, 1995, by and among Spectrum HoloByte,
Inc. and Robertson, Stephens & Company, L.P., Jeffries & Company, Inc. and Piper Jaffray Inc.
(incorporated by reference to Exhibit 4 of Spectrum HoloByte, Inc.'s Current Report on Form
8-K, File No. 0-19463, filed October 17, 1995)
4.15 Certificate of Designation for Series B Convertible Preferred Stock
4.16 Certificate of Designation for Series B-1 Convertible Preferred Stock
10.1+ Form of Purchase Agreement, by and between Spectrum HoloByte, Inc. and certain investors,
effective June 26, 1996 (incorporated by reference to Exhibit 4.3 of Spectrum HoloByte, Inc.'s
Registration on Form S-3, File No. 333-08385, filed July 18, 1996)
11.1 Statement Re: Computation of Loss Per Share
27.1 Statement Re: Financial Data Schedule
</TABLE>
- ------------------------
+ Previously filed.
(B) REPORTS ON FORM 8-K:
None.
22
<PAGE>
SPECTRUM HOLOBYTE, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, on August 14, 1996.
SPECTRUM HOLOBYTE, INC.
BY: /S/ STEPHEN M. RACE
-----------------------------------
Stephen M. Race
CHIEF EXECUTIVE OFFICER, ACTING
CHIEF
FINANCIAL OFFICER AND DIRECTOR
23
<PAGE>
SPECTRUM HOLOBYTE, INC.
CERTIFICATE OF DESIGNATION OF RIGHTS, PREFERENCES
AND PRIVILEGES OF SERIES B PREFERRED STOCK
The undersigned, Stephen Race, does hereby certify:
1. That he is the duly elected and acting President and Chief
Executive Officer of Spectrum HoloByte, Inc., a Delaware corporation (the
"Corporation").
2. That pursuant to the authority conferred upon the Board of
Directors by the Certificate of Incorporation of the said Corporation, said
Board of Directors on May 8, 1996 adopted the following resolution creating a
series of 750,000 shares of Preferred Stock designated as Series B Preferred
Stock:
"RESOLVED, that pursuant to the authority vested in the Board of
Directors of the corporation by the Certificate of Incorporation, the Board
of Directors does hereby provide for the issue of a series of Preferred
Stock, $0.001 par value, of the Corporation, to be designated "Series B
Preferred Stock," initially consisting of 750,000 shares and to the extent
that the designations, powers, preferences and relative and other special
rights and the qualifications, limitations and restrictions of the Series B
Preferred Stock are not stated and expressed in the Certificate of
Incorporation, does hereby fix and herein state and express such
designations, powers, preferences and relative and other special rights and
the qualifications, limitations and restrictions thereof, as follows (all
terms used herein which are defined in the Certificate of Incorporation shall
be deemed to have the meanings provided therein):
Section 1. Designation and Amount. The shares of such series shall be
---------------------
designated as "Series B Preferred Stock," $0.001 par value, and the number of
shares constituting such series shall be 750,000.
Section 2. Dividends.
---------
(a) After all dividends payable with respect to the Series A
Preferred Stock have been declared and paid in full, the holders of the
Series B Preferred Stock shall be entitled to receive dividends, prior and in
preference to any dividend on Common Stock, at the rate per share of Series B
Preferred Stock, per annum (as adjusted for any stock dividends, combinations
or splits with respect to such shares) as determined by the Board of
Directors from time to time whenever funds are legally available and when and
if declared by the Board of Directors. The dividends shall be non-cumulative
and non-accruing and shall in all respects be subordinated to the rights of
the holders of Series A Preferred.
Section 3. Liquidation Preference.
----------------------
(a) The liquidation preference of the Series B Preferred Stock
specified herein shall in all respects be subordinated to the liquidation
preference of the Series A Preferred Stock.
<PAGE>
Subject to the foregoing, in the event of any liquidation, dissolution or
winding up of the Corporation, either voluntary or involuntary, the holders
of the Series B Preferred Stock shall be entitled to receive, prior and in
preference to any distribution of any of the assets or surplus funds of the
Corporation to the holders of Common Stock by reason of their ownership
thereof, the amount of $8.00 per share then held by them (as adjusted for any
stock dividends, combinations or splits with respect to such shares) plus all
declared but unpaid dividends on each such share. If, upon the occurrence of
such event, the assets and funds thus distributed among the holders of the
Series B Preferred Stock shall be insufficient to permit the payment to such
holders and the holders of any other class or series of preferred stock
ranking on a parity with or senior to the Series B Preferred Stock of the
full preferential amounts due to such holders, then the entire assets and
funds of the Corporation legally available for distribution shall be
distributed ratably among the holders of the Series B Preferred Stock and the
holders of any other such class or series of preferred stock in proportion
to, and respecting the stated priority among such series with respect to the
preferential amount each such holder is otherwise entitled to receive.
(b) After payment has been made to the holders of the Series A
Preferred Stock as provided in the Corporation's Certificate of Incorporation
and, if applicable, to the Series B Preferred as provided herein, and the
holders of any other class or series of preferred stock of the full amounts
to which they shall be entitled as provided in Section 3(a), the entire
remaining assets and funds of the Corporation legally available for
distribution, if any, shall be distributed among the holders of Common Stock
in proportion to the shares of Common Stock then held by each.
(c) A consolidation or merger of the Corporation with or into any
other corporation or corporations, or a sale of all or substantially all of
the assets of the Corporation, shall be treated as provided for in the
Certificate of Incorporation.
Section 4. Voting Rights. The holder of each share of Series B
-------------
Preferred Stock shall be entitled to the number of votes equal to the number
of shares of Common Stock into which such share of Series B Preferred Stock
could be converted and shall have voting rights and powers equal to the
voting rights and powers of the Common Stock (except as otherwise expressly
required by law), voting together as a single class. Fractional votes shall
not, however, be permitted and any fractional voting rights resulting from
the above formula (after aggregating all shares into which shares of Series B
Preferred Stock held by each holder could be converted) shall be rounded to
the nearest whole number (with one-half being rounded upward).
Section 5. Conversion Rights. The holders of the Series B Preferred
-----------------
Stock shall have conversion rights as follows:
(a) Right to Convert: Each share of the Series B Preferred Stock
----------------
shall be convertible, at the option of the holder thereof, at any time after
the date of issuance of such share, at the office of the Corporation or any
transfer agent for such shares, into one fully paid and nonassessable share
of Common Stock (the "Series B Conversion Rate"), subject to adjustment as
hereinafter provided.
-2-
<PAGE>
(b) Automatic Conversion. Each share of Series B Preferred Stock
--------------------
shall automatically be converted into shares of Common Stock at the
then-effective Series B Conversion Rate upon the affirmative vote or written
consent of holders of not less than a majority of the shares of Series B
Preferred Stock outstanding at such time.
(c) Mechanics of Conversion. Unless waived or modified by the
------------------------
Corporation, before any holder of Series B Preferred Stock shall be entitled
to convert the same into shares of Common Stock, such holder shall surrender
the certificate or certificates therefor, duly endorsed, at the office of the
Corporation or of any transfer agent for such stock, and shall give written
notice to the Corporation at such office that such holder elects to convert
the same and shall state therein the name or names in which such holder
wishes the certificate or certificates for shares of Common Stock to be
issued. The Corporation shall, as soon as practicable thereafter, issue and
deliver at such office to such holder of Series B Preferred Stock, a
certificate or certificates for the number of shares of Common Stock to which
such holder shall be entitled as aforesaid. Such conversion shall be deemed
to have been made immediately prior to the close of business on the date of
surrender of the shares of Series B Preferred Stock to be converted, and the
person or persons entitled to receive the shares of Common Stock issuable
upon such conversion shall be treated for all purposes as the record holder
or holders of such shares of Common Stock on such date.
(d) Adjustments to Conversion Prices for Combinations or
-----------------------------------------------------
Subdivisions of Common Stock. In the event that this Corporation at any time
- ----------------------------
or from time to time after the date of filing of this Designation shall
declare or pay any dividend on the Common Stock payable in Common Stock or in
any right to acquire Common Stock, or shall effect a subdivision of the
outstanding shares of Common Stock into a greater number of shares of Common
Stock (by stock split, reclassification or otherwise than by payment of a
dividend in Common Stock or in any right to acquire Common Stock), or in the
event the outstanding shares of Common Stock shall be combined or
consolidated, by reclassification or otherwise, into a lesser number of
shares of Common Stock, then the Series B Conversion Rate in effect
immediately prior to such event shall, concurrently with the effectiveness of
such event, be proportionately and equitably decreased or increased, as
appropriate.
(e) Fractional Shares. No fractional shares shall be issued upon
-----------------
the conversion of any share or shares of Series B Preferred Stock. All
shares of Common Stock (including fractions thereof) issuable upon conversion
of more than one share of Series B Preferred Stock by a holder thereof shall
be aggregated for purposes of determining whether the conversion would result
in the issuance of any fractional share. If, after the aforementioned
aggregation, the conversion would result in the issuance of a fraction of a
share of Common Stock, the Corporation shall, in lieu of issuing any
fractional share, pay the holder otherwise entitled to such fraction a sum in
cash equal to the fair market value of such fraction on the date of
conversion (as determined in good faith by the Board of Directors of the
Corporation).
(f) Adjustments. Subject to the provisions of Section 6 below, in
-----------
case of any reorganization or any reclassification of the capital stock of
the Corporation, any consolidation or merger of the Corporation with or into
another corporation or corporations, or the conveyance of all or
substantially all of the assets of the Corporation to another corporation,
each share of Series B
-3-
<PAGE>
Preferred Stock shall thereafter be convertible into the number of shares of
stock or other securities or property (including cash) to which a holder of
the number of shares of Common Stock deliverable upon conversion of such
share of Series B Preferred Stock would have been entitled upon the record
date of (or date of, if no record date is fixed) such reorganization,
reclassification, consolidation, merger or conveyance, and, in any case,
appropriate adjustment (as determined by the Board of Directors) shall be
made in the application of the provisions herein set forth with respect to
the rights and interests thereafter of the holders of the Series B Preferred
Stock, to the end that the provisions set forth herein shall thereafter be
applicable, as nearly as equivalent as is practicable, in relation to any
shares of stock or the securities or property (including cash) thereafter
deliverable upon the conversion of the shares of such Series B Preferred
Stock.
Section 6. Merger, Consolidation. At any time, in the event of a
----------------------
"Merger" (as defined in Section 7, Article IV of the Certificate of
Incorporation, then the holders of the Series B Preferred Stock, the holders
of any other class or series of preferred stock hereafter created and issued
and the holders of Common Stock shall be paid in cash or in securities
received from the acquiring corporation or in a combination thereof, at the
closing of any such transaction, amounts per share equal to the amounts per
share which would be payable to such holders pursuant to Section 3 if all
consideration received by the Corporation and its stockholders in connection
with such event were being available distributed in a liquidation of the
Corporation; provided however, that if upon the occurrence of such event, the
----------------
assets and funds thus available for distribution among the holders of the
Series B Preferred Stock and the holders of any other class or series of
preferred stock ranking on a parity with or senior to the Series B Preferred
Stock shall be insufficient to permit the payment to such holders of the full
preferential amounts due to them pursuant to Section 3 above, then, if any
assets remain available for distribution after full distribution to the
Series A Preferred Stock pursuant to the Certificate of Incorporation, the
entire assets and funds of the Corporation legally available for distribution
shall be distributed ratably among the holders of the Series B Preferred
Stock and the holders of any other such class or series of preferred stock in
proportion to the preferential amount each such holder is otherwise entitled
to receive.
Section 7. No Reissuance of Preferred Stock. No share or shares of
---------------------------------
Series B Preferred Stock acquired by the Corporation by reason of redemption,
purchase, conversion or otherwise shall be reissued, and all such shares
shall be canceled, retired and eliminated from the shares which the
Corporation shall be authorized to issue.
RESOLVED FURTHER, that an authorized officer of this corporation be, and
he hereby is, authorized and directed to prepare and file a Certificate of
Designation of Rights, Preferences and Privileges in accordance with the
foregoing resolution and the provisions of Delaware law and to take such
actions as he may deem necessary or appropriate to carry out the intent of
the foregoing resolution."
3. That the authorized number of shares of Series B Preferred Stock of
the Corporation is 2,000,000 and that no such Series B Preferred Stock has
been issued.
-4-
<PAGE>
I further declare under penalty of perjury that the matters set forth in
the foregoing Certificate of Designation are true and correct of my own
knowledge.
Executed at Alameda, California on June 21, 1996.
/s/ Stephen Race
----------------------------------------------------
Stephen Race, President and Chief Executive Officer
-5-
<PAGE>
SPECTRUM HOLOBYTE, INC.
CERTIFICATE OF DESIGNATION OF RIGHTS, PREFERENCES
AND PRIVILEGES OF SERIES B-1 PREFERRED STOCK
The undersigned, Stephen M. Race, does hereby certify:
1. That he is the duly elected and acting President and Chief
Executive Officer of Spectrum HoloByte, Inc., a Delaware corporation (the
"Corporation").
2. That pursuant to the authority conferred upon the Board of
Directors by the Certificate of Incorporation of the said Corporation, said
Board of Directors on May 8, 1996 adopted the following resolution creating a
series of 1,168,860 shares of Preferred Stock designated as Series B-1
Preferred Stock:
"RESOLVED, that pursuant to the authority vested in the Board of
Directors of the corporation by the Certificate of Incorporation, the Board
of Directors does hereby provide for the issue of a series of Preferred
Stock, $0.001 par value, of the Corporation, to be designated "Series B-1
Preferred Stock," initially consisting of 1,168,860 shares and to the extent
that the designations, powers, preferences and relative and other special
rights and the qualifications, limitations and restrictions of the Series B-1
Preferred Stock are not stated and expressed in the Certificate of
Incorporation, does hereby fix and herein state and express such
designations, powers, preferences and relative and other special rights and
the qualifications, limitations and restrictions thereof, as follows (all
terms used herein which are defined in the Certificate of Incorporation shall
be deemed to have the meanings provided therein):
Section 1. Designation and Amount. The shares of such series shall
----------------------
be designated as "Series B-1 Preferred Stock," $0.001 par value, and the
number of shares constituting such series shall be 1,168,860
Section 2. Dividends.
---------
(a) After all dividends payable with respect to the Series A
Preferred Stock have been declared and paid in full, the holders of the
Series B Preferred Stock and the Series B-1 Preferred Stock shall be entitled
to receive, pari passu, dividends, prior and in preference to any dividend on
---- -----
Common Stock, at the rate per share of Series B-1 Preferred Stock, per annum
(as adjusted for any stock dividends, combinations or splits with respect to
such shares) as determined by the Board of Directors from time to time
whenever funds are legally available and when and if declared by the Board of
Directors. The dividends shall be non-cumulative and non-accruing and shall
in all respects be subordinated to the rights of the holders of Series A
Preferred.
Section 3. Liquidation Preference.
----------------------
(a) The liquidation preference of the Series B-1 Preferred Stock
specified herein shall in all respects be subordinated to the liquidation
preference of the Series A Preferred Stock and
<PAGE>
shall be pari passu with the Series B Preferred Stock. Subject to the
---- -----
foregoing, in the event of any liquidation, dissolution or winding up of the
Corporation, either voluntary or involuntary, the holders of the Series B-1
Preferred Stock shall be entitled to receive, prior and in preference to any
distribution of any of the assets or surplus funds of the Corporation to the
holders of Common Stock by reason of their ownership thereof, the amount of
$7.57 per share then held by them (as adjusted for any stock dividends,
combinations or splits with respect to such shares) plus all declared but
unpaid dividends on each such share. If, upon the occurrence of such event,
the assets and funds thus distributed among the holders of the Series B-1
Preferred Stock shall be insufficient to permit the payment to such holders
and the holders of any other class or series of preferred stock ranking on a
parity with or senior to the Series B-1 Preferred Stock of the full
preferential amounts due to such holders, then the entire assets and funds of
the Corporation legally available for distribution shall be distributed
ratably among the holders of the Series B-1 Preferred Stock and Series B
Preferred Stock and the holders of any other such class or series of
preferred stock in proportion to, and respecting the stated priority among,
such series with respect to the preferential amount each such holder is
otherwise entitled to receive.
(b) After payment has been made to the holders of the Series A
Preferred Stock as provided in the Corporation's Certificate of Incorporation
and, if applicable, to the Series B Preferred Stock and the Series B-1
Preferred Stock as provided herein, and the holders of any other class or
series of preferred stock of the full amounts to which they shall be entitled
as provided in Section 3(a), the entire remaining assets and funds of the
Corporation legally available for distribution, if any, shall be distributed
among the holders of Common Stock in proportion to the shares of Common Stock
then held by each.
(c) A consolidation or merger of the Corporation with or into any
other corporation or corporations, or a sale of all or substantially all of
the assets of the Corporation, shall be treated as provided for in the
Certificate of Incorporation.
Section 4. Voting Rights. The holder of each share of Series B-1
-------------
Preferred Stock shall be entitled to the number of votes equal to the number
of shares of Common Stock into which such share of Series B-1 Preferred Stock
could be converted and shall have voting rights and powers equal to the
voting rights and powers of the Common Stock (except as otherwise expressly
required by law), voting together as a single class. Fractional votes shall
not, however, be permitted and any fractional voting rights resulting from
the above formula (after aggregating all shares into which shares of Series
B-1 Preferred Stock held by each holder could be converted) shall be rounded
to the nearest whole number (with one-half being rounded upward).
Section 5. Conversion Rights. The holders of the Series B-1
-----------------
Preferred Stock shall have conversion rights as follows:
(a) Right to Convert: Each share of the Series B-1 Preferred Stock
----------------
shall be convertible, at the option of the holder thereof, at any time after
the date of issuance of such share, at the office of the Corporation or any
transfer agent for such shares, into one fully paid and
-2-
<PAGE>
nonassessable share of Common Stock (the "Series B-1 Conversion Rate"),
subject to adjustment as hereinafter provided.
(b) Automatic Conversion. Each share of Series B-1 Preferred
--------------------
Stock shall automatically be converted into shares of Common Stock at the
then-effective Series B-1 Conversion Rate upon the affirmative vote or
written consent of holders of not less than a majority of the shares of
Series B-1 Preferred Stock outstanding at such time.
(c) Mechanics of Conversion. Unless waived or modified by the
Corporation, before any holder of Series B-1 Preferred Stock shall be
entitled to convert the same into shares of Common Stock, such holder shall
surrender the certificate or certificates therefor, duly endorsed, at the
office of the Corporation or of any transfer agent for such stock, and shall
give written notice to the Corporation at such office that such holder elects
to convert the same and shall state therein the name or names in which such
holder wishes the certificate or certificates for shares of Common Stock to
be issued. The Corporation shall, as soon as practicable thereafter, issue
and deliver at such office to such holder of Series B-1 Preferred Stock, a
certificate or certificates for the number of shares of Common Stock to which
such holder shall be entitled as aforesaid. Such conversion shall be deemed
to have been made immediately prior to the close of business on the date of
surrender of the shares of Series B-1 Preferred Stock to be converted, and
the person or persons entitled to receive the shares of Common Stock issuable
upon such conversion shall be treated for all purposes as the record holder
or holders of such shares of Common Stock on such date.
(d) Adjustments to Conversion Prices for Combinations or
----------------------------------------------------
Subdivisions of Common Stock. In the event that this Corporation at any time
- ----------------------------
or from time to time after the date of filing of this Designation shall
declare or pay any dividend on the Common Stock payable in Common Stock or in
any right to acquire Common Stock, or shall effect a subdivision of the
outstanding shares of Common Stock into a greater number of shares of Common
Stock (by stock split, reclassification or otherwise than by payment of a
dividend in Common Stock or in any right to acquire Common Stock), or in the
event the outstanding shares of Common Stock shall be combined or
consolidated, by reclassification or otherwise, into a lesser number of
shares of Common Stock, then the Series B-1 Conversion Rate in effect
immediately prior to such event shall, concurrently with the effectiveness of
such event, be proportionately and equitably decreased or increased, as
appropriate.
(e) Fractional Shares. No fractional shares shall be issued upon
-----------------
the conversion of any share or shares of Series B-1 Preferred Stock. All
shares of Common Stock (including fractions thereof) issuable upon conversion
of more than one share of Series B-1 Preferred Stock by a holder thereof
shall be aggregated for purposes of determining whether the conversion would
result in the issuance of any fractional share. If, after the aforementioned
aggregation, the conversion would result in the issuance of a fraction of a
share of Common Stock, the Corporation shall, in lieu of issuing any
fractional share, pay the holder otherwise entitled to such fraction a sum in
cash equal to the fair market value of such fraction on the date of
conversion (as determined in good faith by the Board of Directors of the
Corporation).
-3-
<PAGE>
(f) Adjustments. Subject to the provisions of Section 6 below, in
-----------
case of any reorganization or any reclassification of the capital stock of
the Corporation, any consolidation or merger of the Corporation with or into
another corporation or corporations, or the conveyance of all or
substantially all of the assets of the Corporation to another corporation,
each share of Series B-1 Preferred Stock shall thereafter be convertible into
the number of shares of stock or other securities or property (including
cash) to which a holder of the number of shares of Common Stock deliverable
upon conversion of such share of Series B-1 Preferred Stock would have been
entitled upon the record date of (or date of, if no record date is fixed)
such reorganization, reclassification, consolidation, merger or conveyance,
and, in any case, appropriate adjustment (as determined by the Board of
Directors) shall be made in the application of the provisions herein set
forth with respect to the rights and interests thereafter of the holders of
the Series B-1 Preferred Stock, to the end that the provisions set forth
herein shall thereafter be applicable, as nearly as equivalent as is
practicable, in relation to any shares of stock or the securities or property
(including cash) thereafter deliverable upon the conversion of the shares of
such Series B-1 Preferred Stock.
Section 6. Merger, Consolidation. At any time, in the event of a
---------------------
"Merger" (as defined in Section 7, Article IV of the Certificate of
Incorporation), then the holders of the Preferred Stock, the holders of any
other class or series of preferred stock hereafter created and issued and the
holders of Common Stock shall be paid in cash or in securities received from
the acquiring corporation or in a combination thereof, at the closing of any
such transaction, amounts per share equal to the amounts per share which
would be payable to such holders pursuant to Section 3 if all consideration
received by the Corporation and its stockholders in connection with such
event were being available distributed in a liquidation of the Corporation;
provided however, that if upon the occurrence of such event, the assets and
- ----------------
funds thus available for distribution among the holders of the Series B-1
Preferred Stock and the holders of any other class or series of preferred
stock ranking on a parity with or senior to the Series B-1 Preferred Stock
shall be insufficient to permit the payment to such holders of the full
preferential amounts due to them pursuant to Section 3 above, then, if any
assets remain available for distribution after full distribution to the
Series A Preferred Stock pursuant to the Certificate of Incorporation, the
entire assets and funds of the Corporation legally available for distribution
shall be distributed ratably among the holders of the Series B-1 Preferred
Stock and the holders of any other such class or series of preferred stock in
proportion to the preferential amount each such holder is otherwise entitled
to receive.
Section 7. No Reissuance of Preferred Stock. No share or shares of
--------------------------------
Series B-1 Preferred Stock acquired by the Corporation by reason of
redemption, purchase, conversion or otherwise shall be reissued, and all such
shares shall be canceled, retired and eliminated from the shares which the
Corporation shall be authorized to issue.
RESOLVED FURTHER, that an authorized officer of this corporation be, and
he hereby is, authorized and directed to prepare and file a Certificate of
Designation of Rights, Preferences and Privileges in accordance with the
foregoing resolution and the provisions of Delaware law and to take such
actions as he may deem necessary or appropriate to carry out the intent of
the foregoing resolution."
-4-
<PAGE>
3. That the authorized number of shares of Series B-1 Preferred Stock
of the Corporation is 1,168,860 and that no such Series B-1 Preferred Stock
has been issued.
I further declare under penalty of perjury that the matters set forth in
the foregoing Certificate of Designation are true and correct of my own
knowledge.
Executed at Alameda, California on June 24, 1996.
/s/ Stephen M. Race
------------------------------------------------------
Stephen M. Race, President and Chief Executive Officer
-5-
<PAGE>
EXHIBIT 11.1
SPECTRUM HOLOBYTE, INC.
STATEMENT RE: COMPUTATION OF NET LOSS PER SHARE
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
Three months ended
June 30,
--------------------------
1996 1995
--------- ---------
<S> <C> <C>
Net loss before extraordinary item $ (4,183) $ (9,398)
Cumulative preferred dividends (70) (70)
--------- ---------
Net loss for the purposes of calculating the net loss
per share before extraordinary item (4,253) (9,468)
Extraordinary item, net of tax effect 2,668 --
--------- ---------
Net loss for the purposes of calculating the net loss
per share (1,585) (9,468)
Weighted average number of common
shares outstanding 24,384 22,659
--------- ---------
--------- ---------
Earning (loss) per common share:
- -------------------------------
Net loss before extraordinary item (0.18) (0.42)
Extraordinary item 0.11 --
--------- ---------
Net loss (0.07) (0.42)
--------- ---------
--------- ---------
</TABLE>
25
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEETS AND CONSOLIDATED STATEMENTS OF OPERATIONS FOUND ON
PAGES 3 AND 4 OF THE COMPANY'S FORM 10-Q FOR THE YEAR-TO-DATE, AND IS QUALIFIED
IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> MAR-31-1996
<PERIOD-START> APR-01-1996
<PERIOD-END> JUN-30-1996
<CASH> 39,549
<SECURITIES> 0
<RECEIVABLES> 6,362<F1>
<ALLOWANCES> (9,656)
<INVENTORY> 3,423<F2>
<CURRENT-ASSETS> 54,127
<PP&E> 5,625<F3>
<DEPRECIATION> (10,043)
<TOTAL-ASSETS> 68,753
<CURRENT-LIABILITIES> 15,091
<BONDS> 36,704<F4>
5,881<F5>
11,918<F5>
<COMMON> 129,631<F5>
<OTHER-SE> (130,472)<F6>
<TOTAL-LIABILITY-AND-EQUITY> 68,753
<SALES> 11,560
<TOTAL-REVENUES> 13,072
<CGS> (4,899)
<TOTAL-COSTS> (4,899)
<OTHER-EXPENSES> 5,688
<LOSS-PROVISION> (3,616)
<INTEREST-EXPENSE> (866)
<INCOME-PRETAX> (4,183)
<INCOME-TAX> 0
<INCOME-CONTINUING> (4,183)
<DISCONTINUED> 0
<EXTRAORDINARY> 2,668
<CHANGES> 0
<NET-INCOME> (1,515)
<EPS-PRIMARY> (0.065)<F7>
<EPS-DILUTED> (0.065)<F7>
<FN>
<F1>AMOUNT IS NET OF ALLOWANCES FOR DOUBTFUL ACCOUNTS AND NOTES RECEIVABLE.
<F2>SEE NOTE 3 TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR INVENTORY COMPONENTS.
<F3>AMOUNT IS NET OF ACCUMULATED DEPRECIATION.
<F4>INCLUDES SUBORDINATED NOTES, CAPITAL LEASE OBLIGATIONS, AND OTHER LIABILITIES.
<F5>INCLUDES PAR VALUE OF STOCK ADDITIONAL PAID-IN-CAPITAL.
<F6>INCLUDES ACCUMULATED DEFICIT AND FOREIGN CURRENCY TRANSLATION ADJUSTMENT.
<F7>LOSS PER SHARE IS NET OF EXTRAORDINARY GAIN OF $0.11 PER SHARE.
</FN>
</TABLE>
