<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
For Quarter Ended: December 31, 1997 Commission File Number: 0-19463
-----------------
MICROPROSE, INC.
----------------
Exact Name of registrant as specified in its charter
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)
(510)864-4440
-----------------------------------------------------
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
--- ---
28,631,196 shares of Common Stock were outstanding as of January 30, 1998.
<PAGE>
MICROPROSE, INC.
TABLE OF CONTENTS
Page
----
PART I - FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets at December 31 and
March 31, 1997 3
Consolidated Statements of Operations for the three and
nine months ended December 31, 1997 and 1996 4
Consolidated Statements of Cash Flows for the nine
months ended December 31, 1997 and 1996 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 20
Item 6. Exhibits and Reports on Form 8-K 20
Signatures 22
Exhibits 23
2
<PAGE>
MICROPROSE, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
December 31, March 31,
1997 1997
------------ ---------
(UNAUDITED)
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 24,130 $ 47,110
Accounts receivable, less allowances of $6,542 and $6,568 at December 31
and March 31, 1997, respectively 8,955 7,891
Inventories 1,995 4,042
Prepaid royalties 7,097 2,139
Other current assets 2,055 1,958
--------- ---------
Total current assets 44,232 63,140
Property, plant and equipment, net 7,955 7,802
Goodwill, net 619 892
Investments 3,871 6,050
Other assets 2,920 2,421
--------- ---------
$ 59,597 $ 80,305
--------- ---------
--------- ---------
Liabilities, Redeemable Preferred Stock and Stockholders' Equity
Current liabilities:
Accounts payable $ 6,464 $ 3,508
Salaries, wages and related accruals 4,535 6,337
Royalties payable 1,330 1,840
Current portion of redeemable preferred stock 2,940 -
Other current liabilities 8,271 7,122
--------- ---------
Total current liabilities 23,540 18,807
Other liabilities 1,266 1,280
Long-term debt 32,408 32,739
--------- ---------
Total liabilities 57,214 52,826
--------- ---------
Redeemable preferred stock (net of current portion), $0.001 par value, 4,000
shares designated Series A, outstanding shares and liquidation preference at
December 31 and March 31, 1997, respectively, as follows:
Issued and outstanding: 2,000 and 4,000 shares
Redemption and liquidation amount: $2,735 and $5,260 -- 5,881
Stockholders' equity:
Preferred stock, $0.001 par value, 9,000 shares authorized (of which 4,000
shares have been designated Series A), 16 Series B-1 convertible shares
issued and outstanding at March 31, 1997 -- --
Common stock, $0.001 par value, 40,000 shares authorized, 28,631 and 28,287
shares issued and outstanding at December 31 and March 31, 1997,
respectively 30 29
Additional paid-in capital 144,274 142,558
Accumulated deficit (141,438) (120,468)
Foreign currency translation adjustment (483) (521)
--------- ---------
Total stockholders' equity 2,383 21,598
--------- ---------
$ 59,597 $ 80,305
--------- ---------
--------- ---------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL
STATEMENTS.
3
<PAGE>
MICROPROSE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------------------ ------------------------
1997 1996 1997 1996
---------- ---------- --------- ----------
<S> <C> <C> <C> <C>
Net revenue $ 14,853 $ 35,888 $ 47,632 $ 76,373
Cost of revenue 10,211 13,888 23,994 28,973
--------- --------- --------- ----------
Gross profit 4,642 22,000 23,638 47,400
Operating expenses:
Sales and marketing 4,223 5,086 13,118 14,679
General and administrative 3,240 4,508 8,391 11,952
Research and development 8,106 5,959 20,174 17,862
--------- --------- --------- ----------
Total operating expenses 15,569 15,553 41,683 44,493
--------- --------- --------- ----------
Operating income (loss) (10,927) 6,447 (18,045) 2,907
Interest and other income (expense), net (89) (391) (3,056) 797
--------- --------- --------- ----------
Income (loss) before provision (benefit) for income
taxes and extraordinary item (11,016) 6,056 (21,101) 3,704
Provision (benefit) for income taxes (131) 398 (131) 398
--------- --------- --------- ----------
Income (loss) before extraordinary item (10,885) 5,658 (20,970) 3,306
Extraordinary item, net of tax effect -- -- -- 3,547
--------- --------- --------- ----------
Net income (loss) $( 10,885) $ 5,658 $( 20,970) $ 6,853
--------- --------- --------- ----------
--------- --------- --------- ----------
Basic income (loss) per share:
Income (loss) before extraordinary item $ (0.38) $ 0.21 $ (0.75) $ 0.12
Extraordinary item, net of tax effect -- -- -- 0.14
--------- --------- --------- ----------
Net income (loss) $ (0.38) $ 0.21 $ (0.75) $ 0.26
--------- --------- --------- ----------
--------- --------- --------- ----------
Diluted income (loss) per share:
Income (loss) before extraordinary item $ (0.38) $ 0.20 $ (0.75) $ 0.11
Extraordinary item, net of tax effect -- -- -- 0.13
--------- --------- --------- ----------
Net income (loss) $ (0.38) $ 0.20 $ (0.75) $ 0.24
--------- --------- --------- ----------
--------- --------- --------- ----------
Weighted average shares used to calculate:
Basic income (loss) per share 28,593 26,837 28,422 25,797
Diluted income (loss) per share 28,593 28,470 28,422 27,281
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL
STATEMENTS.
4
<PAGE>
MICROPROSE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(UNAUDITED)
<TABLE>
<CAPTION>
Nine months ended
December 31,
--------------------------------
1997 1996
------------- ------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (20,970) $ 6,853
Adjustments to reconcile net income (loss) to net cash provided by
(used in) operating activities:
Depreciation and amortization 2,568 3,291
Gain on the sale of investment in FASA -- (1,895)
Loss on the write-down of investment in TEN 2,605 --
Extraordinary gain on extinguishment of long-term debt -- (3,547)
Changes in assets and liabilities:
Accounts receivable (865) (3,907)
Inventories 2,119 (967)
Prepaid royalties (5,533) (1,387)
Other current assets (123) 1,106
Other assets 89 118
Accounts payable 2,869 (106)
Salaries, wages and related accruals (1,662) 2,417
Royalties payable (530) 1,291
Other current liabilities 1,070 3,472
Other (98) (36)
---------- ----------
Net cash provided by (used in) operating activities (18,461) 6,703
Cash flows from investing activities:
Acquisitions of property, plant and equipment (2,056) (1,992)
Acquisition of certain net assets of Leisuresoft GmbH, net of cash acquired -- (447)
Proceeds from sale of investment in FASA Interactive Technologies -- 570
Equity investments (426) (570)
Other -- 145
---------- ----------
Net cash used in investing activities (2,482) (2,294)
Cash flows from financing activities:
Extinguishment of debt -- (2,959)
Proceeds from issuance of common stock, net of issuance costs 1,507 10,058
Repurchase of Series A preferred stock (2,730) --
Repayments under notes, lines of credit and capital lease obligations (512) (1,095)
---------- ----------
Net cash provided by (used in) financing activities (1,735) 6,004
Effect of exchange rate changes on cash (302) (270)
---------- ----------
Increase (decrease) in cash and cash equivalents (22,980) 10,143
Cash and cash equivalents at beginning of period 47,110 35,369
---------- ----------
Cash and cash equivalents at end of period $ 24,130 $ 45,512
---------- ----------
---------- ----------
Supplemental disclosures of cash flow information:
Cash paid for interest 1,012 1,148
Cash paid for income taxes 296 56
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL
STATEMENTS.
5
<PAGE>
MICROPROSE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1. BASIS OF PRESENTATION
The consolidated financial statements are the unaudited historical financial
statements of MicroProse, Inc. (formerly 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 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, 1997, as filed with the Securities
and Exchange Commission on June 30, 1997. The March 31, 1997 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.
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.
For the purposes of presentation, the Company has indicated its interim
fiscal periods as ended on December 31, 1997 and 1996, and its prior fiscal
year as ended on March 31, 1997. As the Company's annual fiscal period is
accounted for on a 52-53 week year, the interim period financial statements
included herein represent interim results through December 28, 1997 and
December 29, 1996, and the end of the prior fiscal year included herein
represents amounts as of March 30, 1997.
Certain reclassifications have been made to the prior year consolidated
financial statements to conform to the current year's presentation. These
reclassifications had no effect on previously reported net income (loss) or
stockholders' equity.
NOTE 2. TERMINATED MERGER
On October 5, 1997, the Company entered into a definitive agreement to merge
with GT Interactive Software Corp. ("GT"), a Delaware corporation and a
developer, publisher and distributor of entertainment software for personal
computers and certain console platforms. Under the terms of the proposed
merger, the Company's outstanding shares of common and preferred stock were
to be exchanged for a proportional number of shares of GT stock. On December
5, 1997, the Company and GT announced the mutual agreement to terminate the
definitive merger agreement. There were no breakup fees due to either
company. The accompanying consolidated statements of operations for the three
and nine-month periods ended December 31, 1997, include the write-off of
approximately $700,000 of capitalized costs associated with the proposed
merger.
NOTE 3. INVENTORIES
Inventories are stated at the lower of cost or market on a first-in, first-out
(FIFO) basis. Inventories at December 31 and March 31, 1997 consisted of (IN
THOUSANDS):
<TABLE>
<CAPTION>
December 31, March 31,
1997 1997
----------------- ---------------
<S> <C> <C>
Raw materials $ 348 $ 413
Finished goods 1,647 3,629
----------------- ---------------
$ 1,995 $ 4,042
----------------- ---------------
----------------- ---------------
</TABLE>
NOTE 4. INVESTMENT
In fiscal 1996 and 1997, the Company made minority equity investments of $2.6
million in Total Entertainment Network, Inc. ("TEN"). These cost-basis
investments were made pursuant to an investment and licensing arrangement
whereby the Company committed to allow certain of the Company's future titles
to be played over the Total Entertainment Network. In conjunction with the
planned refinancing of TEN, the Company recorded a $2.6 million charge in the
first quarter of fiscal 1998 to write-down its investment as management
estimated that a decline in fair value had occurred that was other than
6
<PAGE>
MICROPROSE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
temporary in nature. The charge was included in other income and expense in
the accompanying consolidated statement of operations for the nine month
period ended December 31, 1997.
NOTE 5. FOREIGN EXCHANGE
The Company enters into foreign exchange forward contracts to hedge certain
foreign currency denominated balances against changes in rates of exchange.
These contracts, which require the Company to exchange foreign currencies,
generally mature within three months. Contracts that are inversely
correlated to the risk of the hedged item and are designated and effective as
a hedge of transactions for which a firm commitment has been attained qualify
for hedge accounting. Gains and losses on these contracts are deferred and
recognized in income in the same period that the underlying transactions are
settled. If an instrument ceases to qualify for hedge accounting, any
subsequent gains and losses are recognized as income in the current period.
The Company does not use any derivatives for trading or speculative purposes.
Foreign currency transaction gains and losses, net of gains and losses on
hedge contracts, were not material in the periods presented.
NOTE 6. PREFERRED STOCK
During the three-month period ended December 31, 1997, the Company redeemed
2,000,000 shares of the outstanding Series A preferred stock ("Series A
Stock") for approximately $2.7 million. The excess of the carrying value
immediately prior to the redemption (approximately $2.9 million) over the
redemption amount was credited to additional paid-in capital in the
accompanying consolidated balance sheet. The remaining 2,000,000 shares of
Series A Stock outstanding will become redeemable in September 1998.
In September 1997, all outstanding shares of Series B-1 preferred stock
(16,045) were converted into an equivalent number of common shares.
NOTE 7. INCOME (LOSS) PER SHARE
The Company has adopted the provisions of Statement of Financial Accounting
Standards No. 128, "Earnings Per Share," ("SFAS 128") effective December 31,
1997. SFAS 128 requires the presentation of basic and diluted earnings per
share ("EPS"). Basic EPS is computed by dividing income available to common
shareholders by the weighted average number of common shares outstanding for
the period. Diluted EPS is computed giving effect to all dilutive potential
common shares that were outstanding during the period. Dilutive potential
common shares consist of incremental shares issuable upon the conversion of
convertible preferred stock (using the "if converted" method) and exercise of
stock options and warrants. All prior period earnings per share amounts have
been restated to comply with SFAS 128.
In accordance with the disclosure requirements of SFAS 128, a reconciliation
of the numerator and denominator of basic and diluted EPS is provided as
follows (in thousands, except per share amounts):
7
<PAGE>
MICROPROSE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
<TABLE>
<CAPTION>
Three months ended Nine months ended
December 31, December 31,
-------------------- --------------------
1997 1996 1997 1996
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Numerator - Basic and diluted EPS
Net income (loss) $(10,885) $ 5,658 $(20,970) $ 6,853
Less: preferred stock dividends (70) (70) (210) (210)
-------- -------- -------- --------
Income available to common stockholders $(10,955) $ 5,588 $(21,180) $ 6,643
-------- -------- -------- --------
-------- -------- -------- --------
Denominator - Basic EPS
Weighed average shares outstanding 28,593 26,837 28,422 25,797
-------- -------- -------- --------
Basic earnings per share $ (0.38) $ 0.21 $ (0.75) $ 0.26
-------- -------- -------- --------
-------- -------- -------- --------
Denominator - Diluted EPS
Denominator - Basic EPS 28,593 26,837 28,422 25,797
Effect of dilutive securities:
Common stock options -- 336 -- 365
Convertible preferred stock -- 1,297 -- 1,119
-------- -------- -------- --------
28,593 28,470 28,422 27,281
-------- -------- -------- --------
Diluted earnings per share $ (0.38) $ 0.20 $ (0.75) $ 0.24
-------- -------- -------- --------
-------- -------- -------- --------
</TABLE>
Weighted average options to purchase 2,759,329 and 2,870,291 shares of common
stock were outstanding during the three months and nine months ended December
31, 1997, respectively. These options were not included in the calculations
of diluted EPS because their effect on reported losses would be
anti-dilutive. Weighted average options to purchase 3,016,158 and 3,108,241
shares of common stock were outstanding during the three months and nine
months ended December 31, 1996, respectively. Certain of these options were
not included in the calculations of diluted EPS because the options' exercise
price was greater than the average fair market price of the common shares.
NOTE 8. RECENT PRONOUNCEMENTS
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income,"
which requires disclosure of all changes in stockholders' equity except those
resulting from investments or contributions by stockholders. SFAS No. 130 is
effective for the Company for fiscal years beginning after December 15, 1997.
The Company does not expect this pronouncement to materially impact the
Company's results of operations.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information," which requires disclosure about
operating segments in annual financial statements and selected information in
interim financial reports. It also establishes standards for related
disclosures about products and services, geographic areas and major
customers. This statement supersedes SFAS No. 14, "Financial Reporting for
Segments of a Business Enterprise" and is effective for fiscal years
beginning after December 15, 1997. The Company is evaluating the requirements
of SFAS No. 131 and the effects, if any, on the Company's current reporting
and disclosures.
During October 1997, the American Institute of Certified Public Accountants
issued Statement of Position 97-2 ("SOP 97-2"), Software Revenue Recognition.
This statement establishes requirements for revenue recognition for software
companies for fiscal years beginning after December 15, 1997. The Company is
currently evaluating the impact of SOP 97-2 and has not yet determined the
result, if any, on the Company's financial position, results of operations or
cash flows.
8
<PAGE>
MICROPROSE, 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, 1997, as filed with the
Securities and Exchange Commission on June 30, 1997.
This Quarterly Report on Form 10-Q contains forward-looking statements that
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
MicroProse, Inc. ("the Company") derives revenue primarily from publishing
and distributing entertainment software for the personal computer ("PC")
platform on Compact-Disc Read-Only Memory ("CD-ROM") media. In addition,
revenue is generated from CD-ROM products for videogame consoles (including
32-bit "next-generation" systems), the licensing of products to third-party
publishers and the distribution of third-party software and related products.
On October 5, 1997, the Company entered into a definitive agreement to merge
with GT Interactive Software Corp. ("GT"), a Delaware corporation and a
developer, publisher and distributor of entertainment software for personal
computers and certain console platforms. Under the terms of the proposed
merger, the Company's outstanding shares of common and preferred stock were
to be exchanged for a proportional number of shares of GT stock. On December
5, 1997, the Company and GT announced the mutual agreement to terminate the
definitive merger agreement. There were no breakup fees due to either
company.
See additional discussion in "Risk Factors" below.
9
<PAGE>
MICROPROSE, INC.
OPERATING RESULTS
Consolidated net revenue generated in North America and the rest of the world
consisted of the following (DOLLARS IN THOUSANDS):
<TABLE>
<CAPTION>
% of Consolidated Net
Amount Revenue
------------------------- ----------------------
Three months ended December 31: 1997 1996 % CHANGE 1997 1996
------------------------- ------------ ----------------------
<S> <C> <C> <C> <C> <C>
North America $ 2,136 $ 11,594 (81.6%) 14.4% 32.3%
International 12,717 24,294 (47.7%) 85.6% 67.7%
------------------------- ----------------------
Consolidated $ 14,853 $ 35,888 (58.6%) 100.0% 100.0%
------------------------- ----------------------
------------------------- ----------------------
Nine months ended December 31:
North America $ 14,069 $ 26,381 (46.7%) 29.5% 34.5%
International 33,563 49,992 (32.9%) 70.5% 65.5%
------------------------- ----------------------
Consolidated $ 47,632 $ 76,373 (37.6%) 100.0% 100.0%
------------------------- ----------------------
------------------------- ----------------------
</TABLE>
The following table sets forth the components of net revenue in dollars and
as a percentage of total net revenue (DOLLARS IN THOUSANDS):
<TABLE>
<CAPTION>
% of Consolidated Net
Amount Revenue
------------------------- ---------------------
Three months ended December 31: 1997 1996 % CHANGE 1997 1996
------------------------- ------------ ---------------------
<S> <C> <C> <C> <C> <C>
Company-published titles:
CD-ROM $ 7,290 $ 26,233 (72.2%) 49.1% 73.1%
Videogame 283 3,031 (90.7%) 1.9% 8.5%
Licensing/OEM 1,351 1,197 12.9% 9.1% 3.3%
Floppy disk and other 251 725 (65.4%) 1.7% 2.0%
------------------------- ---------------------
Total published titles 9,175 31,186 (70.6%) 61.8% 86.9%
Third-party distribution 5,678 4,702 20.8% 38.2% 13.1%
------------------------- ---------------------
Consolidated $ 14,853 $ 35,888 (53.4%) 100.0% 100.0%
------------------------- ---------------------
------------------------- ---------------------
Nine months ended December 31:
Company-published titles:
CD-ROM $ 32,961 $ 57,049 (42.2%) 69.2% 74.7%
Videogame 1,143 7,793 (85.3%) 2.4% 10.2%
Licensing/OEM 4,298 3,768 14.1% 9.0% 4.9%
Floppy disk and other 949 849 11.8% 2.0% 1.1%
------------------------- ---------------------
Total published titles 39,351 69,459 (43.3%) 82.6% 90.9%
Third-party distribution 8,281 6,914 19.8% 17.4% 9.1%
------------------------- ---------------------
Consolidated $ 47,632 $ 76,373 (37.6%) 100.0% 100.0%
------------------------- ---------------------
------------------------- ---------------------
</TABLE>
Net revenue declined in both the three and nine-month periods due principally to
the prior year success of two Company-published products, GRAND PRIX II and SID
MEIER'S CIVILIZATION II. These two titles combined for 37% and 53% of revenue
in the three and nine-month periods ended December 31, 1996, respectively. Net
revenue in the
10
<PAGE>
MICROPROSE, INC.
December 1997 quarter was also adversely impacted by lower North American
market acceptance of new product releases. The Company released two new
titles in the third quarter of both fiscal 1997 and 1998, although domestic
shipments of new titles in the comparable third fiscal quarters declined from
235,000 to 65,000 units. Provisions for future returns and markdowns also
increased due to lower holiday sell-through of these new releases and other
previously released titles.
The decline in videogame revenue in fiscal 1998 was due to the release of
three console titles in the first three quarters of the prior fiscal year as
compared to no titles released to date in fiscal 1998, as the Company has
strategically focused on PC CD-ROM products in the current fiscal year. The
three fiscal 1997 titles (all for the SONY PLAYSTATION-Registered Trademark-)
were TOP GUN: FIRE AT WILL, GUNSHIP 2000, and X-COM: TERROR FROM THE DEEP.
Third-party distribution revenue includes shipments of computer software and
related products published or manufactured by third parties and distributed
by the Company. This revenue is generally derived under either standard,
low-margin distribution agreements (which include the purchase and resale of
products) or high-margin, lower revenue agency relationships (under which the
Company earns a commission or agency fee). The increases in third party
distribution revenue were due largely to the European release in the third
quarter of fiscal 1998 of WORMS II, a distribution title which is being
published in Europe by the third-party developer and marketed by the Company.
Partially offsetting these increases were declines in revenue due to a shift
in strategic focus in Germany from distribution to higher-margin
agency-related revenue.
Gross profit consisted of the following (DOLLARS IN THOUSANDS):
<TABLE>
<CAPTION>
% of Consolidated Net
Amount Revenue
-------------------- --------------------
1997 1996 % CHANGE 1997 1996
-------------------- -------- --------------------
<S> <C> <C> <C> <C> <C>
Three months ended December 31 $ 4,642 $ 22,000 (78.9%) 31.3% 61.3%
-------------------- --------------------
-------------------- --------------------
Nine months ended December 31 $ 23,638 $ 47,400 (50.1%) 49.6% 62.1%
-------------------- -------- --------------------
-------------------- -------- --------------------
</TABLE>
Gross profit as a percent of consolidated net revenue declined in the third
quarter due to an increased proportion of revenue generated from third-party
developed titles. The Company's two most significant product releases in the
December 1997 quarter were third-party developed products, one of which was a
low-margin distribution title. In addition, margins were adversely impacted
by declining average selling prices for back catalog titles, mostly in
Europe. Partially offsetting the decreases in gross profit in the third
quarter and first nine months of fiscal 1998 was a reduction in shipments of
Sony PlayStation titles which generally have lower margins than PC products.
The following table sets forth operating expenses, interest and other income
(expense) and extraordinary items (DOLLARS IN THOUSANDS):
<TABLE>
<CAPTION>
% of Consolidated Net
AMOUNT Revenue
-------------------- --------------------
Three months ended December 31: 1997 1996 % CHANGE 1997 1996
-------------------- -------- --------------------
<S> <C> <C> <C> <C> <C>
Sales and marketing $ 4,223 $ 5,086 (17.0%) 28.4% 14.2%
General and administrative 3,240 4,508 (28.1%) 21.8% 12.5%
Research and development 8,106 5,959 36.0% 54.6% 16.6%
-------------------- --------------------
Total operating expenses $ 15,569 $ 15,553 0.1% 104.8% 43.3%
-------------------- --------------------
-------------------- --------------------
Interest and other income
(expense), net $ (89) $ (391) (77.2%) (0.6%) (1.1%)
-------------------- --------------------
-------------------- --------------------
Provision (benefit) for
income taxes $ (131) $ 398 -- (0.9%) 1.1%
-------------------- --------------------
-------------------- --------------------
</TABLE>
11
<PAGE>
MICROPROSE, INC.
<TABLE>
<CAPTION>
% of Consolidated Net
AMOUNT Revenue
-------------------- --------------------
Nine months ended December 31: 1997 1996 % CHANGE 1997 1996
-------------------- -------- --------------------
<S> <C> <C> <C> <C> <C>
Sales and marketing $ 13,118 $ 14,679 (10.6%) 27.6% 19.2%
General and administrative 8,391 11,952 (29.8%) 17.6% 15.7%
Research and development 20,174 17,862 12.9% 42.3% 23.4%
-------------------- --------------------
Total operating expenses $ 41,683 $ 44,493 (6.3%) 87.5% 58.3%
-------------------- --------------------
-------------------- --------------------
Interest and other income
(expense), net $ (3,056) $ 797 (483.4%) (6.4%) 1.0%
-------------------- --------------------
-------------------- --------------------
Provision (benefit) for
income taxes $ (131) $ 398 -- (0.3%) 0.5%
-------------------- --------------------
-------------------- --------------------
Extraordinary item, net of
tax effect $ -- $ 3,547 (100.0%) -- 4.6%
-------------------- --------------------
-------------------- --------------------
</TABLE>
Sales and marketing expenses declined in fiscal 1998 due mostly to declining
net revenue and associated variable marketing and selling costs.
General and administrative costs were down in fiscal 1998 due mostly to a
decline in bad debt charges ($0.6 million and $2.5 million for the three and
nine-month periods, respectively) related to the improved stability of
certain customers, and to a $1.0 million reduction in incentive compensation
due to lower operating profits. Partially offsetting these amounts was a
$0.7 million charge in the December 1997 quarter to write-off costs
associated with the proposed merger with GT Interactive, which was terminated
during the quarter.
Research and development costs were up in the most recent three-month and
nine-month periods due to a $2.0 million charge in the quarter ended December
31, 1997, to write-off unrealizable third-party royalty advances. This
write-off was made primarily due to lower than anticipated holiday
sell-through, mostly due to one third-party developed title.
The change in other income and expense for the nine-month period ended
December 31, 1997, was due to the following factors: 1) in the first quarter
of fiscal 1998, a $2.6 million charge was recorded to write-down the
Company's equity investment in Total Entertainment Network, Inc. due to
management's determination that a decline in fair value had occurred that was
other than temporary in nature, 2) a $1.9 million gain was recorded in the
first quarter of the prior year related to the sale of the Company's
investment in FASA Interactive Technologies, Inc., and 3) lower interest
costs were incurred in the first nine months of fiscal 1998 due to a
reduction in indebtedness outstanding.
The changes in the tax provision (benefit) during fiscal 1998 are due to the
net losses generated. The extraordinary item recorded in the prior year
reflects the gains realized upon the repurchase and the conversion to equity
of a portion of the Company's notes payable at a discount from face value.
LIQUIDITY AND CAPITAL RESOURCES
Cash decreased to $24.1 million and working capital decreased to $20.7
million during the first nine months of fiscal 1998. The main uses of cash
and cash equivalents in fiscal 1998 to date were to fund operating losses,
royalty advances, bonuses earned in fiscal 1997 and a Series A preferred
stock repurchase.
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MICROPROSE, INC.
The Company has authorized 9,000,000 shares of preferred stock, $0.001 par
value, of which 4,000,000 shares are designated Series A redeemable preferred
stock ("Series A Stock"). During the quarter ended December 31, 1997,
2,000,000 of the outstanding shares of Series A Stock were redeemed for
approximately $2.7 million. At December 31, 1997, there were 2,000,000
shares of Series A Stock outstanding which are convertible into 98,039 shares
of common stock and which accrue dividends at an annual rate of 7%. Preferred
stockholders receive one vote for each common share into which their
preferred shares are convertible. The Series A Stock is redeemable for $1.00
per share plus all accumulated but unpaid dividends (total redemption of $2.7
million as of December 31, 1997) (i) at any time by the Company, or (ii) in
its entirety commencing on September 24, 1998, upon written demand of holders
of the majority of Series A Stock.
Management believes that existing cash and cash equivalents, together with
cash generated from operations, will be sufficient to meet the Company's
liquidity and capital needs for at least the next 12 months.
RISK FACTORS
THE FOLLOWING RISK FACTORS SHOULD BE CAREFULLY CONSIDERED IN EVALUATING THE
COMPANY AND ITS BUSINESS PROSPECTS.
TERMINATED BUSINESS COMBINATION. In October 1997, the Company entered into a
definitive agreement to merge with GT Interactive Software Corp. Under the
terms of the proposed merger, the Company's outstanding shares of common and
preferred stock were to be exchanged for a proportional number of shares of
GT stock. On December 5, 1997, the Company and GT announced the mutual
agreement to terminate the definitive merger agreement.
The termination of the merger agreement has had an adverse impact on (a) the
Company's sales and operating results, (b) the Company's ability to attract
and retain key sales and administrative personnel, (c) the progress of
certain development projects and (d) the trading price of the Company's
Common Stock. There can be no assurance that the termination of the merger
will not continue to adversely impact the Company's business and results of
operations in future periods.
NASDAQ LISTING. As of December 31, 1997, the Company is not in compliance
with the current net tangible assets requirement of The Nasdaq Stock Market
("NASDAQ") for continued listing on The Nasdaq National Market. However, new
listing requirements taking effect February 23, 1998, include alternative
requirements for continued listing. The Company is considering a number of
options for meeting the new requirements, including a reverse stock split,
and has been proactive in initiating a dialog with NASDAQ with respect to
these new requirements. Until the Company completes the steps necessary to
address this situation and those steps have been approved by NASDAQ, there
can be no assurance that the Company will be in compliance with the National
Market listing requirements.
If the Company is unable to comply with the new National Market listing
requirements, the Company believes that it will 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 6.5% 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 likely be materially and
adversely affected.
COMPUTER SYSTEMS AND YEAR 2000
Many currently installed computer systems and software products are coded to
accept only two digit entries in the date code field. These date code fields
will need to accept four digit entries to distinguish twenty-first century
dates from twentieth century dates. As a result, many companies' software
and computer systems may need to be upgraded or replaced in order to comply
with such "Year 2000" requirements. Although the Company is planning to
upgrade its systems before the Year 2000 to be Year 2000 compliant, the
Company currently utilizes third-party equipment and software that is not
Year 2000 compliant. Failure of the Company's third-party equipment or
software to meet the Company's Year 2000 system requirements by the Year 2000
would require the Company to incur unanticipated expenses to remedy any
problems, which would have a material adverse effect on the Company's
business, operating results and financial condition.
Operating Results. The Company reported net losses for the third quarter and
first nine months of fiscal 1998 of $10.9 million, or $0.38 per diluted
common share, and $21.0 million, or $0.75 per diluted common share,
respectively. Although the Company reported net income for the year ended
March 31, 1997 of $8.0 million or $0.28 per share, the Company had net losses
of approximately $39.8 million, $18.1 million and $58.5 million for fiscal
years 1996, 1995 and 1994, respectively. There can be no assurance that the
Company's business strategies and tactics will be successful or that the
Company will be able to generate profitability in future quarterly or annual
periods.
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) volume shipments of significant new products, 2) the degree of market
acceptance of the Company's products, 3) the introduction of products
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MICROPROSE, INC.
competitive with those of the Company, 4) the timing and market acceptance of
new hardware and software product introductions, 5) the size and growth rate
of the consumer software market, 6) the seasonality of sales, 7) development
and promotional expenses relating to the introduction of new products or new
versions of existing products, 8) product returns and markdowns, 9) changes
in pricing policies by the Company and its competitors, 10) the accuracy of
retailers' forecasts of consumer demand, 11) the timing of orders from major
customers, 12) order cancellations, 13) delays of shipment, and 14)
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, is largely dependent on releases of major new products and, as such,
may not necessarily reflect the seasonal patterns of the industry as a whole.
The Company expects that its net revenue and operating results will continue
to fluctuate significantly in the future.
SIGNIFICANT LEVERAGE. As of December 31, 1997, the Company had outstanding
indebtedness for borrowed funds of approximately $32.4 million and cumulative
manditorily redeemable preferred stock of $2.9 million. 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 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.
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-catalogue 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-catalogue 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 and sustain market acceptance, are developed for the
appropriate platforms and are introduced in a timely manner. The Company is
continuing to devote considerable resources toward the development of new
products and has
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MICROPROSE, INC.
secured rights to intellectual properties and technologies 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, that third
party technology will be delivered or completed on schedule, or that the
Company's 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 materially and 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 and
retail shelf space.
The Company's current production schedules contemplate that the Company will
commence shipments of a number of new products in the fourth quarter of
fiscal 1998 and in fiscal 1999. 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 are
scheduled to be introduced.
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.
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. In addition, a
majority of the unit sales for a product typically occurs in the first 90 to
120 days after the product is introduced, and, therefore, the Company cannot
rely on the sales of current products to sustain its business in the future.
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. 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.
COMPETITION. The entertainment software industry is intensely competitive.
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, Cendant (formerly
CUC International), Lucas Arts, Interplay, GT Interactive, Acclaim
Entertainment, Broderbund Software, Activision and Virgin Interactive. The
success of one or more of these companies or the entry and participation of
new companies, including diversified entertainment companies, may adversely
affect the Company's future performance. 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
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MICROPROSE, INC.
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 addition to such competitors' most popular titles.
Many of the Company's competitors are developing on-line interactive computer
games 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 continue 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 promotional 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, online services and the
Internet to reach the broader market. 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 on-line 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 resell the products to consumers. During the three and
nine-month periods ended December 31, 1997, sales to the top ten such
customers represented approximately 46% and 51%, respectively, 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 require collateral to secure payment. Retailers and distributors
compete in a volatile industry and are subject to the risk of business
failure. 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.
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. 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.
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MICROPROSE, INC.
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. Certain agreements allow
third parties to approve a product prior to its release, and therefore,
subject the product to delay. The Company is also in negotiations for
extension or renewal of certain licenses that have expired or are about to
expire. There can be no assurance that the Company's 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. 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.
The Company has made certain minority equity investments that it believes
will provide future access to products, technologies or distribution
channels. Management performs ongoing evaluations of the future realization
of these investments, and charges any declines in value that are other than
temporary in nature to other expense in its quarterly Consolidated Statements
of Operations. A write down of one or more of these investments could have a
material adverse impact on the Company's operating results and financial
condition.
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 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 software
developed for use on the PC. However, there are multiple, competing and
incompatible formats being introduced in this new market. 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
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MICROPROSE, INC.
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. 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
in whole or in part 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. In addition, there can
be no assurance that future products which incorporate software developed by
third parties will be released in accordance with internal delivery schedules
or at all.
INTERNATIONAL REVENUE. International net revenue represented approximately
86%, 70%, 64%, and 49% of the Company's net revenue for the three and
nine-month periods ended December 31, 1997, and for fiscal years 1997 and
1996, 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. The Company attempts to minimize its exposure to currency
fluctuations by entering into forward currency contracts, however, there can
be no assurance that the Company will be successful at mitigating currency
risks. In some markets, localization of the Company's products is essential
to achieve market penetration. The Company may incur substantial costs and
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MICROPROSE, INC.
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 revenue 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 royalty advances and guaranteed minimum
royalty payments. If the future anticipated sales volumes of products
subject to such arrangements are not sufficient to recover such advances and
guarantees, the Company provides a reserve for the anticipated portion of
such payments that will not be recovered. If existing advances are
determined to be unrecoverable in future periods, the Company's 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 proprietary rights to its
products. It is the Company's policy that all employees and third-party
developers sign nondisclosure agreements. There can be no assurance that
these measures will be sufficient to protect the Company's intellectual
property rights against infringement. The Company owns or licenses various
trademarks and copyrights. However, the Company has only standard "shrink
wrap" license agreements or no license agreements at all with the end users
of its products and does not copy-protect its software. The Company relies
largely on the copyright laws to prevent unauthorized distribution of its
software. Existing copyright laws afford only limited protection. It may be
possible for unauthorized third 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
rights to the same extent as the laws of the United States.
The Company believes that its products, trademarks and other proprietary
rights do not infringe on the proprietary rights of third parties. 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.
19
<PAGE>
MICROPROSE, INC.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Other than as set forth below, no material developments occurred with regard
to legal proceedings in this quarter.
On November 12, 1997, a lawsuit entitled Activision, Inc. and The Avalon Hill
Game Company v. MicroProse Software, Inc., MicroProse, Inc., and Spectrum
HoloByte, Inc., Case No. 97-8302ER, was filed in the United States District
Court for the Central District of California. The complaint alleged causes
of action for trademark infringement, trademark dilution, false designation
of origin, false advertising, unfair competition, and deceptive trade
practices in connection with the Company's publication of certain
CIVILIZATION computer game products.
On January 21, 1998, the Company and its Maryland subsidiary, MicroProse
Software, Inc., filed an action against Activision, Inc. and The Avalon Hill
Game Company in the United States District Court for the Central District of
California. The Company's complaint alleges that the defendants have engaged
in false advertising, trademark infringement, and unfair business practices
in connection with announced plans to develop and publish CIVILIZATION
computer games under a claimed licensing relationship between Activision and
Avalon Hill. The Company also seeks cancellation of Avalon Hill's related
trademark registration.
On February 4, 1998, Activision and Avalon Hill filed a First Amended
Complaint, correcting certain statements in their original complaint and
adding claims for declaratory relief and cancellation of the Company's
related trademark registration. The action was served upon the Company for
the first time on February 5, 1998.
Both the Company and opposing parties are seeking damages and injunctive
relief with respect to publication of future CIVILIZATION products.
The Company intends to defend itself and pursue its claims vigorously in
these actions. However, in the event that the Company should not prevail in
the lawsuit filed by Activision and Avalon Hill, the Company may not be able
to ship or sell certain of its products and may be required to pay damages,
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
- ------- ---------------------------------------------------------------------
<S> <C>
3.1+ Certificate of Incorporation of the Registrant
3.2+ Amended 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)
</TABLE>
20
<PAGE>
MICROPROSE, INC.
<TABLE>
<CAPTION>
Exhibit
Number Description
- ------- ---------------------------------------------------------------------
<S> <C>
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)
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.,
Jefferies & 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)
27.1 Statement Re: Financial Data Schedule
</TABLE>
+ Previously filed.
(b) REPORTS ON FORM 8-K:
October 15, 1997 - Item 5 - Other events - Reporting that MicroProse,
Inc. had entered into an Agreement and Plan of Merger with GT
Interactive Software Corp. and Swan Acquisition Corp. (a wholly owned
subsidiary of GT Interactive Software Corp.).
21
<PAGE>
MICROPROSE, 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 October 13, 1997.
MICROPROSE, INC.
By: /s/ Stephen M. Race
--------------------------------------
Stephen M. Race
CHIEF EXECUTIVE OFFICER, ACTING CHIEF
FINANCIAL OFFICER AND DIRECTOR
22
<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 10-Q FOR THE YEAR-TO-DATE, AND IS QUALIFIED IN
ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> MAR-31-1998
<PERIOD-START> OCT-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 24,130
<SECURITIES> 0
<RECEIVABLES> 8,955
<ALLOWANCES> 6,542
<INVENTORY> 1,995
<CURRENT-ASSETS> 44,232
<PP&E> 21,161
<DEPRECIATION> 13,206
<TOTAL-ASSETS> 59,597
<CURRENT-LIABILITIES> 23,540
<BONDS> 33,674
2,940
0
<COMMON> 144,304
<OTHER-SE> (141,921)
<TOTAL-LIABILITY-AND-EQUITY> 59,597
<SALES> 43,334
<TOTAL-REVENUES> 47,632
<CGS> 23,994
<TOTAL-COSTS> 23,994
<OTHER-EXPENSES> 41,731
<LOSS-PROVISION> 8,058
<INTEREST-EXPENSE> 356
<INCOME-PRETAX> (21,101)
<INCOME-TAX> (131)
<INCOME-CONTINUING> (20,970)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (20,970)
<EPS-PRIMARY> (0.75)
<EPS-DILUTED> (0.75)
</TABLE>
