Back to GetFilings.com
1
================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-------------------------
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JUNE 30, 1998
COMMISSION FILE NUMBER 1-12367
MIDWAY GAMES INC.
(Exact name of registrant as specified in its charter)
DELAWARE 22-2906244
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
3401 NORTH CALIFORNIA AVE., CHICAGO, ILLINOIS 60618
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (773) 961-2222
Securities registered pursuant to Section 12(b) of the Act:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
------------------- ---------------------
Common Stock, $.01 par value New York Stock Exchange
Stock Purchase Rights pursuant to Rights Agreement New York Stock Exchange
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: None.
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, and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the 36,710,457 shares of Common Stock held by
non-affiliates of the registrant on September 15, 1998 was $454,292,000. Solely
for purposes of this calculation, all shares held by directors and executive
officers of the registrant have been excluded. Such exclusion should not be
deemed an admission that such individuals are affiliates of the registrant. On
such date, the number of shares of Common Stock outstanding (excluding 1,079,400
shares held as treasury shares) was 37,420,600 shares.
DOCUMENTS INCORPORATED BY REFERENCE:
PART
----
Annual Report to Stockholders of Registrant for the fiscal
year ended June 30, 1998.................................. I, II, IV
================================================================================
2
PART I
This Annual Report on Form 10-K contains forward looking information and
describes the beliefs of Midway Games Inc. (the "Company" or "Midway")
concerning future business conditions and the outlook for the Company based on
currently available information. Wherever possible, the Company has identified
these forward looking statements by words such as "anticipates," "believes,"
"estimates," "expects" and similar expressions. These forward looking statements
are subject to risks and uncertainties which could cause the Company's actual
results or performance to differ materially from those expressed in these
statements. These risks and uncertainties include the following: the financial
strength of the amusement games industry, the ability of the Company to develop
new technologies on a timely basis and to design, introduce and market
successful new game titles, the level of consumer spending for such games, the
success of planned advertising, marketing and promotional campaigns and the
introduction of new dedicated platforms, as well as the items set forth under
"Item 1. Business -- Factors Affecting Future Performance." The Company assumes
no obligation to update publicly any forward looking statements, whether as a
result of new information, future events or otherwise. Discussions containing
such forward looking statements may be found in the materials set forth under
"Item 1. Business -- The Company," "-- Business" and "-- Factors Affecting
Future Performance" contained herein and in "Management's Discussion and
Analysis of Financial Condition and Results of Operations" contained in the
Company's 1998 Annual Report to Stockholders (the "1998 Annual Report").
ITEM 1. BUSINESS
THE COMPANY
Midway is a leading designer, publisher and marketer of interactive
entertainment software played in both the coin-operated and home markets. Since
the late 1970s, Midway has released many of the industry's leading games,
including Mortal Kombat (which line of games has sold over 15 million copies in
the home market), NFL Blitz, Cruis'n USA, Cruis'n World, Rampage, NBA Jam,
Joust, Defender, Pacman and Space Invaders, and, through its Atari Games
Corporation subsidiary ("Atari Games"), such leading games as San Francisco Rush
Extreme Racing, The NHLPA & NHL Present Wayne Gretzky's 3D Hockey, Area 51,
Gauntlet, Centipede, Asteroids and Pong. Midway's games are generally available
for play on all major dedicated home video game platforms, including those of
Nintendo, Sony and Sega, and personal computers.
On October 29, 1996, the Company completed an initial public offering of
5,100,000 shares of common stock, par value $.01 per share (the "Common Stock"),
at a price of $20.00 per share (the "Offering"). As of September 15, 1998, the
Company had 37,420,600 shares of Common Stock outstanding.
Prior to the Offering, the Company was a wholly-owned subsidiary of WMS
Industries Inc. ("WMS"). WMS is a leading designer, manufacturer and marketer of
gaming equipment and coin-operated pinball and novelty games. WMS continues to
provide certain administrative, accounting and information services and
facilities to the Company and acts as a contract manufacturer for the Company's
coin-operated video games. The Company provides certain sales and marketing
services to WMS. See "Item 13. Certain Relationships and Related Transactions."
Prior to July 1996, the Company also conducted certain aspects of the pinball
operations of WMS' amusement games business, which operations were transferred
to another subsidiary of WMS and the results of which are not included in the
Company's results of operations. See Note 3 to the Company's financial
statements contained in the 1998 Annual Report.
On April 6, 1998, WMS distributed, on a pro rata basis to its stockholders,
the remaining 33,400,000 shares (or 86.8%) of the Company's Common Stock owned
by WMS (the "Distribution"). Pursuant to the Distribution, WMS stockholders
received 1.19773 shares of Midway Common Stock for each share of WMS common
stock owned. Fractional shares were sold and the net proceeds thereof paid in
cash. The distribution ratio reflected 27,886,021 shares of WMS common stock
outstanding on the record date for the Distribution.
The Company is a Delaware corporation formed in July 1988. Its address is
3401 North California Avenue, Chicago, Illinois 60618, and its telephone number
is (773) 961-2222.
1
3
Midway(R) is a registered trademark of the Company. With the exception of
trademarks licensed from third parties, titles to all of the Company's games
referred to in this Annual Report on Form 10-K are either registered trademarks
of the Company or the subject of pending trademark applications. Nintendo, Super
Nintendo Entertainment System, Game Boy, and Nintendo 64 and N64 are trademarks
of Nintendo of America, Inc. Sega, Genesis, Game Gear and Saturn are trademarks
of Sega Enterprises, Ltd. Sony and PlayStation are trademarks of Sony Computer
Entertainment of America Inc. This Annual Report on Form 10-K includes
trademarks other than those identified in this paragraph. The use of any such
trademark herein is in an editorial form only, and to the benefit of the owner
thereof, with no intention of infringement of the trademark.
INDUSTRY OVERVIEW
GENERAL
Video games are sold in two primary formats: (i) coin-operated games
distributed to arcades and route operators and (ii) home games for dedicated
hardware platforms (Nintendo 64, Sony PlayStation and Sega Saturn), portable
game systems (Nintendo's Game Boy), and personal computers distributed to mass
merchandisers, national and regional retailers, discount store chains, video
rental retailers and entertainment software distributors. A successful video
game may present the opportunity to exploit ancillary rights such as film,
television and merchandising rights. The primary groups that play video games
are male teenagers and young adults.
The video game business has undergone significant consolidation in recent
years, and the Company believes that significant barriers to entry into the
video game business exist that make it difficult for new entrants to succeed.
The video game business requires specialized creative talent capable of
utilizing the sophisticated technological tools required to design the complex
video games that characterize the business today. The cost of developing video
games is high and likely to increase as technology continues to evolve. In the
home video game business, distribution channels are dominated by a select group
of companies, and access to retail shelf space is a significant competitive
factor.
COIN-OPERATED GAMES
Coin-operated video games utilize specialized technology and hardware
platforms that permit greater design flexibility than dedicated home platforms,
which are limited by the design specifications of the particular platform.
Coin-operated video games are manufactured in self-contained cabinetry
containing large video screens that display the game. Multiple players can play
the same game simultaneously, and games are generally designed to permit the
players to play against each other, in addition to being able to play against
the game itself. Most coin-operated video games cost 50c to play a game of
approximately two minutes in duration. New technologies employed in the
manufacturing of coin-operated video games utilize advanced video platforms in
which digital images are mapped to computer generated polygons that allow for
the creation of three-dimensional graphic images.
Coin-operated games are sold through distributors to two primary
customers -- arcades and route operators. The distributors typically provide
product warranties to their customers and receive a price allowance from the
manufacturer to cover warranty claims. A typical arcade is located in a shopping
mall and operates numerous types of games, including video, pinball, novelty and
redemption games. An arcade will often purchase multiple units of the most
popular games. Route operators purchase coin-operated video games and provide
the games on a revenue sharing basis to various establishments, such as
restaurants, taverns, convenience stores and movie theaters, which typically
install only a few games and only rarely lease multiple units of the same games
for a particular location.
After introduction, a coin-operated video game will generally experience a
product life cycle for a manufacturer of one to two years, although sales are
generally concentrated in the first six to eight months after introduction.
2
4
Coin-operated games are distributed throughout North America, Europe, and
to a lesser extent to Australia and countries in Asia and South America. The
Company believes that the market for coin-operated video games, particularly in
the United States, is mature and stable and is unlikely to experience
significant growth in the near-term. Growth in international markets may occur
in emerging markets as well as developed countries where the coin-operated video
game market is more mature. The Company believes that Japan is the second
largest market for coin-operated video games after the United States. Although
the Company is pursuing marketing opportunities in Japan, United States
manufacturers of coin-operated games, including the Company, have not as yet
achieved meaningful sales in the Japanese market.
HOME GAMES
Like coin-operated video games, interactive software programs for the home
allow the consumer to participate actively in the outcome of the game. The
interactive software publishing business involves the creation or acquisition of
titles or intellectual property rights, the development of interactive software
products based on these titles or rights, and the publication, marketing,
merchandising, distribution and licensing of the resulting software products.
This process in general involves converting software created for the
coin-operated version of a game into software for use on the multiple platforms
on which home games are released, or creating original games for release into
the home market. The business is highly dependent on consumer tastes and
preferences and on the commercial success of the hardware platforms for which
the software is produced. The principal types of interactive hardware platforms
are dedicated game systems, such as those manufactured by Nintendo, Sony and
Sega, portable game systems and personal computers.
Dedicated Platforms. Historically, no hardware platform or system has
achieved long-term dominance in the interactive entertainment market. In 1986
and 1987 Nintendo and Sega, respectively, introduced 8-bit video game systems
that, compared to existing personal computers available at the time, were low in
price, easy to use and had sophisticated audio-video capabilities. In late 1989,
Sega began shipping its Genesis system, a more-powerful 16-bit video game
system. In August 1991, Nintendo introduced its 16-bit Super Nintendo
Entertainment System. Sega and Sony each began distribution of their 32-bit
hardware systems (named Saturn and PlayStation, respectively) in Japan during
the quarter ended December 1994. Sega began limited shipment of the Saturn in
North America in May 1995, and Sony commenced shipping the PlayStation in North
America in September 1995. Nintendo shipped its 64-bit Nintendo 64 system in
Japan in June 1996 and in North America in September 1996. By June 1998, the
estimated number of units of the Nintendo 64 system, Saturn system and the
PlayStation system owned by users worldwide was approximately 16 million units,
9 million units and 30 million units, respectively. The Company believes that
content providers with demonstrated capability for developing successful games
will be in a position to develop games for whichever platforms achieve
significant consumer acceptance.
Previously, most software products for dedicated platforms were sold in
cartridge form. However, compact discs have become increasingly popular because
they have substantially lower manufacturing costs than games in cartridge form.
The newer Sony PlayStation and Sega Saturn platforms are based on CD-ROM
technology. However, the 64-bit Nintendo 64 system continues to utilize software
products in cartridge form.
Portable Game Systems. Nintendo's release in 1989 of the Game Boy, a
battery-operated, hand-held interactive entertainment system incorporating an
8-bit microprocessor, revolutionized the hand-held game machine market.
Previously, the only hand-held systems available were dedicated to a single
game.
Personal Computer Software. The introduction of faster microprocessors,
graphics accelerator chips, high density disk drives, enhanced operating
systems, and increases in memory and processing power have facilitated the
development of more cost-effective, graphically oriented and user-friendly
personal computer software. As personal computers have become more powerful,
less expensive and easier to use, their use in both the home and business
environments has expanded, resulting in increased demand for a wide variety of
software products, including video games.
New Technologies. Recent advances in digital processing, data storage,
graphics, data compression and communications technologies have made possible a
new range of interactive software products and services. A number of companies
are developing technologies to permit the broadcast of interactive entertainment
services
3
5
directly via satellite, fiber optic cables, and telephone and cable television
lines. Many companies are also developing on-line interactive games and
interactive networks for playing video games, such as the Company's interactive
multi-player video game network product, Wavenet.
BUSINESS
GENERAL
Midway is a leading designer, publisher and marketer of interactive
entertainment software played in both the coin-operated and home markets. Since
the late 1970s, Midway has released many of the industry's leading games,
including NFL Blitz, Mortal Kombat (which line of games has sold over 15 million
copies in the home market), Cruis'n USA, Cruis'n World, Rampage, NBA Jam, Joust,
Defender, Pacman and Space Invaders, and, through its Atari Games subsidiary,
such leading games as San Francisco Rush Extreme Racing, The NHLPA & NHL Present
Wayne Gretzky's 3D Hockey, Area 51, Gauntlet, Centipede, Asteroids and Pong.
Midway's games are generally available for play on all major dedicated home
video game platforms, including those of Nintendo, Sony and Sega, and personal
computers.
Midway began publishing home video games based on its own coin-operated
video games in September 1995 with the introduction of Mortal Kombat 3, the best
selling home video game in the United States in 1995 according to TRSTS reports.
Prior to that time, Midway had granted a third party the right to publish home
versions of most coin-operated video games released by Midway for a modest
royalty. In preparation for the end of this arrangement and to maximize
profitability, Midway developed and implemented a new strategy to begin to
publish home versions of its coin-operated video games and expand the number of
its coin-operated and home video game releases. As part of this strategy, in
April 1994 Midway acquired the operating assets and business of three commonly
owned companies: Tradewest, Inc., Tradewest International, Inc., and The Leland
Corporation (collectively "Tradewest"), a home video game development and
distribution business, and in March 1996 Midway acquired Atari Games, a
designer, publisher and marketer of interactive entertainment software. Midway
also significantly increased its research and development expenditures to $67.5
million in fiscal 1998, up from $55.9 million in fiscal 1997 and $32.5 million
in fiscal 1996. In fiscal 1998, Midway released eight coin-operated video games
and 35 home video games (directly or under licensing arrangements, including all
platforms), compared to seven new coin-operated video games and 29 new home
video games (directly or under licensing arrangements, including all platforms)
in fiscal 1997.
Midway's coin-operated video games are primarily sold through a worldwide
network of distributors who in turn sell or lease such games directly to arcades
and route operators. The Company currently markets and sells its home video
games in North America through a combination of direct sales by Midway's
internal sales staff and independent sales representatives. Midway's principal
customers for its home video games are mass merchandisers such as Toys-R-Us,
Wal-Mart and Target, national and regional retailers, discount store chains,
video rental retailers and entertainment software distributors.
STRATEGY
Midway's business strategy is based upon the following:
- CREATE PORTFOLIO OF EXCITING GAMES -- The key to success in the video
game business is to produce games that are the most fun and exciting to
play, which requires the creative talents of experienced game designers.
Midway employs over 350 game design personnel organized in teams
comprised of programmers, artists, mechanical and electrical engineers,
musicians and actors. The game design teams operate in a studio
environment that encourages creativity, productivity and cooperation
among design teams. Midway believes that this environment, together with
a compensation structure that rewards design teams for the success of
their games and a policy of providing design teams substantial
independence and flexibility, enables Midway to attract and retain
designers who the Company believes are among the best game designers in
the industry. The design teams are supported by state-of-the-art design
technology that allows for the creation of cutting-edge,
three-dimensional graphics and
4
6
advanced audio effects. Midway produces games in the action, simulation,
adventure and sports categories.
- EXPLOIT COIN-OPERATED PROVING GROUND -- Midway generally develops its
video games for initial release in the coin-operated market. To be
successful, a coin-operated video game must be action packed and fun, and
provide enough excitement to encourage players to play such game
repeatedly. Midway considers coin-operated video games that sell at least
5,000 units and home games that sell at least 100,000 units per dedicated
platform to be successful games. Midway's experience has been that a
successful coin-operated game is almost always a success in the home
market. Each of the coin-operated video games released by Midway in the
past four years which has sold at least 5,000 units has then sold at
least 100,000 units for each major dedicated platform on which it was
released in the home market. The significant benefits realized by Midway
from this strategic approach are threefold: (i) the results achieved in
the initial coin-operated release are a meaningful indicator of the
success the game might realize in the home market and help to determine
the strategy which Midway will follow in choosing and releasing games in
the home market, (ii) the knowledge that a particular coin-operated video
game is popular with consumers allows Midway to maximize profitability
through simultaneous publication across multiple home platforms thereby
spreading developmental, advertising and promotional costs over a greater
number of units and (iii) a successful coin-operated game promotes sales
for subsequent home versions of the game among the players exposed to the
game in arcades and other coin-operated venues.
- MAINTAIN PLATFORM INDEPENDENCE -- Midway develops games for all major
dedicated home platforms (Nintendo, Sony and Sega) as well as for the
personal computer and hand-held platforms. Midway is a leading developer
of video games for the 32-and 64-bit game platforms which are currently
being marketed by hardware manufacturers. According to TRSTS reports for
fiscal 1998, the Company was ranked fourth among 53 companies in sales of
32- and 64-bit home video games. In August 1996, the Company ranked
seventh in sales for these platforms. In both fiscal 1998 and fiscal
1997, Midway released more games on the new Nintendo 64 platform than any
developer other than Nintendo itself. Because it produces video games for
multiple platforms, Midway is not dependent on any particular game
platform. Midway believes that, as a result of its relationships with the
major home platform manufacturers, its game development expertise and its
strategy of investing in advanced technology, it is well positioned for
the rapid technological evolution that characterizes the home video game
market.
- EXPLOIT FRANCHISE AND LIBRARY VALUE -- Midway seeks to exploit its
franchise properties such as Mortal Kombat. Midway has released five
different coin-operated games under the Mortal Kombat title and published
or licensed home versions of each of those games. Midway has also
licensed two film adaptations of Mortal Kombat and granted merchandising
licenses in the toy, clothing, comic book, strategy guide and other
product lines. In fiscal 1997, Midway released two Mortal Kombat home
games, Ultimate Mortal Kombat 3 and Mortal Kombat Trilogy, and in fiscal
1998, Midway released Mortal Kombat 4 and Mortal Kombat Mythologies:
Sub-Zero. An animated television series based on Mortal Kombat was
introduced in the fall of 1996, and a sequel to the movie version of
Mortal Kombat entitled Mortal Kombat -- Annihilation was released in the
fall of 1997. A live action television series based on Mortal Kombat is
scheduled to debut in the fall of 1998. Midway also seeks to utilize its
large library of video games to release "arcade classics" and updated
versions of such classics. For the home market in fiscal 1997, Midway
released two collections of arcade classic games and Robotron X, a new
version of a classic arcade game. In fiscal 1998, Midway released two
additional collections of arcade classic games. Midway's TouchMaster
products also incorporate a variety of games including versions of
classic games such as Centipede and Breakout.
- DEVELOP AND EXPLOIT MULTI-SITE GAME PLAYING NETWORK -- Midway is testing
its own proprietary multi-player interactive video game playing network
technology known as Wavenet, allowing players to play against others
located at remote coin-operated locations. This technology has resulted
in greater player utilization and profitability of games. As new on-line
interactive formats develop for game playing, such as over the Internet
or other networks, Midway intends to create a competitive advantage by
exploiting its developing multi-player network technology.
5
7
- INVEST IN ADVANCED TECHNOLOGY -- Midway has developed its own proprietary
hardware and software for creating digitally texture-mapped polygon
images, which enable it to produce games with state-of-the-art visual
simulations at cost levels that are attractive to Midway's customers.
Midway has also created proprietary tools to facilitate the development
of new products, the transfer of game features from one product to
another and the transfer of existing products to additional hardware
platforms. Midway believes its proprietary hardware and software have
helped it to achieve and sustain a reputation for developing high quality
products and to position itself for involvement in evolving technologies.
NEW PRODUCT DEVELOPMENT
The Company's goal is to produce video games that are action packed and
fun, and provide enough excitement and challenge at various levels of
proficiency to encourage players to play such game repeatedly. The Company's
game design personnel are organized in teams comprised of programmers, artists,
mechanical and electrical engineers, musicians and actors. The lead designers
manage the work of the other team members and are responsible for the overall
design of the game. Ideas for new games generally originate with the Company's
lead designers. The Company also evaluates coin-operated games designed by
others with a view toward obtaining licenses authorizing it to manufacture and
sell such games. Each concept, whether from the Company's designers or from
third parties, is reviewed initially for technical feasibility and evaluated
relative to several factors, including whether the proposed product fits in with
the Company's general strategy and profitability objectives. The Company
produces games in the action, simulation, adventure and sports categories.
The game design teams operate in a studio environment that encourages
creativity, productivity and cooperation among design teams. The Company
believes that this environment, together with a compensation structure that
rewards design teams for the success of their games and a policy of providing
design teams substantial independence and flexibility, enables the Company to
attract and retain game designers that are among the best in the industry.
The designers are supported by state-of-the-art design technology that
allows for the creation of cutting-edge, three-dimensional graphics and advanced
audio effects. The Company has developed and maintains a substantial library of
proprietary software and development tools, including animation and digitally
texture-mapped polygon images that are used primarily in game products. Use of
these tools streamlines the development process, allowing members of the
development team to focus their efforts on the play and simulation aspects of
the product under development. The Company has also developed software tools to
expedite conversion of software from one hardware format to another and provide
sound and special visual effects. The Company continually creates new software
and development tools and refines and upgrades its existing tools.
Development of a new coin-operated video game generally takes 18 months or
longer, and typically involves the expenditure of substantial funds, including
development, testing and sampling costs. The Company believes that the basic
development costs of a coin-operated game can exceed $2.5 million and, depending
on the specific hardware and software requirements, may cost up to $5.0 million
per game. Because of changing technology during the past few years, both the
time and cost to develop games have increased during the same period. Conversion
of a coin-operated game to a home game usually takes six to 12 months, which
period may overlap with the development period of the coin-operated version of
the game. The Company utilizes both independent third parties and its own
personnel to convert coin-operated games to home games. The Company is generally
obligated to submit new games to the dedicated platform manufacturers for
approval prior to development and/or manufacturing. Additionally, prior to
release, each product undergoes careful quality assurance testing which involves
technical review of each component of the final product and testing on the
applicable platforms.
During the fiscal years ended June 30, 1998, 1997 and 1996, the Company
spent approximately $67.5 million, $55.9 million and $32.5 million,
respectively, on research and development. Certain features of the Company's
products are protected by patents, trademarks and copyrights. The Company is
both a licensor and licensee of these proprietary rights.
6
8
Under the Company's arrangements with GT Interactive Software Corp. ("GT
Interactive"), the Company and GT Interactive shared equally the cost to develop
personal computer CD-ROM versions of those of the Company's coin-operated video
games released prior to March 1997 that GT Interactive elected to release into
the home market. For later games, the Company bears all costs of development,
and GT Interactive bears the cost of translating and localizing games which it
elects to release outside of North America and Japan. In the event that the
Company elects not to convert a coin-operated video game for use on personal
computers, GT Interactive may elect to do so, but must then bear all conversion
costs.
From time to time, the Company has also purchased distribution rights to
certain games under development by third parties for various home video game
platforms and personal computers. Certain of these games are sequels to games
which have previously been successfully released. The Company also from time to
time obtains the right to adapt games owned by third parties from one platform
to another, where it believes that success on the original platform suggests a
probability of success on the other platform.
The Company endeavors to comply with the rules established by a domestic
ratings board voluntarily established by the home game and coin-operated video
game industries and certain foreign countries' ratings boards and properly
displays the ratings received for its products. The Company believes that
ratings as to the violence contained in home games and coin-operated video games
will not have an adverse effect upon the Company so long as such ratings are
consistently applied throughout the industry.
PRODUCTS
Coin-Operated Games. The Company is one of the leading developers and
marketers of coin-operated video games, having released since the late 1970s
such titles as Mortal Kombat, Cruis'n USA, Cruis'n World, NBA Jam, Terminator 2,
Joust, Robotron: 2084, Ms. Pacman, Defender, Pacman and Space Invaders, and,
through its Atari Games subsidiary, such titles as San Francisco Rush Extreme
Racing, Area 51, Primal Rage, Hard Drivin', Gauntlet, Centipede, Missile
Command, Break Out, Asteroids and Pong. In fiscal 1998, the Company released
eight new coin-operated video games: Mortal Kombat 4, NFL Blitz, Off Road
Challenge, Hyper Drive, Rush: The Rock, California Speed, Surf Planet and
Radikal Bikers. During fiscal 1997, seven coin-operated video games were
introduced under the Midway name: Maximum Force, The NHLPA & NHL Present Wayne
Gretzky's 3D Hockey, San Francisco Rush Extreme Racing, Mace -- The Dark Age,
Rampage World Tour, Cruis'n World and War Gods. During fiscal 1996, the Company
introduced TouchMaster, a touchscreen countertop game containing multiple game
options which the Company continued to sell through fiscal 1998 and which the
Company expects to continue to update in fiscal 1999. The Company also released
two software upgrades for the TouchMaster System during fiscal 1998 and
introduced an upright version of the game in the third quarter of fiscal 1998.
At the March 1998 Amusement Showcase International, Play Meter Magazine
named Cruis'n World Best Video Simulator and Maximum Force Best Dedicated Video.
At the March 1997 Amusement Showcase International, Play Meter Magazine named
Cruis'n USA the Best Dedicated Video Game and Area 51 Best Video Kit. Six of
Midway's video games were awarded the American Amusement Machine Association's
("AAMA") Silver, Gold and Platinum Sales Achievement Awards during fiscal 1998,
and two of Midway's video games were Silver and Gold Sales Achievement Awards
during fiscal 1997. In fiscal 1998, Midway's Cruis'n World and San Francisco
Rush coin-operated video games were awarded the AAMA Diamond Sales Achievement
Award -- the highest category of award presented in any given year. During
fiscal 1997, Midway's Mortal Kombat 3 coin-operated video game conversion kit
was awarded the Diamond Sales Achievement Award. At the October 1997 Amusement
and Music Operators Association ("AMOA") trade show, Cruis'n World was named
Most Played Dedicated Video Game.
Coin-operated games are sold to distributors at prices ranging from $3,000
to $7,000. The Company also manufactures kits which can be used by the operator
to convert an existing coin-operated cabinet to a new release. The kits are sold
at prices ranging from $1,000 to $3,000.
The Company has developed a proprietary multi-player interactive
coin-operated video game playing network, known as Wavenet, allowing players to
play against others located at remote coin-operated locations. The Company
believes that this technology will result in greater player utilization and
profitability.
7
9
Home Games. In fiscal 1999, the Company expects to release at least 22 home
game titles. The fiscal 1998 home game product line featured 20 titles,
including Mortal Kombat 4, Mortal Kombat Mythologies: Sub-Zero, Top Gear Rally,
The NHL & NHLPA Present Wayne Gretzky's 3D Hockey '98, San Francisco Rush
Extreme Racing, Rampage World Tour, Mace -- The Dark Age, Gex 2 and Pandemonium
2. During fiscal 1997, the Company published 15 video games for the home market,
including Ultimate Mortal Kombat 3, Mortal Kombat Trilogy, NBA Hangtime, Doom
64, Final Doom, War Gods, The NHLPA & NHL Present Wayne Gretzky's 3D Hockey,
Area 51 and two collections of arcade classics. Most titles are published in
multiple versions, each of which is designed for a specific dedicated platform.
However, certain new games featuring advanced three-dimensional graphics can
only be played on 32- and/or 64-bit platforms. Although the Company did not
release any game titles for hand-held platforms during fiscal 1998, the Company
anticipates releasing at least six new hand-held titles during fiscal 1999.
Most of the Company's home games have suggested retail prices ranging from
$39.95 to $59.95.
1998 MIDWAY HOME GAME RELEASES
The following table sets forth the games that were released by the Company
directly or under licensing arrangements during fiscal 1998 and the platforms on
which each can be played in the home market.
GAME CATEGORY PLATFORM(S)
---- -------- -----------
Arcade's Greatest Hits -- Atari
Collection*............................ Classic Super Nintendo Entertainment System
Arcade's Greatest Hits -- Midway
Collection 2*.......................... Classic PlayStation Personal Computer
BioFreaks................................ Action Nintendo 64
PlayStation
Chopper Attack........................... Action Nintendo 64
NBA Fastbreak '98........................ Sports PlayStation
Gex: Enter the Gecko..................... Action PlayStation
Mace -- The Dark Age*.................... Action Nintendo 64
Maximum Force*........................... Action PlayStation
Saturn
Personal Computer
Micro Machines V3........................ Driving PlayStation
Mortal Kombat 4*......................... Action Nintendo 64
PlayStation
Personal Computer
Mortal Kombat Mythologies: Sub-Zero*..... Action PlayStation
Nintendo 64
Mortal Kombat Trilogy*................... Action Saturn
Personal Computer
The NHL & NHLPA Present Wayne Gretzky's
3D Hockey '98*......................... Sports Nintendo 64
PlayStation
Off Road Challenge*...................... Driving Nintendo 64
Olympic Hockey Nagano '98................ Sports Nintendo 64
Open Ice................................. Sports Personal Computer
Pandemonium 2............................ Action PlayStation
Quake.................................... Action Nintendo 64
8
10
GAME CATEGORY PLATFORM(S)
---- -------- -----------
Rampage World Tour*...................... Action PlayStation
Saturn
Nintendo 64
Personal Computer
Robotron X............................... Action Nintendo 64
San Francisco Rush Extreme Racing*....... Driving Nintendo 64
PlayStation
Top Gear Rally........................... Driving Nintendo 64
- -------------------------
* Based upon one or more previously released coin-operated video games.
1997 MIDWAY HOME GAME RELEASES
The following table sets forth the games that were released by the Company
directly or under licensing arrangements during fiscal 1997 and the platforms on
which each can be played in the home market.
GAME CATEGORY PLATFORM(S)
---- -------- -----------
Arcades Greatest Hits*................... Classic Super Nintendo Entertainment System
Genesis
Saturn
Arcades Greatest Hits -- Atari Collection
1*..................................... Classic PlayStation
Saturn
Area 51*................................. Action PlayStation
Saturn
Personal Computer
Doom 64.................................. Action Nintendo 64
Final Doom............................... Action PlayStation
Mortal Kombat Trilogy*................... Action Nintendo 64
PlayStation
Ms. Pacman*.............................. Classic Super Nintendo Entertainment System
NBA Hangtime*............................ Sports Nintendo 64
Super Nintendo Entertainment System
PlayStation
Genesis
Personal Computer
The NHLPA & NHL Present Wayne Gretzky's
3D Hockey*............................. Sports Nintendo 64
Open Ice*................................ Sports PlayStation
Return Fire.............................. Action Personal Computer
Robotron X*.............................. Action PlayStation
Personal Computer
T-MEK*................................... Action Personal Computer
Ultimate Mortal Kombat 3*................ Action Super Nintendo Entertainment System
Genesis
9
11
GAME CATEGORY PLATFORM(S)
---- -------- -----------
War Gods*................................ Action Nintendo 64
PlayStation
Personal Computer
- -------------------------
* Based upon one or more previously released coin-operated video games.
MARKETING AND DISTRIBUTION
Coin-Operated Games. Coin-operated video games are sold under the Midway
and Atari trademarks. Coin-operated video games are marketed primarily through
approximately 106 independent distributors worldwide. Distributors sell these
products to operators who own and operate the machines and place them in
amusement arcades, restaurants, taverns, convenience stores and movie theaters.
Distributors are primarily responsible for the sale and distribution of these
products in designated territories and are generally expected to provide
replacement parts and service and to arrange for installment financing. It is
customary for distributors of the Company's coin-operated video games also to
distribute games produced by other manufacturers.
Coin-operated games are also marketed through trade shows, promotional
videotapes and advertising in trade publications. The Company maintains separate
sales and marketing teams for its Midway and Atari product lines.
Export sales of coin-operated games, primarily to Western Europe, were
approximately $36.1 million (9.2% of revenues) for the fiscal year ended June
30, 1998 compared with $62.4 million (16.1% of revenues) for the fiscal year
ended June 30, 1997 and $25.3 million (10.3% of revenues) for the fiscal year
ended June 30, 1996. Substantially all foreign sales are made in United States
dollars and, therefore, the Company is not generally subject to the risk of
fluctuation of the value of foreign currencies in relation to the dollar. The
Company believes that while the loss of a single distributor could temporarily
affect the distribution of a particular model, it would not have a material
adverse effect on the business of the Company. In any such event, the Company
believes it could make arrangements with alternate distributors for the
distribution of the Company's coin-operated games.
Home Games. Commencing with the Company's fall 1996 product line, all newly
released home video games are marketed under the Midway trademark. Prior to that
time, the Company's home video games had been marketed under the Williams and
Tradewest trademarks and Atari Games home games had been marketed under the
Tengen and Time Warner Interactive trademarks.
The Company began to publish home video games based on its own
coin-operated video games in September 1995 with the introduction of Mortal
Kombat 3, the best selling home video game in the United States in 1995. Prior
to that time, the Company had granted a third party the right to publish home
video game versions of most coin-operated video games released by the Company.
Home games are marketed in the United States through the Company's internal
sales staff and through independent sales representatives to approximately
14,000 stores domestically, including mass merchandisers, national and regional
retailers, discount store chains, video rental retailers and entertainment
software distributors.
The Company's marketing activities include television and print
advertising, retail store promotions, direct mailings and user support programs.
The Company also utilizes a store-oriented marketing approach which includes
point-of-purchase promotions, use of display cards and other forms of
merchandise displays. The Company's sales literature, which features advance
information on new products, encourages potential users to purchase the
Company's products at their local retail outlets, creating retail demand for new
products before their release. The Company provides technical support for its
home products through its customer support department, which is staffed by
personnel trained to respond to customer inquiries.
Midway has launched a web site located at www.midway.com which displays
currently available games and future game releases searchable by either game
title or platform. Service updates and press releases are
10
12
available on the web site as well as interactive features, including the ability
to download music featured in certain video games and on-line registration for
the Midway Fan Club.
The Company's principal customers for its home video games are mass
merchandisers such as Toys-R-Us, Wal-Mart and Target. Sales to the Company's
largest customer, Toys-R-Us, in fiscal 1998 represented 12.5% of total Company
revenues compared to 10.5% of total Company revenues in fiscal 1997. It is
customary for the sales representatives and the distributors of the Company's
home games who are assigned specific customers to also distribute games produced
by other manufacturers. The Company exploits the worldwide markets for these
games through direct distribution channels and market licensing agreements.
These distribution efforts are supported by marketing programs which emphasize
product awareness, brand recognition, dealer merchandising opportunities and
celebrity endorsements.
The Company has also entered into strategic relationships for the
distribution of home games. In December 1994, the Company appointed GT
Interactive as distributor of certain of its games as adapted for play on
personal computers worldwide. In March 1995, the Company also appointed GT
Interactive as an international distributor (excluding the U.S., Canada and
Mexico) of certain of the Company's domestically distributed home video games
for play on several of the 32- and 64-bit platforms, such as Sega Saturn,
Nintendo 64 and Sony PlayStation. The Company's personal computer and platform
game distribution agreements with GT Interactive expire in March 2000 and June
2001, respectively, subject to various conditions under which each agreement may
be extended if licensing fees remain unrecouped or terminated if certain sales
performance criteria have not been achieved. Games optioned under these
agreements are licensed for varying terms. In March 1996, the Company entered
into agreements with GT Interactive with respect to games developed by Atari
Games, which agreements contain similar expiration and renewal provisions as the
other agreements. Licensing fees under the Atari Games agreements are recoupable
in certain circumstances from royalties payable under the other agreements.
Pursuant to the agreements with GT Interactive described above, GT
Interactive paid non-refundable license fees in the aggregate amount of $35.0
million. GT Interactive will not be required to pay more than $5.0 million of
additional license fees to the Company unless certain sales levels are achieved.
All of the license fees were recognized as revenue by the Company in the year in
which the applicable agreement was entered into ($25.0 million in fiscal 1995
and $10.0 million in fiscal 1996). As a result, the Company does not expect that
it will recognize significant further revenue from the exploitation of its games
in the territories or on the platforms licensed to GT Interactive during at
least the next year. The royalties are contracted in United States dollars and,
therefore, the Company is not generally subject to the risk of fluctuation of
the value of foreign currencies in relation to the dollar. In March 1998, the
Company reacquired from GT Interactive the distribution rights for personal
computer games in North America and Japan for games subsequently released by the
Company and games not previously accepted by GT Interactive. For fiscal 1999,
the Company anticipates releasing at least eight new personal computer games. As
of July 1, 1999, the Company will have the right to terminate GT Interactive's
distribution of future platform games if GT Interactive has not met certain
sales performance criteria. If the Company exercises this right, it will be
obligated to repay the unrecouped portion of the advance paid by GTIS (excluding
the advance for the Midway personal computer games), plus interest.
In March 1994, the Company formed a joint venture with Nintendo to develop
video games on certain platforms being developed by Nintendo. The joint venture
is owned 50% by each of the Company and Nintendo. In connection with the
formation of the joint venture, the Company also entered into arrangements with
Nintendo for the development of a version of Cruis'n USA and Cruis'n World for
Nintendo 64. The joint venture has the right to distribute home versions of any
coin-operated sequels of Cruis'n USA developed by the Company and the right of
first negotiation with respect to distribution of home versions of any
coin-operated video games developed by the Company on a new coin-operated
platform developed by Nintendo. To date, no home video games have been released
through this joint venture, although the Company expects Nintendo to release the
home video game Cruis'n World under license from the joint venture in Fall 1998.
In September 1996, the Company entered into a master license agreement with
Tiger Electronics, Inc. pursuant to which the Company granted Tiger the right to
manufacture and distribute throughout the world
11
13
certain liquid crystal display ("LCD") games based on certain of the Company's
coin-operated video games and home games. The product categories licensed to
Tiger include certain LCD game systems, including cartridges for Tiger's
proprietary hand-held dot matrix LCD game system, and certain other electronic
products. The initial term of the agreement with Tiger expires in December 2001,
subject to certain renewal rights. The license agreements for specific products
optioned under the master license agreement expire upon the later of the
expiration of the master license agreement or 24 months after the prescribed
release date. In March 1998, Tiger assigned the master license agreement to
Hasbro, Inc. in connection with Hasbro's acquisition of Tiger's assets and
business.
MANUFACTURING
Coin-Operated Games. The Company's coin-operated games are manufactured by
WMS at WMS' factory in Illinois pursuant to the Manufacturing Agreement dated as
of April 6, 1998 between the parties (the "Manufacturing Agreement"). Prior to
the Distribution, WMS manufactured the Company's coin-operated video games
pursuant to the Manufacturing and Services Agreement dated as of July 1, 1996
(the "Manufacturing and Services Agreement"), which agreement was entered into
in connection with the Offering. Effective as of April 6, 1998 and in connection
with the Distribution, the Manufacturing Agreement superseded the Manufacturing
and Services Agreement. See "Item 13. Certain Relationships and Related
Transactions." The Company believes such arrangements and facilities are
adequate for its current and planned production needs. Game production is
generally based on advance purchase orders from distributors with respect to
coin-operated games, and no significant inventory of finished goods is
customarily maintained.
Since the amount of backlog orders varies from the beginning to the end of
a normal two-to three-month production process of a game, meaningful comparison
of backlog orders can only be made at the same period during a production cycle
and not at the end of fiscal years. The Company does not consider order backlog
to be a meaningful indicator of future sales.
Most coin-operated games are warranted for a period of 60 days, and home
games are warranted for a period of 90 days. The costs incurred by the Company
in connection with these warranties have been insignificant.
The raw materials used in manufacturing coin-operated video games include
various metals, plastics, wood and glass obtained from numerous sources of
supply. In addition, numerous component parts, including electronic
subassemblies and video monitors, are purchased from suppliers. Wood cabinets
for coin-operated video games are manufactured by WMS' subsidiary Lenc-Smith
Inc. pursuant to the Cabinet Supply Agreement dated as of April 6, 1998 between
Lenc-Smith Inc. and the Company, as well as by other outside suppliers. See
"Item 13. Certain Relationships and Related Transactions." The Company believes
that the sources of supply of component parts and raw materials are adequate and
that substitute sources of materials are available.
Software Products for Home Games. Manufacturing of home games for 32- and
64-bit platforms is performed for the Company by the developer of the game
platform (i.e., Nintendo, Sony or Sega), as required by the applicable platform
license. The Company is one of only a limited number of software publishers who
have been granted the right by Nintendo and Sega to self-manufacture cartridges
for their 16-bit platforms. For such platforms, the Company generally employs
contract manufacturing sources in Mexico. Platform manufacturers typically
retain the right to limit the number of games and approve timing of release
under manufacturing and licensing arrangements. Home game production is based
upon estimated demand for each specific title and the level of the inventory of
finished goods depends upon the variance in market demand during the life of a
specific game title. At the time a product is approved for manufacturing, the
Company must provide certain of the platform manufacturers with a purchase order
for that product and an irrevocable letter of credit for 100% of the purchase
price. Most products manufactured by the dedicated platform manufacturers for
the Company are purchased by the Company on an "as is" and "where is" basis and
are delivered to the Company FOB place of manufacture and shipped at the
Company's own expense and risk. Initial orders generally require 30 to 75 days
to manufacture depending on the platform. Reorders of cartridge based products
require approximately 50 days to manufacture, while reorders of CD-ROM based
products
12
14
generally require only 14 days. Shipping of orders requires an additional three
to 10 days, depending on the mode of transport and location of manufacturer.
The Company leases a warehouse facility in Dallas, Texas from which it
distributes home games. Certain products are imported into the United States,
whereupon they are inspected by customs agents and transferred to the Company's
warehouse facility where they are unpacked and shipped to the Company's
customers. Certain of these product components are assembled into finished
products for the Company by third parties prior to their transfer to the
Company's warehouse facility. Products ordered for inventory are stored at the
warehouse facility and used to fill additional orders as received.
The Company participates in the electronic data interchange program
maintained by most of its largest customers for home games. Re-orders from
inventory are generally filled by the Company within two days. As a result, home
games traditionally have no backlog of orders.
CD-ROM Based Software Products for Personal Computers. Under the Company's
arrangements with GT Interactive, the Company and GT Interactive shared equally
the cost to develop personal computer CD-ROM versions of those of the Company's
coin-operated video games released prior to March 1997 that GT Interactive
elected to release to the home market. If GT Interactive elects to release a
game for the home market, it is responsible for and bears the cost of the
manufacture of the CD-ROMs as well as all other costs related to the sale of
these CD-ROMs. For games released after March 1997, the Company bears all costs
of development, and GT Interactive bears the cost of translating and localizing
games which it elects to release outside of North America and Japan. In the
event that the Company elects not to convert a coin-operated video game for use
on personal computers, GT Interactive may elect to do so, but must then bear all
conversion costs.
PRODUCT RETURNS AND PRICE ADJUSTMENTS
In its home video game business, the Company accepts product returns for
defective products and sometimes provides replacements, markdowns or other
credits on varying terms in the event that the customer holds slow-moving
inventory of the Company's home games. At the time of product shipment, the
Company establishes reserves, including reserves under the Company's policies
for price protection and returns of defective products, which estimate the
potential for future returns of products based on historical return rates,
seasonality of sales, retailer inventories of the Company's products and other
factors. Product returns, markdowns and credits that exceed the Company's
reserves could have a material adverse effect on the Company's business,
operating results and financial condition. Although the Company maintains
reserves which it believes to be adequate with respect to product returns and
price reductions, there can be no assurance that the reserves established will
not be exceeded.
PLATFORM LICENSES
Under non-exclusive license arrangements with Nintendo, Sony and Sega, the
Company has the right to develop and market software products for (i) Nintendo's
Super Nintendo Entertainment System, Nintendo 64, Game Boy and Color Game Boy
platforms, (ii) Sony's PlayStation, and (iii) Sega's Genesis and Saturn
platforms. Generally, no specific hardware license is required for the
development and marketing of personal computer software. Certain of the platform
license agreements or renewals of existing agreements are in the process of
being finalized with the platform manufacturers. However, the Company and such
platform manufacturers have proceeded as if the formal agreements were in place
by approving new game concepts, manufacturing new home games and otherwise. The
Company believes such informal arrangements are not uncommon in the home video
game business. The Company does not believe there is any significant risk that
the definitive platform license agreements will not be finalized on terms
acceptable to the Company.
Each dedicated platform manufacturer requires that the software and a
prototype of each title, together with all related artwork and documentation, be
submitted to such dedicated platform manufacturer, as applicable, for
pre-publication approval. Such approval is generally discretionary. The Company
bears all costs and expenses in connection with its development of games under
its agreements with each of the dedicated platform manufacturers. Dedicated
platform manufacturers charge the Company a fixed amount for each
13
15
software cartridge or CD-ROM manufactured by such dedicated platform
manufacturer. This charge generally includes a manufacturing, printing and
packaging fee, as well as a royalty for the use of the manufacturer's name and
proprietary information and technology, and may be subject to adjustment by such
dedicated platform manufacturer in its discretion. The Company is responsible in
most cases for resolving, at its own expense, any software warranty or repair
claim. To date, the Company has not experienced any material software warranty
claims.
Certain platform license arrangements require that the Company bear the
risk that the information and technology licensed from the dedicated platform
manufacturers and incorporated into the Company's software may infringe the
rights of third parties. The Company must indemnify the dedicated platform
manufacturers against certain claims resulting from the development, marketing,
sale or use of the Company's software products, including certain claims for
copyright, patent or trademark infringement that may be brought against a
dedicated platform manufacturer. To date, no dedicated platform manufacturer has
sought indemnity for any liabilities incurred as a result of such lawsuits or
for any legal expenses incurred in defending such lawsuits. No assurance can be
given, however, that the Company's indemnification obligations under its license
arrangements with the dedicated platform manufacturers will not have a material
adverse effect on the Company's future results of operations or financial
condition.
The Company's licenses from dedicated platform manufacturers may be
terminated by the manufacturer upon a breach or default by the Company, or upon
the occurrence of certain other specified events. Generally, if a dedicated
platform license is terminated by reason of breach by the Company, the Company
will be required to destroy all of its inventory for use on such dedicated
platform. Additionally, upon expiration of a dedicated platform license, the
Company usually is provided a period of limited duration to sell off all its
inventory subject to such license, after which time any remaining inventory is
generally required to be destroyed.
There can be no assurance that the Company's licenses with any of the
dedicated platform manufacturers will be renewed upon expiration. Furthermore,
there is no limit on the number of licenses that dedicated platform
manufacturers may grant to others or on the number of titles that they may
permit their licensees to publish or that they themselves may release in the
future. Nintendo, Sony and Sega are the largest publishers of software for use
on their respective systems and are direct competitors of the Company.
In fiscal 1998, 86% of the Company's unit sales of software products were
for use on 32- and 64-bit game platforms (Nintendo 64, Sony PlayStation and Sega
Saturn platform). The balance of the Company's home video game unit sales were
primarily for the 16-bit Super Nintendo Entertainment System and Sega Genesis
platforms, as well as for portable game systems. The Company expects that an
increasing portion of its revenues in the coming years will be comprised of
games for 32- and 64-bit game platforms. If the popularity of home video games
on dedicated hardware platforms materially declines, or if the Company were to
lose its license to publish software from any of these companies, the Company's
business would be materially and adversely affected.
INTELLECTUAL PROPERTY LICENSES
While the Company primarily seeks to develop original proprietary games,
certain of the Company's games are based on properties or trademarks owned by
third parties, such as the National Basketball Association, National Football
League, National Hockey League or their respective players' associations, and
licensed to the Company. Typically, the Company is obligated to make certain
minimum guaranteed royalty payments over the term of the license and to advance
payment against such guarantees. License agreements generally extend for a term
of two to three years, are terminable in the event of material breach (including
failure to pay any amounts owing to the licensor in a timely manner) by the
Company and certain other events, and, in some cases, are renewable upon payment
of certain minimum guarantees or the attainment of specified sales levels during
the term of the license. Certain licenses are limited to specific territories or
platforms. Each license typically provides that the licensor retains the right
to exploit the licensed property for all other purposes, including the right to
license the property for use with other products and, in some cases, software
for other interactive hardware platforms.
14
16
The Company depends on Nintendo, Sony and Sega for the protection of the
intellectual property rights to their respective hardware platforms and
technology, their ability to control the proliferation of new titles by
licensees and others and their ability to discourage unauthorized persons from
producing software for the Nintendo, Sony and Sega platforms.
PATENT, TRADEMARK, COPYRIGHT AND PRODUCT PROTECTION
Each software title may embody a number of separately protected
intellectual property rights, including: (i) trademarks associated with elements
of the game (e.g., the NBA team logos in NBA Hangtime); (ii) the trademarks
under which the game is marketed (e.g., Mortal Kombat); (iii) the copyrights for
the game software (including the game's audiovisual elements); (iv) copyrights
for the software associated with the hardware platform; and (v) the patents for
inventions in the game software and hardware platforms.
Each dedicated home game includes patents, copyrights and trademarks
licensed from the platform manufacturer. Elements of certain of the Company's
titles are owned by third parties and licensed to the Company. The Company
relies on such third parties for protection of such intellectual property
rights. Their failure to adequately protect such rights could have a material
adverse effect on the Company.
The Company has over 1,000 trademark registrations worldwide for its games
and applies for trademark protection for all of its game titles, other than
those licensed from third parties.
The Company has registered the copyrights in the video game software for
most of its owned coin-operated titles. Notwithstanding such copyright
protection, preventing unauthorized duplication of software products is
difficult and costly and, in the case of personal computer software, such
unauthorized duplication is relatively common. Certain of the Company's personal
computer products require the user to refer to materials shipped with the
software in order to use the product. Despite such protection, the Company
believes that such requirements can be, and in certain instances have been,
circumvented.
The dedicated platform manufacturers have procured patents for certain of
the technology utilized in connection with their respective home game systems.
The dedicated platform manufacturers incorporate security devices in their
cartridges, CD-ROMs and platforms which seek to prevent unlicensed software
products from being played on their platforms. The Company does not own the
trademarks, copyrights or patents, if any, covering the proprietary information
and technology utilized in the dedicated platform manufacturers' cartridges or
CD-ROMs. Accordingly, the Company relies upon each dedicated platform
manufacturer for protection of such intellectual property from infringement and
bears the risk of claims of infringement brought by third parties arising from
the sale of software with respect to intellectual property supplied by third
party developers and embodied in the Company's software products. The Company's
agreements with these outside developers generally require the developers to
indemnify the Company for costs and damages incurred in connection with such
claims. No assurance can be given, however, that such software developers will
have sufficient resources to indemnify the Company fully in respect of any such
claims that may arise.
COMPETITION
The video game business is intensely competitive and is characterized by
the continuous introduction of new titles and the development of new
technologies. The ability of the Company to compete successfully in this market
is based, in large part, upon its ability to select and develop popular titles,
to identify and obtain rights to commercially marketable intellectual properties
and to adapt its products for use with new technologies. In addition, successful
competition is also based upon price, access to retail shelf space in the case
of home games, product enhancements, new product introductions, marketing
support and distribution systems. 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.
In the coin-operated market, the Company competes principally with foreign
manufacturers such as Capcom, Konami, Namco, Sega and Taito.
15
17
In the home market, the Company competes principally with Nintendo, Sony
and Sega, the largest publishers of software for their respective systems. Due
to their dominant position in the industry as primary manufacturers of dedicated
platform hardware and software, Nintendo, Sony and Sega have a competitive
advantage with respect to retail pricing, acquiring intellectual property
licenses and securing shelf space. There can be no assurance that Nintendo, Sony
or Sega will not increase their own software development efforts. The Company
also competes in the United States and Canada with numerous companies licensed
by Nintendo, Sony and Sega to develop software products for use with their
respective systems. These competitors include Acclaim, Capcom, Eidos, Electronic
Arts, GT Interactive, Konami, Lucas Arts, Namco and THQ. Additionally, the
Company's games which are sold for use on personal computers compete with
entertainment software sold by companies such as Acclaim, Cendant, Electronic
Arts, GT Interactive, Learning Co. and Microsoft, among others. The entry and
participation of new industries and companies, including diversified
entertainment companies, in markets in which the Company competes may adversely
affect the Company's performance in such markets.
The Company believes that many of the Company's competitors, in addition to
large software companies such as Microsoft, are developing on-line interactive
games and interactive networks that will be competitive with the Company's
interactive products. See "Factors Affecting Future Performance -- Competition"
below.
FLUCTUATIONS IN OPERATING RESULTS; SEASONALITY
The Company has experienced and expects to continue to experience
significant quarterly fluctuations in net sales and operating results due to a
variety of factors, including fluctuations in the mix of products with varying
profit margins sold by the Company, the size and rate of growth of the consumer
software market, market acceptance of the Company's products and those of its
competitors and dedicated platform manufacturers, development and promotional
expenses relating to the introduction of new products or enhancements of
existing products, the timing and success of product introductions, changes in
pricing policies by the Company and its competitors, the accuracy of the
Company's and retailers' forecasts of consumer demand, the timing of orders from
major customers, order cancellations and delays in shipment. The Company's
expense levels are based, in part, on its expectations regarding future sales
and, as a result, operating results would be adversely affected by a decrease in
sales or a failure to meet the Company's sales expectations.
While the coin-operated video game business is not generally seasonal in
nature, the home video game business is highly seasonal. Sales of home video
games are typically significantly higher during the September and December
quarters due to the year-end holiday buying season. Sales in other quarters are
generally lower and vary significantly as a result of new product introductions
and other factors. There can be no assurance that the Company will achieve
consistent profitability on a quarterly or annual basis.
EMPLOYEES
At June 30, 1998, the Company had approximately 550 employees. The Company
believes that its relations with its employees are satisfactory.
16
18
FACTORS AFFECTING FUTURE PERFORMANCE
Some of the risks and uncertainties which may cause the Company's operating
results to vary from anticipated results or which may materially and adversely
affect its operating results are as follows:
DEPENDENCE ON NEW PRODUCT INTRODUCTIONS; PRODUCT DELAYS
The Company's success depends on generating revenue from new products and
enhancements of existing products. 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 new platforms and
technologies are introduced. In addition, consumer preferences for video games
are difficult to predict, and few video game products achieve sustained market
acceptance. There can be no assurance that new products introduced by the
Company will achieve any significant degree of market acceptance, or that such
acceptance will be sustained for any meaningful period. A significant delay in
the introduction of one or more new products or enhancements or the failure of
new products to achieve or sustain market acceptance would have a material
adverse effect on the Company's business, operating results and financial
condition.
TECHNOLOGICAL CHANGE
The video game market, both in the coin-operated and home segments, is
characterized by rapidly changing technology. The Company must continually
anticipate and adapt its products to emerging technologies, including new
hardware platforms. When the Company chooses to incorporate a new technology in
its products or to publish or develop a product for a new platform, it may be
required to make a substantial development investment one to two years in
advance of initial shipment of such products. There can be no assurance that the
Company will be able to identify accurately which emerging technologies will
gain widespread acceptance. If the Company invests in the development of a video
game that does not achieve significant commercial success, the Company's
revenues from that product will be adversely affected and it may not recover its
development costs. If the Company does not choose to pursue the development of
products incorporating new technology or for new platforms that achieve
significant commercial success, the Company's revenue growth may be adversely
affected. In addition, consumers may defer purchasing software for use on
existing platforms following the announcement of an introduction date for
hardware platforms incorporating new technologies. Accordingly, sales of the
Company's existing software products could be adversely affected by such
announcements. There can be no assurance that the Company will be able to
develop or acquire the expertise necessary to enable it to develop or market
products for emerging technologies.
RELIANCE ON MORTAL KOMBAT PRODUCTS
Revenues from Mortal Kombat products accounted for approximately 19.1%,
22.0% and 34.9% of the Company's total revenues during fiscal 1998, 1997 and
1996, respectively. If Mortal Kombat products fail to continue to sell or if the
Company fails to replace the Mortal Kombat products with additional products
generating significant revenues, the Company's business, operating results and
financial condition could be materially and adversely affected.
FLUCTUATIONS IN OPERATING RESULTS; SEASONALITY
The Company has experienced and expects to continue to experience
significant quarterly fluctuations in net sales and operating results due to a
variety of factors, including fluctuations in the mix of products with varying
profit margins sold by the Company, the size and rate of growth of the consumer
software market, market acceptance of the Company's products and those of its
competitors and dedicated platform manufacturers, development and promotional
expenses relating to the introduction of new products or enhancements of
existing products, the timing and success of product introductions, changes in
pricing policies by the Company and its competitors, the accuracy of the
Company's and retailers' forecasts of consumer demand, the timing of orders from
major customers, order cancellations and delays in shipment. The Company's
expense levels are based, in part, on its expectations regarding future sales
and, as a result,
17
19
operating results would be adversely affected by a decrease in sales or a
failure to meet the Company's sales expectations.
While the coin-operated game business is not generally seasonal in nature,
the home video game business is highly seasonal. Sales of home video games are
typically significantly higher during the September and December quarters due to
the year-end holiday buying season. Sales in other quarters are generally lower
and vary significantly as a result of new product introductions and other
factors. There can be no assurance that the Company will achieve consistent
profitability on a quarterly or annual basis.
COMPETITION
The video game business is intensely competitive and is characterized by
the continuous introduction of new titles and the development of new
technologies. The ability of the Company to compete successfully in this market
is based, in large part, upon its ability to select and develop popular titles,
to identify and obtain rights to commercially marketable intellectual properties
and to adapt its products for use with new technologies. In addition, successful
competition is also based upon price, access to retail shelf space in the case
of home games, product enhancements, new product introductions, marketing
support and distribution channels. 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. See "Business -- Competition" above.
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 games and
interactive networks that will be competitive with the Company's interactive
products. 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 and
financial condition.
PRODUCT RETURNS AND PRICE ADJUSTMENTS
In its home video game business, the Company accepts product returns for
defective products and sometimes provides replacements, markdowns or other
credits on varying terms in the event that the customer holds slow-moving
inventory of the Company's home games. At the time of product shipment, the
Company establishes reserves, including reserves under the Company's policies
for price protection and returns of defective products, which estimate the
potential for future returns of products based on historical return rates,
seasonality of sales, retailer inventories of the Company's products and other
factors. Product returns, markdowns and credits that exceed the Company's
reserves could have a material adverse effect on the Company's business,
operating results and financial condition. Although the Company maintains
reserves which it believes to be adequate with respect to product returns and
price reductions, there can be no assurance that the reserves established will
not be exceeded.
DEPENDENCE ON DEDICATED PLATFORM MANUFACTURERS
In fiscal 1998, 86% of the Company's unit sales of software products were
for use on 32- and 64-bit game platforms (Nintendo 64, Sony PlayStation and Sega
Saturn platform). The balance of the Company's home video game unit sales were
primarily for the 16-bit Super Nintendo Entertainment System and Sega Genesis
platforms, as well as for portable game systems. The Company expects an
increasing portion of its revenues in the coming years will be comprised of
games for 32- and 64-bit game platforms. If the popularity of home video games
on dedicated hardware platforms materially declines, or if the Company were to
lose its license to publish software from any of the major platform
manufacturers, namely Nintendo and Sony, the Company's business would be
materially and adversely affected.
The Company is generally obligated to submit new games to the dedicated
platform manufacturers for approval prior to development and/or manufacturing.
Rejection or substantial delay in approval of a product by a dedicated platform
manufacturer could have a material adverse effect on the Company's financial
18
20
condition and results of operations. The Company has not experienced any
significant delays in the approval process for any of its games in the past.
However, there can be no assurance that the Company will not experience such
delays in the future. The dedicated platform manufacturers may also limit the
number of titles that the Company can release in any year, which may limit any
future growth in sales.
The Company depends on Nintendo, Sony and Sega for the protection of the
intellectual property rights to their respective hardware platforms and
technology, their ability to control the proliferation of new titles by
licensees and others and their ability to discourage unauthorized persons from
producing software for the Nintendo, Sony and Sega platforms. The Company also
relies upon the dedicated platform manufacturers for the manufacturing of
software cartridges and CD-ROMs for their platforms.
MANUFACTURING RISKS
The manufacturing of cartridges and CD-ROMs for the Company's home games is
performed for the Company by third parties. While the Company has not to date
experienced any material delays or interruptions in the manufacture of the
Company's products, there can be no assurance that such delays or interruptions
will not occur or, if any do occur, that they could be remedied without further
delay and without materially and adversely affecting the Company's business,
operating results or financial condition. Unanticipated delays in receipt of
shipments or price increases from any of the Company's contract manufacturing
sources could adversely affect the Company's business.
INTELLECTUAL PROPERTY LICENSES AND APPROVALS
While the Company primarily seeks to develop original proprietary games,
certain of the Company's games are based on properties or trademarks owned by
third parties, such as the National Basketball Association, National Football
League, National Hockey League or their respective players' associations. The
Company's future success may also be dependent upon its ability to procure
licenses for additional popular intellectual properties. There is competition
for such licenses, and there can be no assurance that the Company will be
successful in acquiring additional intellectual property rights with significant
commercial value.
The Company's intellectual property licenses generally require that new
products developed under such licenses be submitted to the licensor for approval
prior to release. Such approval is generally discretionary. Rejection or delay
in approval of a product by a licensor could have a material adverse effect on
the Company's business, operating results and financial condition. While the
Company has not experienced any significant delays in obtaining new product
approvals from its licensors in the past, there can be no assurance that the
Company will not experience delays in the future. The owners of intellectual
property licensed by the Company generally reserve the right to protect such
intellectual property against infringement.
DEPENDENCE ON KEY PERSONNEL
The success of the Company depends to a significant extent upon the
performance of senior management and on its ability to continue to attract,
motivate and retain highly qualified software developers. The loss of services
of senior management, highly-qualified software developers or other key
personnel could have a material adverse effect on the Company. Competition for
highly skilled employees with technical, management, marketing, sales, product
development and other specialized training is intense, and there can be no
assurance that the Company will be successful in attracting and retaining such
personnel. Specifically, the Company may experience increased costs in order to
attract and retain skilled employees.
CONFLICTS OF INTEREST WITH WMS
Certain of the Company's officers and directors are also officers,
directors and stockholders of WMS, and may be subject to various conflicts of
interest including, among others, the performance by the two companies under
their existing agreements with each other as well as the negotiation of any
agreements required to be entered into in the future between these two parties.
Additionally, the Company may be subject to various conflicts of interest
arising from the relationship among it and WMS and their respective affiliates.
19
21
Mr. Neil D. Nicastro, the Chairman of the Board, President, Chief Executive
Officer and Chief Operating Officer of the Company is also a Director of and a
consultant to WMS. Mr. Louis J. Nicastro, a Director of the Company is also the
Chairman of the Board, President and Chief Executive Officer of WMS. Mr. Neil D.
Nicastro is the son of Mr. Louis J. Nicastro. Mr. Harold H. Bach, Jr., Mr.
Kenneth J. Fedesna and Mr. Orrin J. Edidin, officers and employees of WMS and/or
various of its affiliates, are also officers of the Company. Mr. Bach and Mr.
Fedesna are also Directors of the Company. Each of Messrs. Bach, Fedesna and
Edidin will devote such time to the business and affairs of the Company as the
Company's Board of Directors deems appropriate. However, each such person has
other duties and responsibilities with WMS that may conflict with time which
might otherwise be devoted to his duties with the Company. The Company
anticipates that Messrs. Bach, Fedesna and Edidin will resign their positions
with WMS by the end of fiscal 1999.
ITEM 2. PROPERTIES.
The Company's principal office is located at 3401 North California Avenue,
Chicago, Illinois in premises owned by WMS. The following table contains certain
information describing the general character of the Company's other principal
properties, all of which are leased facilities.
APPROXIMATE ANNUAL LEASE
LOCATION PRINCIPAL USE SQUARE FEET RENT($) EXPIRATION DATE
-------- ------------- ----------- ------- ---------------
2727 W. Roscoe Street Video Game Design and 47,500 146,000 06/30/01
Chicago, IL Development
675 Sycamore Drive Video Game Design and 84,501 593,196 07/31/05
Milpitas, CA Development and Offices
800 N. Main Street Video Games Sales and 14,700 77,760 06/01/03
Corsicana, TX Marketing
1800 S. Business 45 Video Games Sales and 6,000 48,000 02/28/99
Corsicana, TX Marketing
2400 S. Business 45 Office/Warehouse 5,000 30,000 month-to-month
Corsicana, TX
2820 Merrell Road Warehouse 28,234 84,702 07/31/99
Dallas, TX
10110 Mesa Rim Road Video Game Design and 27,512 250,644 06/01/02
San Diego, CA Development
6865 Flanders Drive Video Game Design and 4,187 50,244 06/30/02
San Diego, CA Development
6620 Mesa Ridge Road Video Game Sales and 9,104 98,329 06/30/02
San Diego, CA Marketing
The Company believes that its facilities and equipment will be suitable for
the purposes for which they are employed, are adequately maintained and will be
adequate for current requirements and projected normal growth.
ITEM 3. LEGAL PROCEEDINGS.
The Company currently and from time to time is involved in litigation
incidental to the conduct of its business, none of which, in the opinion of the
Company, is likely to have a material adverse effect on the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
20
22
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Reference is made to "Market for the Company's Common Stock and Related
Security-Holder Matters" set forth in the 1998 Annual Report, which information
is incorporated by reference herein.
ITEM 6. SELECTED FINANCIAL DATA.
Reference is made to "Selected Five-Year Financial Data" set forth in the
1998 Annual Report, which information is incorporated by reference herein.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
Reference is made to "Management's Discussion and Analysis of Financial
Condition and Results of Operations" set forth in the 1998 Annual Report, which
information is incorporated by reference herein.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not Applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Reference is made to the Financial Statements and Notes thereto and Report
of Independent Auditors set forth in the 1998 Annual Report, which information
is incorporated by reference herein.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
21
23
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
(a) Identification of Directors. The following table sets forth certain
information with respect to each director of the Company. Mr. Neil D. Nicastro
is the son of Mr. Louis J. Nicastro; otherwise, there is no family relationship
between any of the directors or executive officers of the Company.
Upon approval by the Company's stockholders at the 1998 Annual Meeting of
Stockholders, the Board of Directors was divided into three classes. The initial
term of office for the Class III directors expires at the Annual Meeting of
Stockholders to be held in 1999; the initial term of office for the Class II
directors expires at the Annual Meeting of Stockholders to be held in 2000; and
the initial term of the Class I directors expires at the Annual Meeting of
Stockholders to be held in 2001. Upon expiration of the initial staggered terms,
directors will be elected for three year terms to succeed those directors whose
terms expire.
SHARES OF
COMMON STOCK PERCENTAGE
DIRECTOR OR DEEMED TO BE OF
EXECUTIVE BENEFICIALLY OUTSTANDING
POSITION(S) WITH THE COMPANY AND OFFICER OF THE OWNED AS OF COMMON
NAME (AGE) PRINCIPAL OCCUPATION AS OF 9/15/98 COMPANY SINCE 9/15/98(1) STOCK(2)
---------- ---------------------------------- -------------- ------------ -----------
Class I Directors: Initial term expiring at the Company's 2001 Annual Meeting
Neil D. Nicastro (41)......... Chairman of the Board of Directors, 1998 863,458(3) 2.3%
President, Chief Executive Officer
and Chief Operating Officer of the
Company
William C. Bartholomay (70)... Director of the Company and President 1996 80,370(4) *
of Near North National Group
Norman J. Menell (66)......... Director of the Company and Vice 1996 52,506(4) *
Chairman of the Board of WMS
Louis J. Nicastro (70)........ Director of the Company and Chairman 1998 50,547(4) *
of the Board, President and Chief
Executive Officer of WMS
Class II Directors: Initial term expiring at the Company's 2000 Annual Meeting
Kenneth J. Fedesna (48)....... Executive Vice President -- Coin-Op 1996 132,463(5) *
Video and Director of the Company and
Vice President and General Manager of
Williams Electronics Games, Inc.
William E. McKenna (79)....... Director of the Company and General 1996 51,958(4) *
Partner, MCK Investment Company
Harvey Reich (69)............. Director of the Company and Attorney 1996 51,277(4) *
Ira S. Sheinfeld (60)......... Director of the Company and Attorney, 1996 56,801(4) *
Squadron, Ellenoff, Plesent &
Sheinfeld LLP
Class III Directors: Initial term expiring at the Company's 1999 Annual Meeting
Harold H. Bach, Jr. (66)...... Executive Vice President -- Finance, 1990 121,674(5) *
Treasurer and Chief Financial Officer
and Director of the Company and Vice
President -- Finance, Treasurer,
Chief Financial and Chief Accounting
Officer of WMS
Byron C. Cook (44)............ Executive Vice President -- Home 1996 158,589(5) *
Video and Director of the Company
22
24
SHARES OF
COMMON STOCK PERCENTAGE
DIRECTOR OR DEEMED TO BE OF
EXECUTIVE BENEFICIALLY OUTSTANDING
POSITION(S) WITH THE COMPANY AND OFFICER OF THE OWNED AS OF COMMON
NAME (AGE) PRINCIPAL OCCUPATION AS OF 9/15/98 COMPANY SINCE 9/15/98(1) STOCK(2)
---------- ---------------------------------- -------------- ------------ -----------
Richard D. White (44)......... Director of the Company and Managing 1996 35,000(4) *
Director, CIBC Oppenheimer Corp.
Gerald O. Sweeney, Jr. (46)... Director of the Company and Attorney, 1996 35,000(4) *
Lord, Bissell & Brook
- -------------------------
* Less than 1% of the number of outstanding shares of Common Stock on
September 15, 1998.
(1) Pursuant to Rule 13d-3(d)(1) of the Securities Exchange Act of 1934, as
amended, shares underlying options are deemed to be beneficially owned if
the holder of the option has the right to acquire beneficial ownership of
such shares within 60 days.
(2) For purposes of calculating the percentage of outstanding Common Stock owned
by each director, shares beneficially owned and issuable upon the exercise
of stock options exercisable within 60 days have been deemed to be
outstanding.
(3) Includes 430,000 shares of Common Stock which the director has the right to
acquire upon the exercise of stock options.
(4) Includes 35,000 share of Common Stock which the director has the right to
acquire upon the exercise of stock options.
(5) Includes 90,000 shares of Common Stock which the director has the right to
acquire upon the exercise of stock options.
NEIL D. NICASTRO has been the President and Chief Operating Officer of the
Company since July 1, 1991 and a Director since July 29, 1988. On July 26, 1996,
Mr. Nicastro became Chairman of the Board of Directors and Chief Executive
Officer of the Company, having served as Co-Chief Executive Officer and Chief
Operating Officer since December 1, 1994. Mr. Nicastro served as President and
Chief Operating Officer (1991-1995), Treasurer (1991-1994), Executive Vice
President and Treasurer (1989-1991) and Senior Vice President and Treasurer
(1988-1989). Mr. Nicastro has also served as a Director of WMS since 1986 and as
consultant to WMS since April 6, 1998. Mr. Nicastro was elected President of WMS
June 18, 1991, sole Chief Executive Officer June 26, 1996, Co-Chief Executive
Officer August 29, 1994 and Chief Operating Officer September 30, 1990. Mr.
Nicastro resigned his officerships with WMS on April 6, 1998, the date WMS
completed the Distribution.
WILLIAM C. BARTHOLOMAY is President of Near North National Group, Chicago,
Illinois (insurance brokers) and Chairman of the Board of the Atlanta Braves
(National League Baseball). He has served as Vice Chairman of Turner
Broadcasting System, Inc., a division of Time Warner Inc. since April 1994
having also held that office during the period 1976-1992 and having served as a
Director (1976-1994). He also served as Vice Chairman of the Board of Directors
of Frank B. Hall & Co. Inc. (1974-1990). Mr. Bartholomay has also served as a
Director of WMS since 1981 and was elected as a Director of the Company in
October 1996.
NORMAN J. MENELL has been Vice Chairman of the Board of Directors of WMS
since 1990 and a Director of WMS since 1980. He also served as President
(1988-1990), Chief Operating Officer (1986-1990) and Executive Vice President
(1981-1988) of WMS and was elected as a Director of the Company in October 1996.
LOUIS J. NICASTRO has been the President and Chief Executive Officer of WMS
since April 6, 1998. He has served as Chairman of the Board of Directors of WMS
since its incorporation in 1974. Mr. Nicastro has also served WMS as Co-Chief
Executive Officer (1994-1996), Chief Executive Officer (1974-1994), President
(1985-1988 and 1990-1991) and Chief Operating Officer (1985-1986 and 1998). Mr.
Nicastro also served as Chairman of the Board and Chief Executive Officer of WHG
Resorts & Casinos Inc. and its predecessors from 1983 until January 1998. Mr.
Nicastro was a Director of the Company from 1988 until June 26, 1996. He
rejoined the Company as a Director on August 30, 1996. Mr. Nicastro also served
as
23
25
Chairman of the Board and Co-Chief Executive Officer of the Company from
December 1, 1994 to June 26, 1996, Chairman of the Board and Chief Executive
Officer of the Company (1988-1994), and President of the Company (1988-1989 and
1990-1991).
KENNETH J. FEDESNA became a Director and Executive Vice
President -- Coin-Op Video of the Company on August 30, 1996. Mr. Fedesna served
as Vice President and General Manager of the Company from July 29, 1988 to
August 30, 1996. He has also served as Vice President and General Manager of
Williams Electronics Games, Inc., a wholly-owned subsidiary of WMS, for in
excess of five years and was a Director of WMS from 1993 until his resignation
on April 6, 1998.
WILLIAM E. MCKENNA has served as a General Partner of MCK Investment
Company, Beverly Hills, California for in excess of five years. He also is a
Director of California Amplifier, Inc., Drexler Technology Corporation and
Safeguard Health Enterprises, Inc. Mr. McKenna has also served as a Director of
WMS since 1981 and was elected as a Director of the Company in October 1996.
HARVEY REICH was a member of the law firm of Robinson Brog Leinwand Greene
Genovese & Gluck, P.C., New York, New York and its predecessor firms for in
excess of five years until his retirement from that firm in July 1998. He has
also served as a Director of WMS since 1983 and was elected as a Director of the
Company in October 1996.
IRA S. SHEINFELD has been a member of the law firm of Squadron, Ellenoff,
Plesent & Sheinfeld LLP, New York, New York for in excess of five years. He has
also served as a Director of WMS since 1993 and was elected as a Director of the
Company in October 1996.
HAROLD H. BACH, JR. became a Director, Executive Vice President -- Finance
and Chief Financial Officer of the Company on August 30, 1996. Previously, Mr.
Bach served as Senior Vice President -- Finance and Chief Financial Officer of
the Company from September 17, 1990 to August 30, 1996, and he has served as
Treasurer continuously since December 1, 1994. Additionally, Mr. Bach has also
served as Vice President -- Finance, Chief Financial and Chief Accounting
Officer of WMS for in excess of five years. Prior to joining WMS, Mr. Bach was a
partner in the accounting firms of Ernst & Young (1989-1990) and Arthur Young &
Company (1967-1989).
BYRON C. COOK became a Director and Executive Vice President -- Home Video
of the Company on August 30, 1996. Mr. Cook is also the President and Chief
Operating Officer of Midway Home Entertainment Inc., a wholly-owned subsidiary
of the Company, positions he assumed upon the acquisition of Tradewest in April
1994. Prior to the acquisition, Mr. Cook was President of Tradewest (1988-1994)
as well as a co-founder thereof.
RICHARD D. WHITE has been a Managing Director of CIBC Wood Gundy Capital
Corp., New York, New York, an affiliate of CIBC Oppenheimer Corp. and its
predecessor, for in excess of five years, and was elected as a Director of the
Company in October 1996. Mr. White is also a director of Vestcom International,
Inc.
GERALD O. SWEENEY, JR. has been a member of the law firm Lord, Bissell &
Brook, Chicago, Illinois for in excess of five years. He was elected as a
Director of the Company in November 1996.
(b) Identification of Executive Officers. The following table sets forth
certain information with respect to each executive officer of the Company. Each
executive officer serves as an executive officer until the next
24
26
annual meeting of the Company's Board of Directors and until his respective
successor is duly elected and qualify.
NAME AGE POSITION
---- --- --------
Neil D. Nicastro..................... 41 Chairman of the Board of Directors, President, Chief
Executive Officer and Chief Operating Officer
Harold H. Bach, Jr................... 66 Executive Vice President -- Finance, Treasurer and Chief
Financial Officer
Byron C. Cook........................ 44 Executive Vice President -- Home Video
Kenneth J. Fedesna................... 48 Executive Vice President -- Coin-Op Video
Orrin J. Edidin...................... 37 Vice President, Secretary and General Counsel
The current principal occupation or employment of Messrs. Nicastro, Bach,
Cook and Fedesna during the last five years is set forth in Item 10(a) above.
See also "Item 11. Executive Compensation -- Employment Contracts" with respect
to the term of employment of each of Mr. Nicastro and Mr. Cook.
Mr. Edidin has served as Vice President, Secretary and General Counsel of
the Company since June 30, 1997. Mr. Edidin served as Associate General Counsel
of Fruit of the Loom, Inc. from August 1992 until May 1997. Mr. Edidin has also
served as Vice President, Secretary and General Counsel of WMS since May 30,
1997.
(c) Section 16(a) Beneficial Ownership Reporting Compliance. Section 16(a)
of the Securities Exchange Act of 1934 requires the Company's officers and
directors, and persons who own more than 10 percent of a registered class of the
Company's equity securities, to file reports of ownership and changes in
ownership with the Securities and Exchange Commission. Such reporting persons
are required by regulation to furnish the Company with copies of all Section
16(a) reports that they file.
Based on its review of the copies of such reports received by it, or
written representations from certain reporting persons that no Form 5 was
required for those persons, the Company believes that, during the period from
July 1, 1997 through June 30, 1998, all filing requirements applicable to its
officers, directors and greater than 10 percent beneficial owners were complied
with, except that WMS was late in filing its Form 4 reporting the Distribution.
ITEM 11. EXECUTIVE COMPENSATION.
The executive officers of the Company (other than Mr. Neil D. Nicastro and
Mr. Byron C. Cook) received no compensation from the Company during the fiscal
years ended June 30, 1998, 1997 or 1996. The Summary Compensation Table below
sets forth the cash compensation paid by WMS (or in the case of (i) Mr.
Nicastro, (A) for the period from the date of the Offering until the date of the
Distribution, by WMS and the Company, and (B) for the period from the date of
the Distribution through June 30, 1998, by the Company and (ii) Mr. Cook, by the
Company) for service in all capacities (including on behalf of the Company)
during the fiscal years ended June 30, 1998, 1997 and 1996 to each of the
Company's executive officers who served during such period and whose
compensation from WMS or the Company exceeded $100,000. Pursuant to the
Manufacturing and Services Agreement between WMS and the Company, after the
Offering and until the Distribution the compensation paid by WMS to the
executive officers of the Company (other than Messrs. Nicastro and Cook) was
allocated to the Company based upon estimates by management of the Company and
management of WMS of the percentage of time devoted to the Company. After the
Distribution, compensation paid by WMS to the executive officers of the Company
(other than Messrs. Nicastro and Cook) is reimbursed by the Company in amounts
equal to the Company's allocated cost pursuant to the Temporary Support Services
Agreement dated as of April 6, 1998 between WMS and the Company (the "Temporary
Support Services Agreement"). Management of the Company believes that such
executive officers devoted 40% to 70% of their time to the Company during fiscal
1998. The results of operations for each of the fiscal years ended June 30,
1998, 1997 and 1996 include an allocation of the compensation of the Company's
executive officers based on estimates by management of WMS. See
25
27
"Item 13. Certain Relationships and Related Transactions" for a description of
the Manufacturing and Services Agreement and the Temporary Support Services
Agreement.
SUMMARY COMPENSATION TABLE
LONG TERM
COMPENSATION
ANNUAL COMPENSATION AWARDS
------------------------------ -------------
SECURITIES
UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY($) BONUS(4) OPTIONS(#)(1) COMPENSATION($)(2)
--------------------------- ---- --------- -------- ------------- ------------------
Neil D. Nicastro(3).................. 1998 575,000 1,387,820 150,000 47,074(4)
Chairman of the Board, Chief 1997 600,000 969,160 500,000 54,632(4)
Executive Officer, President and 1996 532,500 267,600 -- 35,791(4)
Chief Operating Officer
Harold H. Bach, Jr................... 1998 300,000 220,000 50,000
Executive Vice
President -- Finance, 1997 300,000 175,000 100,000 --
Treasurer and Chief Financial
Officer 1996 262,500 67,800 -- --
Byron C. Cook........................ 1998 300,000 350,000 50,000 --
Executive Vice President--Home
Video........................... 1997 300,000 250,000 100,000 --
1996 250,000 150,000 -- --
Kenneth J. Fedesna................... 1998 310,000 150,000 50,000 2,500(5)
Executive Vice President--Coin-Op 1997 310,000 150,000 100,000 2,500(5)
Video 1996 267,500 66,000 -- 2,500(5)
Orrin J. Edidin...................... 1998 180,000 75,000 35,000 --
Vice President, Secretary and
General Counsel
- -------------------------
(1) Excludes options to purchase shares of WMS common stock, all of which were
granted at an exercise price equal to market value on the date of grant. In
fiscal 1998, Mr. Nicastro received options to purchase 250,000 shares of WMS
common stock, and Mr. Edidin received 25,000 options to purchase WMS common
stock. In fiscal 1997, Mr. Edidin received 25,000 options to purchase WMS
common stock.
(2) Excludes adjustments to WMS options made pursuant to the adjustment plan
described under "Compensation from WMS Option Adjustment" below.
(3) Mr. Nicastro also received severance payments from WMS in fiscal 1998
consisting of $2,500,000 in addition to the stock options described in
footnote 1 above. See "Employment Agreements" below.
(4) Amount shown for Mr. Neil D. Nicastro includes for fiscal 1998, 1997 and
1996 life insurance premiums of $1,571, $1,467 and $691, respectively, and
$45,503, $53,165 and $35,100 for fiscal 1998, 1997 and 1996, respectively,
accrual for contractual retirement benefits.
(5) Amount shown for Mr. Fedesna includes life insurance premiums.
26
28
The following table sets forth certain information with respect to options
to purchase Common Stock granted during fiscal year 1998 under the Company's
Stock Option Plans for the executive officers named in the Summary Compensation
Table above.
OPTION GRANTS IN LAST FISCAL YEAR
INDIVIDUAL GRANTS
----------------- POTENTIAL REALIZABLE VALUE
PERCENT OF AT ASSUMED ANNUAL RATE
TOTAL OPTIONS OF STOCK PRICE
GRANTED TO APPRECIATION FOR OPTION
NUMBER OF SECURITIES EMPLOYEES IN TERM (1)
UNDERLYING OPTIONS FISCAL EXERCISE PRICE --------------------------
NAME GRANTED (#) YEAR (%) ($/SHARE) EXPIRATION DATE 5%($) 10%(S)
---- -------------------- ------------- -------------- --------------- ----- ------
Neil D. Nicastro........ 150,000(2) 31.6 16.50 5/17/08 1,556,514 3,944,512
Harold H. Bach, Jr...... 50,000(2) 10.5 16.50 5/17/08 518,838 1,314,837
Byron C. Cook........... 50,000(2) 10.5 16.50 5/17/08 518,838 1,314,837
Kenneth J. Fedesna...... 50,000(2) 10.5 16.50 5/17/08 518,838 1,314,837
Orrin J. Edidin......... 35,000(3) 7.4 16.50 5/17/08 363,187 920,386
- -------------------------
(1) The assumed appreciation rates are set pursuant to the rules and regulations
promulgated under the Securities Exchange Act of 1934, as amended, and are
not derived from the historical or projected prices of the Company's Common
Stock. Total potential stock price appreciation from May 18, 1998 to May 17,
2008 for all stockholders based on the price of $16.50 per share of Common
Stock on May 18, 1998 and a total of 38,500,000 shares of Common Stock then
outstanding would be $399,505,000 and $1,012,425,000 at assumed rates of
stock appreciation of 5% and 10%, respectively.
(2) Twenty percent of these options were immediately exercisable upon the date
of the grant. The balance of the options become exercisable up to 40%, 60%,
80% and 100% of the total number of options granted upon the first, second,
third and fourth anniversaries, respectively, of the date of the grant.
(3) This option becomes exercisable up to 10%, 30%, 60% and 100% of the total
number of options granted upon the first, second, third and fourth
anniversaries, respectively, of the date of the grant.
27
29
The following table sets forth certain information with respect to the
number and assumed values of options to purchase Common Stock owned by the
executive officers named in the Summary Compensation Table above.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR-END OPTION VALUES
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS AT
SHARES OPTIONS AT 6/30/98(#) 6/30/98($)(1)
ACQUIRED EXERCISABLE(E) EXERCISABLE(E)
NAME ON EXERCISE(#) VALUE REALIZED($) UNEXERCISABLE(U) UNEXERCISABLE(U)
---- -------------- ----------------- ---------------------- -----------------------
Neil D. Nicastro....... -- -- 330,000(E) --(E)
320,000(U) --(U)
Harold H. Bach, Jr. ... -- -- 70,000(E) --(E)