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<SEC-DOCUMENT>0000950123-96-005791.txt : 19961021

<SEC-HEADER>0000950123-96-005791.hdr.sgml : 19961021

ACCESSION NUMBER:     0000950123-96-005791

CONFORMED SUBMISSION TYPE:   S-1/A

PUBLIC DOCUMENT COUNT:       18

FILED AS OF DATE:     19961018

SROS:         NONE

 

FILER:

 

    COMPANY DATA:

       COMPANY CONFORMED NAME:          MIDWAY GAMES INC

       CENTRAL INDEX KEY:           0001022080

       STANDARD INDUSTRIAL CLASSIFICATION:    MISCELLANEOUS MANUFACTURING INDUSTRIES [3990]

 

    FILING VALUES:

       FORM TYPE:    S-1/A

       SEC ACT:      1933 Act

       SEC FILE NUMBER:  333-11919

       FILM NUMBER:      96645520

 

    BUSINESS ADDRESS:

       STREET 1:     3401 NORTH CALIFORNIA AVE

       CITY:         CHICAGO

       STATE:        IL

       ZIP:          60618

 

    MAIL ADDRESS:

       STREET 1:     3401 NORTH CALIFORNIA AVE

       CITY:         CHICAGO

       STATE:        IL

       ZIP:          60618

</SEC-HEADER>

<DOCUMENT>

<TYPE>S-1/A

<SEQUENCE>1

<DESCRIPTION>AMENDMENT NO. 2 TO FORM S-1

<TEXT>

 

<PAGE>   1

 

  

    AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON OCTOBER 18, 1996

   

                                                      REGISTRATION NO. 333-11919

- --------------------------------------------------------------------------------

- --------------------------------------------------------------------------------

                       SECURITIES AND EXCHANGE COMMISSION

                             WASHINGTON, D.C. 20549

                            ------------------------

 

  

                                AMENDMENT NO. 2

   

                                       TO

 

                                    FORM S-1

                             REGISTRATION STATEMENT

                                     UNDER

                           THE SECURITIES ACT OF 1933

                            ------------------------

 

                               MIDWAY GAMES INC.

             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

 

<TABLE>

<S>                                   <C>                                   <C>

             DELAWARE                                3999                               22-2906244

   (STATE OR OTHER JURISDICTION          (PRIMARY STANDARD INDUSTRIAL                (I.R.S. EMPLOYER

         OF INCORPORATION)                CLASSIFICATION CODE NUMBER)             IDENTIFICATION NUMBER)

</TABLE>

 

                          3401 NORTH CALIFORNIA AVENUE

                            CHICAGO, ILLINOIS 60618

                                 (312) 961-2222

              (ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,

       INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)

                            ------------------------

 

                                NEIL D. NICASTRO

                             CHAIRMAN OF THE BOARD

                               MIDWAY GAMES INC.

                          3401 NORTH CALIFORNIA AVENUE

                            CHICAGO, ILLINOIS 60618

                                 (312) 961-2222

           (NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,

                   INCLUDING AREA CODE, OF AGENT FOR SERVICE)

                            ------------------------

 

                                   Copies to:

 

<TABLE>

<S>                                                     <C>

                PAUL S. GOODMAN, ESQ.                                  HOWARD L. SHECTER, ESQ.

                SHACK & SIEGEL, P.C.                                 MORGAN, LEWIS & BOCKIUS LLP

                  530 FIFTH AVENUE                                         101 PARK AVENUE

              NEW YORK, NEW YORK 10036                                NEW YORK, NEW YORK 10178

                   (212) 782-0700                                          (212) 309-6000

</TABLE>

 

                            ------------------------

 

     APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO PUBLIC: As soon as

practicable after this Registration Statement becomes effective.

 

     If any of the securities being registered on this form are to be offered on

a delayed or continuous basis pursuant to Rule 415 under the Securities Act of

1933, check the following box.  / /

 

     If this Form is filed to register additional securities for an offering

pursuant to Rule 462(b) under the Securities Act, please check the following box

and list the Securities Act registration statement number of the earlier

effective registration statement for the same offering.  / /

 

     If this Form is a post-effective amendment filed pursuant to Rule 462(c)

under the Securities Act, check the following box and list the Securities Act

registration statement number of the earlier effective registration statement

for the same offering.  / /

 

     If delivery of the prospectus is expected to be made pursuant to Rule 434,

please check the following box.  / /

                            ------------------------

     THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR

DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL

FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION

STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF

THE SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME

EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),

MAY DETERMINE.

- --------------------------------------------------------------------------------

- --------------------------------------------------------------------------------

<PAGE>   2

 

  

                 SUBJECT TO COMPLETION, DATED OCTOBER 18, 1996

   

                                5,100,000 SHARES

 

                               MIDWAY GAMES INC.

 

                                  COMMON STOCK

                            ------------------------

 

     All of the shares of the Company's Common Stock offered hereby (the

"Shares") are being sold by Midway Games Inc. (the "Company"). Immediately

following the offering (the "Offering"), WMS Industries Inc. ("WMS") will own

approximately 86.8% of the outstanding shares of Common Stock (85.1% if the

Underwriters' over-allotment option is exercised in full).

 

     Prior to the Offering, there has been no public market for the Company's

Common Stock. It is anticipated that the initial public offering price will be

between $20.00 and $22.00 per share. See "Underwriting" for a discussion of the

factors to be considered in determining the initial public offering price. The

Common Stock has been approved for listing on the New York Stock Exchange under

the trading symbol "MWY," subject to official notice of issuance.

 

     SEE "RISK FACTORS" BEGINNING ON PAGE 7 FOR A DISCUSSION OF CERTAIN FACTORS

THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE SHARES.

                            ------------------------

 

THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND

  EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE

     SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION

      PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY

        REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.

 

<TABLE>

<S>                             <C>                   <C>                   <C>

- -------------------------------------------------------------------------------------------------

- -------------------------------------------------------------------------------------------------

                                        PRICE             UNDERWRITING            PROCEEDS

                                      TO PUBLIC            DISCOUNT(1)          TO COMPANY(2)

- -------------------------------------------------------------------------------------------------

Per Share......................           $                     $                     $

Total(3).......................           $                     $                     $

- -------------------------------------------------------------------------------------------------

- -------------------------------------------------------------------------------------------------

</TABLE>

 

(1) See "Underwriting" for information concerning indemnification of the

    Underwriters and other information.

 

  

(2) Before deducting expenses of the Offering payable by the Company estimated

    at $          .

   

 

(3) The Underwriters have been granted an option, exercisable within 30 days

    from the date hereof, to purchase up to 765,000 additional shares of Common

    Stock at the Price to Public per share, less the Underwriting Discount, for

    the purpose of covering over-allotments, if any. If the Underwriters

    exercise such option in full, the total Price to Public, Underwriting

    Discount and Proceeds to Company will be $          , $          , and

    $          , respectively. See "Underwriting."

                            ------------------------

 

     The Shares are offered severally by the Underwriters when, as and if

delivered to and accepted by them, subject to their right to withdraw, cancel or

reject orders in whole or in part and subject to certain other conditions. It is

expected that delivery of certificates representing the Shares will be made

against payment on or about             , 1996 at the office of Oppenheimer &

Co., Inc., Oppenheimer Tower, World Financial Center, New York, New York 10281.

                            ------------------------

 

OPPENHEIMER & CO., INC.

            HAMBRECHT & QUIST

                        UBS SECURITIES

                                     WASSERSTEIN PERELLA SECURITIES, INC.

               The date of this Prospectus is             , 1996.

 

     Information contained herein is subject to completion or amendment. A

     registration statement relating to these securities has been filed with the

     Securities and Exchange Commission. These securities may not be sold nor

     may offers to buy be accepted prior to the time the registration statement

     becomes effective. This prospectus shall not constitute an offer to sell or

     the solicitation of an offer to buy nor shall there be any sale of these

     securities in any State in which such offer, solicitation or sale would be

     unlawful prior to registration or qualification under the securities laws

     of any such State.

<PAGE>   3

 

                                [COLOR PICTURES]

 

  

     IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT

TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE SHARES OF THE

COMPANY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET.

SUCH TRANSACTIONS MAY BE EFFECTED ON THE NEW YORK STOCK EXCHANGE, IN THE

OVER-THE-COUNTER MARKET OR OTHERWISE. SUCH STABILIZING, IF COMMENCED, MAY BE

   

DISCONTINUED AT ANY TIME.

 

                                        2

<PAGE>   4

 

                               PROSPECTUS SUMMARY

 

  

     The following summary is qualified in its entirety by, and should be read

in conjunction with, the more detailed information and financial statements and

pro forma financial information, including the notes thereto, appearing

elsewhere in this Prospectus. Unless otherwise indicated, all financial

information, share and per share data (i) assume no exercise of the

Underwriters' over-allotment option, (ii) assume no exercise of currently

outstanding stock options and (iii) give effect to a 33,400 for one stock split

in the Company's Common Stock, par value $.01 per share (the "Common Stock"), to

be effected immediately prior to the Offering. As used in this Prospectus, the

terms "Company" and "Midway" refer collectively to Midway Games Inc. and its

subsidiaries, unless the context otherwise requires. Pro forma financial

information used in this Prospectus gives effect to the acquisition of Atari

Games Corporation ("Atari Games") as if it had occurred on July 1, 1995.

   

 

                                  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 10 million copies in

the home market), Cruis'n USA, NBA Jam, Joust, Defender, Pacman and Space

Invaders, and, through its recently acquired Atari Games subsidiary, such

leading games as Area 51, Gauntlet, Centipede, Asteroids and Pong. Midway's

games are available for play on all major dedicated home video game platforms,

including Nintendo, Sony and Sega, and personal computers.

 

  

     Midway 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, Midway

had granted Acclaim Entertainment 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 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 $32.5 million in fiscal

1996, up from $14.7 million in fiscal 1995. As a result of these efforts, in

fiscal 1997 Midway expects to release approximately 12 coin-operated video games

and publish approximately 20 home video games compared to four coin-operated

video games and eight home video games in fiscal 1996.

   

 

     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 fun and exciting to play,

       which requires the creative talents of experienced game designers. Midway

       employs over 250 game design personnel organized in teams comprised of

       programmers, artists, mechanical and electrical engineers, musicians and

       actors. The design teams are supported by state-of-the-art design

       technology that allows for the creation of cutting-edge three-dimensional

       graphics and 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 spend 50c almost every

       two minutes. Midway considers coin-operated 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 video 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 that (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 releasing the game in the home

 

                                        3

<PAGE>   5

 

       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 the

       subsequent home version 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. Midway is a leading developer of video games for the

       32- and 64-bit game platforms, commonly referred to as "next generation"

       platforms, which are currently being marketed by hardware manufacturers.

       In fiscal 1997, Midway expects to release 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 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. In fiscal 1997, Midway plans

       to release a new coin-operated game, Mortal Kombat 4, and three

       additional home games, Ultimate Mortal Kombat 3, Mortal Kombat Trilogy

       and an adventure game tentatively entitled Mortal Kombat Mythologies. An

       animated television series based on Mortal Kombat is scheduled to air in

       the fall of 1996, and a sequel to the movie version of Mortal Kombat is

       scheduled to be released in the summer of 1997. 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 plans to release three collections of arcade classic games and

       Robotron X, a new version of a classic arcade game.

 

     - DEVELOP 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

       consistently 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.

 

   

     Midway's revenue increased to $245.4 million in fiscal 1996, from $180.5

million in fiscal 1995 and $121.9 million in fiscal 1994. Such growth resulted

from the growth in Midway's revenues from home games which increased to $154.1

million in fiscal 1996 (63% of revenues), from $60.8 million in fiscal 1995 (34%

of revenues) and $24.0 million in fiscal 1994 (20% of revenues). In fiscal 1997,

Midway plans to release approximately 12 coin-operated video games, including

Mortal Kombat 4, Cruis'n World and War Gods, and approximately 20 home video

games, including Ultimate Mortal Kombat 3, Mortal Kombat Trilogy, Mortal Kombat

Mythologies, Doom 64, Final Doom, War Gods, Area 51, The NHLPA & NHL Present

Wayne Gretzky's 3D Hockey and NBA Hangtime.

   

 

     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 dedicated platform

versions of 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 Best Buy, national and regional

retailers, discount store chains, video rental retailers and entertainment

software distributors.

 

     Prior to the Offering, Midway was a wholly-owned subsidiary of WMS

Industries Inc. WMS is a leading designer, manufacturer and marketer of

coin-operated pinball and novelty games and gaming equipment. WMS also owns

interests in hotels and casinos in Puerto Rico which WMS has announced it

intends to spin off to its stockholders in early 1997. After the Offering, WMS

will continue to provide certain management, administrative, sales, marketing

and accounting and information services to Midway and will act as a contract

manufacturer for Midway's coin-operated games. Immediately following the

Offering, WMS will own approximately 86.8% of the outstanding shares of Common

Stock (85.1% if the Underwriters' over-allotment option is exercised in full).

 

                                        4

<PAGE>   6

 

                                      THE OFFERING

 

<TABLE>

<S>                                 <C>

Common Stock offered.............   5,100,000 shares.

Common Stock to be outstanding

  after the Offering(1)..........   38,500,000 shares.

Use of proceeds..................   For working capital and general corporate

                                    purposes, to pay dividend notes to WMS in

                                    the aggregate amount of $50.0 million and to

                                    repay other seasonal working capital

                                    borrowings from WMS. See "Use of Proceeds."

Proposed New York Stock Exchange

  symbol.........................   MWY

</TABLE>

 

- ---------------

(1) Excludes 765,000 shares issuable upon exercise of the Underwriters'

    over-allotment option and 1,455,000 shares of Common Stock issuable upon the

    exercise of options which have been or will be granted prior to the Offering

    under the Company's Stock Option Plan exercisable at the initial offering

    price per share.

 

  

                                  RISK FACTORS

   

 

  

     An investment in the Shares being offered by this Prospectus involves

certain risks associated with the Company's business, including the following:

(i) the Company's dependence on new product introductions and the possibility of

delays in the introduction of new products; (ii) the Company's ability to

anticipate and adapt to emerging technologies for its products; (iii) reliance

by the Company on certain of its products; (iv) fluctuations in operating

results and seasonality; (v) competition; (vi) product returns and price

adjustments; (vii) the Company's dependence on dedicated platform manufacturers;

(viii) certain manufacturing risks; (ix) the Company's ability to procure

intellectual property licenses and approvals; (x) dependence on key personnel;

(xii) voting control of the Company by WMS; (xiii) various conflicts of interest

between the Company and WMS which could arise following the Offering; (xiv) the

Company's lack of operating history as a stand-alone company; (xv) the Company's

various continuing arrangements with WMS; (xvi) the absence of a public market

and the possible volatility of the price of the Common Stock; (xvii) the

immediate dilution in the tangible net book value per share of Common Stock;

(xviii) the Company's dividend policy; (xix) various anti-takeover provisions;

and (xx) the number of shares of Common Stock eligible for future sale. For a

fuller discussion of these risk factors, see "Risk Factors."

   

                            ------------------------

 

  

     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 Prospectus are either registered trademarks of the Company

or the subject of pending trademark applications. Nintendo(R), Super Nintendo

Entertainment System(R), Game Boy(R) and Nintendo 64(R) are registered

trademarks of Nintendo of America, Inc. Sega(R), Genesis(R), Game Gear(R) and

Saturn(R) are registered trademarks of Sega of America, Inc. Sony PlayStation(R)

is a registered trademark of Sony Computer Entertainment Inc. This Prospectus

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.

   

                            ------------------------

 

  

     The Company intends to distribute to its stockholders annual reports

containing audited financial statements, certified by its independent certified

public accountants, and to make available to its stockholders quarterly reports

containing unaudited interim financial information for each of the first three

quarters of each fiscal year.

   

 

                                        5

<PAGE>   7

 

                             SUMMARY FINANCIAL DATA

 

  

     The summary financial data set forth below for the fiscal years ended June

30, 1994, 1995 and 1996 have been derived from the audited combined financial

statements of the Company for such periods. The combined financial statements

for the fiscal years ended June 30, 1992 and 1993 have not been audited, but, in

the opinion of management, reflect all adjustments, consisting only of normal

recurring adjustments, considered necessary for a fair presentation of the

results for such periods. The historical financial statements of the Company for

the foregoing periods give effect as of July 1, 1996 to certain transfers of the

portions of the pinball operations of WMS that were conducted by the Company and

the transfer to the Company of the stock of certain subsidiaries of WMS that

conduct the home video games business and the Atari Games business. See Note 2

to the Combined Financial Statements of the Company. The pro forma statement of

income data gives effect to the acquisition of Atari Games as if it had occurred

on July 1, 1995 and includes certain pro forma adjustments relating to the

implementation of the Company's integration plan. The adjusted balance sheet

data reflect the effect of the Offering and intended use of proceeds as if the

Offering had been completed on June 30, 1996. The data should be read in

conjunction with "Management's Discussion and Analysis of Financial Condition

and Results of Operations," the Combined Financial Statements of the Company and

related notes thereto, the Unaudited Pro Forma Condensed Combined Statement of

Income of the Company and other financial information included elsewhere in this

Prospectus.

   

 

  

<TABLE>

<CAPTION>

                                                       FISCAL YEARS ENDED JUNE 30,

                                      --------------------------------------------------------------

                                                                                              PRO

                                                                                             FORMA

                                       1992       1993     1994(1)      1995     1996(2)      1996

                                      -------   --------   --------   --------   --------   --------

                                                  (IN THOUSANDS, EXCEPT PER SHARE DATA)

<S>                                   <C>       <C>        <C>        <C>        <C>        <C>

SELECTED STATEMENT OF INCOME DATA:

Revenues

  Home video........................  $ 1,960   $  1,806   $ 23,959   $ 60,839   $154,102   $206,651

  Coin-operated video...............   36,370     83,825     97,923    119,640     91,321    122,798

                                      -------   --------   --------   --------    -------    -------

          Total revenues............   38,330     85,631    121,882    180,479    245,423    329,449

Cost of sales.......................   22,967     51,753     62,679    101,752    140,056    192,527

                                      -------   --------   --------   --------    -------    -------

Gross profit........................   15,363     33,878     59,203     78,727    105,367    136,922

Research and development expense....    3,148      4,787      8,418     14,661     32,495     48,066

Selling expense.....................      654        975      1,603      9,692     22,815     34,785

Administrative expense..............    1,450      2,362      3,945      7,238      9,563     13,444

                                      -------   --------   --------   --------    -------    -------

Operating income....................   10,111     25,754     45,237     47,136     40,494     40,627

Interest income (expense), net......       54         --        221       (143)       271       (732)

                                      -------   --------   --------   --------    -------    -------

Income before tax provision.........   10,165     25,754     45,458     46,993     40,765     39,895

Provision for income taxes..........   (3,928)    (9,915)   (17,435)   (17,854)   (15,536)   (15,188)

                                      -------   --------   --------   --------    -------    -------

Net income..........................  $ 6,237   $ 15,839   $ 28,023   $ 29,139   $ 25,229   $ 24,707

                                      =======   ========   ========   ========    =======    =======

Pro forma earnings per share(3).....  $   .19   $    .47   $    .84   $    .87   $    .76   $    .74

                                      =======   ========   ========   ========    =======    =======

Pro forma shares outstanding(3).....   33,400     33,400     33,400     33,400     33,400     33,400

                                      =======   ========   ========   ========    =======    =======

</TABLE>

   

 

  

<TABLE>

<CAPTION>

                                                                           FISCAL YEAR ENDED

                                                                             JUNE 30, 1996

                                                                        ------------------------

                                                                         ACTUAL      AS ADJUSTED

                                                                        --------     -----------

                                                                             (IN THOUSANDS)

<S>                                                                     <C>          <C>

SELECTED BALANCE SHEET DATA:

Cash and cash equivalents...........................................    $  9,199      $  58,002

Working capital.....................................................     (11,618)        87,185

Total assets........................................................     118,262        167,065

Dividend notes(4)...................................................      50,000             --

Long-term debt(5)...................................................       7,863          7,863

Stockholders' equity................................................       5,488(6)     104,291

</TABLE>

   

 

- ---------------

(1) The operating assets and business of Tradewest were acquired on April 29,

    1994 and are being accounted for by the purchase method of accounting. See

    Note 4 to the Notes to Combined Financial Statements of the Company.

 

(2) Atari Games was acquired on March 29, 1996 and is being accounted for by the

    purchase method of accounting. See Note 4 to the Notes to Combined Financial

    Statements of the Company.

 

  

(3) Pro forma earnings per share and shares outstanding give effect to a 33,400

    for one stock split in the Company's Common Stock to be effected immediately

    prior to the Offering.

   

 

  

(4) The Dividend Notes (as defined) were distributed to WMS as sole stockholder

    during fiscal 1996.

   

 

  

(5) Long-term debt consists of a portion of the purchase price for Atari Games.

   

 

  

(6) Represents WMS' net investment as sole stockholder of the Company prior to

    the Offering.

   

 

                                        6

<PAGE>   8

 

                                  RISK FACTORS

 

     An investment in the Shares being offered by this Prospectus involves a

high degree of risk. In addition, this Prospectus contains forward-looking

statements that involve risks and uncertainties. Discussions containing such

forward-looking statements may be found in the material set forth under

"Prospectus Summary," "Risk Factors," "Management's Discussion and Analysis of

Financial Condition and Results of Operations," "Industry Overview,"

"Business -- General," "Business -- Strategy," "Business -- New Product

Development," "Business -- Products," "Business -- Marketing and Distribution"

and "Business -- Platform Licenses," as well as in the Prospectus generally. The

Company's actual results could differ materially from those anticipated in these

forward-looking statements as a result of certain factors, including those set

forth in the following risk factors and elsewhere in the Prospectus.

Accordingly, prospective investors should consider carefully the following risk

factors, in addition to the other information concerning the Company and its

business contained in this Prospectus, before purchasing the Shares.

 

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. See "Business -- New Product Development." 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. See "Industry Overview -- Home Games."

 

RELIANCE ON MORTAL KOMBAT PRODUCTS

 

     On a pro forma basis, revenues from Mortal Kombat products accounted for

approximately 34.9% and 17.1% of the Company's total revenues during fiscal 1996

and 1995, 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,

 

                                        7

<PAGE>   9

 

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.

 

  

     The acquisition agreements with respect to Atari Games and Tradewest both

provide that a portion of each respective purchase price is payable in the

future based on certain contingencies. If the maximum contingent purchase prices

of Atari Games and Tradewest are paid, annual goodwill amortization charged to

operations would increase by approximately $2,641,000 ($1,587,000 on an after

tax basis) as compared to the amount charged to operations in fiscal 1996. See

"Recent Acquisitions."

   

 

     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. See "Management's Discussion and

Analysis of Financial Condition and Results of Operations."

 

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.

 

     In the coin-operated market, the Company competes principally with foreign

manufacturers such as Capcom, Konami, Namco, Sega and Taito.

 

     In the home market, the Company competes 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 currently

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 hardware systems. These competitors include Acclaim, Activision,

Capcom, Disney Interactive, Electronic Arts, Konami, Lucas Arts, Namco and

Viacom New Media. Additionally, the Company's games which are sold for use on

personal computers compete with entertainment software sold by companies such as

Broderbund Software, CUC International, Electronic Arts, GT Interactive, Maxis

and Spectrum Holobyte, 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 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,

operating results and financial condition.

 

                                        8

<PAGE>   10

 

PRODUCT RETURNS AND PRICE ADJUSTMENTS

 

     In its home video game business, the Company accepts product returns for

defective products and provides 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 1996, sales of software products for use on the 16-bit Super

Nintendo Entertainment System and Sega Genesis platforms represented

approximately 47.5% and 31.0% respectively, of home video revenues. The Company

has also developed games for the next generation 32- and 64-bit game platforms

(Nintendo 64 platform, the Sony PlayStation platform and the Sega Saturn

platform), which the Company expects will comprise a significant and increasing

portion of its revenues in the coming years. 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.

 

     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

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 the next generation platforms. See

"-- Manufacturing Risks," "Business -- Platform Licenses" and "-- Competition."

 

MANUFACTURING RISKS

 

     The manufacturing of the Company's home games is performed for the Company

by third parties in accordance with the Company's specifications. 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.

See "Business -- Platform Licenses" and "-- Competition."

 

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 NBA, NFL, NHL or their respective players'

associations, and licensed to the Company. 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. See

"Business -- Intellectual Property Licenses," "-- Patent, Trademark, Copyright

and Product Protection" and "-- Competition."

   

 

                                        9

<PAGE>   11

 

     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. See "Business -- Intellectual

Property Licenses."

 

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.

 

  

     The Company has entered into a five year employment agreement with Neil D.

Nicastro effective July 1, 1996, subject to the completion of the Offering,

pursuant to which Mr. Nicastro will be employed as the Company's President and

Chief Executive Officer. In addition, the Company has entered into an employment

agreement expiring May 1, 1998 with Byron C. Cook, pursuant to which Mr. Cook

serves as President and Chief Operating Officer of the Company's home video

games subsidiary. See "Management -- Employment Agreements."

   

 

VOTING CONTROL BY WMS

 

     Upon completion of the Offering, WMS will beneficially own approximately

86.8% (85.1% if the Underwriters' over-allotment option is exercised in full) of

the outstanding Common Stock. Accordingly, WMS will have the ability to elect

and remove the entire Board of Directors of the Company and to determine the

outcome of all matters submitted to the Company's stockholders for approval.

Voting control of the Company by WMS will have the effect of making it

impossible for a third party to acquire a majority of the outstanding voting

stock of the Company without the approval of WMS. See "Principal Stockholders,"

"Arrangements With WMS" and "Shares Eligible for Future Sale."

 

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 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. The Negotiating

Committee of the Company's Board of Directors will be responsible for the review

and authorization of any agreement to be entered into in the future, and any

modification to any existing agreement, between the Company and WMS. The

Negotiating Committee will be comprised of two independent directors not

otherwise affiliated with WMS or the Company. See "Arrangements With WMS" and

"Management -- Committees of the Board of Directors."

 

  

     Mr. Neil D. Nicastro, the Chairman of the Board, President, Chief Executive

Officer and Chief Operating Officer of the Company is also the President, Chief

Executive Officer and Chief Operating Officer of WMS. Mr. Harold H. Bach, Jr.,

Mr. Kenneth J. Fedesna and Ms. Barbara M. Norman are officers of the Company and

are full-time employees of WMS and various of its affiliates. Mr. Bach and Mr.

Fedesna are also directors of the Company. Each of these key employees will

devote such time to the business and affairs of the Company as the 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. WMS has designated, among others, the

following additional persons intended to become

   

 

                                       10

<PAGE>   12

 

  

directors of the Company upon completion of the offering: Messrs. William C.

Bartholomay, William E. McKenna, Norman J. Menell, Harvey Reich and Ira

Sheinfeld. Each of the foregoing persons is also a director of WMS. See

"Management" and "Arrangements With WMS."

   

 

  

LACK OF OPERATING HISTORY AS A STAND-ALONE COMPANY

   

 

  

     The Company has been a wholly-owned subsidiary of WMS since 1988, and prior

to the Offering has not operated as a stand-alone business. Although the Company

believes that cash flow from operations, net cash proceeds of the Offering

(after deducting expenses and payment of the Dividend Notes) and amounts

available under the bank line of credit into which the Company intends to enter

prior to completion of the Offering will be adequate to fund the Company's

present anticipated needs, there can be no assurance that the Company's

financial resources will be adequate for its continuing operations.

Additionally, although WMS will continue to own approximately 86.8% (85.1% if

the Underwriters' over-allotment option is exercised in full) of the outstanding

Common Stock after the Offering, WMS is not contractually obligated to provide

the Company with any financial support in the future.

   

 

ARRANGEMENTS WITH WMS

 

     After the Offering, WMS will continue to provide certain management,

administrative, sales, marketing, accounting and information services to the

Company and will act as a contract manufacturer for the Company's coin-operated

games. The cost of certain of these services will be a portion of the aggregate

cost incurred by WMS allocated to the Company based upon the relative revenues

of and/or units produced for the Company and the other amusement games

businesses of WMS and other factors. As a result, the cost allocated to the

Company will in part be dependent upon the performance of such other businesses.

These arrangements are terminable by either the Company or WMS upon 180 days'

notice. In the event the arrangements with WMS are terminated, the Company will

need to create its own management infrastructure. There can be no assurance that

the Company will be able to establish such an infrastructure promptly or without

adverse effect. See "Arrangements with WMS -- Manufacturing and Services

Agreement."

 

     The Company has been a member since 1988 of the consolidated group of

corporations of which WMS was the common parent for federal income tax purposes

(the "WMS Group"). Therefore, the Company is jointly and severally liable for

any federal tax liability incurred by the WMS Group. The Company and WMS have

entered into a sharing agreement with respect to tax matters (the "Tax Sharing

Agreement"). The Tax Sharing Agreement is not binding on the Internal Revenue

Service (the "IRS") or upon state, local or foreign taxing authorities. The

effectiveness of the Tax Sharing Agreement is therefore dependent on each member

of the WMS Group having the ability to pay its relative share of taxes. Because

the IRS or other taxing authorities can be expected to seek payment from WMS

prior to seeking payment from the individual group members, it is likely that

the Company would seek to enforce any rights it may have against WMS for sharing

at a time when WMS was unable to pay its proportionate share of taxes. See

"Arrangements With WMS -- Tax Sharing Agreement."

 

ABSENCE OF PUBLIC MARKET; POSSIBLE VOLATILITY OF STOCK PRICE

 

     Prior to the Offering, there has been no public market for the Common

Stock. The initial public offering price for the Common Stock has been

determined by negotiations between the Company and the Representatives of the

Underwriters and may not be indicative of the market price for the Common Stock

after the Offering. See "Underwriting" for a discussion of the factors to be

considered in the determination of the initial public offering price. Although

the Common Stock has been approved for listing on the New York Stock Exchange,

subject to official notice of issuance, there can be no assurance that an active

trading market in the Common Stock will develop or, if it does develop, that it

will be sustained after the completion of the Offering. There has been a history

of significant volatility in the market prices of companies engaged in the

interactive entertainment software industry. It is possible that the market

price of the Common Stock will be highly volatile. Factors such as the timing

and market acceptance of new product introductions by the Company, the

introduction of new products by the Company's competitors, loss of key personnel

of the Company, variations in quarterly operating results or changes in market

conditions in the interactive entertainment software industry may have a

significant impact on the market price of the Common Stock. In the past, the

Company has experienced fluctuations in its operating results, and it is likely

that in some future

 

                                       11

<PAGE>   13

 

quarter the Company's revenue or operating results will be below the

expectations of, and certain new products will not be introduced when

anticipated by, market analysts and investors. In such event, the price of the

Common Stock would likely be materially adversely affected. Market prices for

the Common Stock following the Offering will be influenced by a number of

factors, including quarterly variations in the financial results of the Company

and its competitors, changes in earnings estimates by analysts, conditions in

the interactive entertainment software industry, the financial markets and the

overall economy.

 

DILUTION

 

  

     Purchasers of the Shares will experience immediate dilution of $18.88 in

the net tangible book value per share of Common Stock. See "Dilution."

   

 

DIVIDEND POLICY

 

  

     The Company expects that it will retain all available earnings, if any,

generated by its operations for the development and growth of its business and,

except for payment of a previously declared dividend to WMS out of the proceeds

of the Offering, does not anticipate paying any cash dividends on its Common

Stock in the foreseeable future. The Company expects that the bank line of

credit it intends to enter into prior to completion of the Offering will contain

limitations on the ability of the Company to pay dividends. See "Dividend

Policy."

   

 

ANTI-TAKEOVER PROVISIONS

 

     The Company's Board of Directors has the authority to issue shares of

Preferred Stock and to determine the designations, preferences and rights and

the qualifications or restrictions of those shares without any further vote or

action by the stockholders. The rights of the holders of Common Stock will be

subject to, and may be adversely affected by, the rights of the holders of any

Preferred Stock that may be issued in the future. The issuance of Preferred

Stock, while providing desirable flexibility in connection with possible

acquisitions and other corporate actions, could have the effect of making it

more difficult for a third party to acquire a majority of the outstanding voting

stock of the Company. In addition, the Company will, upon consummation of the

Offering, be subject to the anti-takeover provisions of Section 203 of the

Delaware General Corporation Law (the "DGCL"). In general, this statute

prohibits a publicly held Delaware corporation from engaging in a "business

combination" with an "interested stockholder" for a period of three years after

the date of the transaction in which the person became an interested

stockholder, unless the business combination is approved in a prescribed manner.

Furthermore, certain other provisions of the Company's Certificate of

Incorporation and Bylaws may have the effect of discouraging, delaying or

preventing a merger, tender offer or proxy contest, which could adversely affect

the market price of the Company's Common Stock. See "Description of Capital

Stock."

 

     In addition, the preferred stock purchase rights to be issued pursuant to

the Rights Agreement (as defined) will provide discount purchase rights to

stockholders of the Company upon certain acquisitions of beneficial ownership of

10 percent or more of the outstanding shares of Common Stock. The effect of the

foregoing may be to inhibit a change in control of the Company that may be

beneficial to the Company's stockholders. See "Description of Capital

Stock -- Stockholder Rights Agreement."

 

SHARES ELIGIBLE FOR FUTURE SALE

 

     There will be 38,500,000 shares of Common Stock outstanding immediately

following the Offering (39,265,000 shares if the Underwriters' over-allotment

option is exercised in full). WMS owns 33,400,000 shares of Common Stock

representing all of the outstanding shares of Common Stock prior to the

Offering. All of such shares will be "restricted shares" for purposes of the

Securities Act of 1933, as amended (the "Securities Act"). In general, under

Rule 144 as currently in effect, a person who has beneficially owned shares of

Common Stock that have been outstanding and not held by an "affiliate" of the

Company for a period of two years is entitled to sell such shares, subject to

certain volume limitations and other restrictions, without registration under

the Securities Act. The Company's officers and directors and WMS, the Company's

sole stockholder prior to the Offering, have agreed not to offer, sell, contract

to sell, pledge or grant any option to purchase or otherwise dispose of such

securities for 180 days after the date of this Prospectus, without the prior

written consent of Oppenheimer & Co., Inc. The Company has also agreed not to

offer, sell, contract to sell, or otherwise dispose of any shares of Common

Stock or any securities convertible into or

 

                                       12

<PAGE>   14

 

exercisable or exchangeable for Common Stock or any rights to acquire Common

Stock (other than shares issuable upon exercise of outstanding options) for a

period of 180 days after the date of this Prospectus, without the prior written

consent of Oppenheimer & Co., Inc., subject to certain limited exceptions. Such

shares may thereafter be sold in the public market pursuant to Rule 144 under

the Securities Act or pursuant to an effective registration statement. The

Company has entered into a registration rights agreement with WMS pursuant to

which the Company has agreed to file registration statements under certain

circumstances and take other steps requested by WMS in order to enable WMS to

sell its shares of Common Stock. See "Arrangements With WMS -- Registration

Rights Agreement." Sales of a substantial number of shares of Common Stock in

the public market could adversely affect the market price of the Common Stock.

An additional 2,000,000 shares of Common Stock are reserved for issuance under

the Company's Stock Option Plan, of which options for approximately 1,455,000

shares have been or will be granted prior to the Offering, subject to the

consummation of the Offering. It is the Company's intention to register the

shares underlying options granted under the Company's Stock Option Plan under

the Securities Act shortly after the date of this Prospectus, and such shares

may be sold in the public market at any time thereafter, subject to certain

restrictions under Rule 144 with respect to shares held by affiliates of the

Company and subject to certain vesting schedules applicable to such options and

the aforementioned agreements restricting the ability of the Company's officers

and directors and WMS to sell such shares for 180 days. See "Shares Eligible for

Future Sale."

 

                                       13

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                                  THE COMPANY

 

     Prior to the Offering, the Company was a wholly-owned subsidiary of WMS

Industries Inc. WMS is a leading designer, manufacturer and marketer of

coin-operated pinball and novelty games and gaming equipment. WMS also owns

interests in hotels and casinos in Puerto Rico which WMS has announced it

intends to spin off to its stockholders in early 1997. After the Offering, WMS

will continue to provide certain management, administrative, sales, marketing,

accounting and information services to the Company and will act as a contract

manufacturer for the Company's coin-operated games. See "Arrangements With WMS."

Prior to the Offering, 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.

 

     Immediately following the Offering, WMS will own approximately 86.8% of the

outstanding shares of Common Stock (85.1% if the Underwriters' over-allotment

option is exercised in full). As a result, WMS will have the ability to elect

and remove the entire Board of Directors of the Company and to determine the

outcome of all matters submitted to the Company's stockholders for approval.

 

     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 312-961-2222.

 

                              RECENT ACQUISITIONS

 

     In preparation for the end of the arrangements with Acclaim, the Company

developed and implemented a new strategy to begin to publish home versions of

its coin-operated video games and expand the number of coin-operated and home

video game releases. As part of this strategy, in April 1994 Midway acquired

Tradewest, a home video game development and distribution business, and in March

1996 Midway acquired Atari Games, a leading designer, publisher and marketer of

interactive entertainment software.

 

     Tradewest.  In April 1994, the Company acquired the operating assets and

business of three commonly owned companies ("Tradewest"): Tradewest, Inc.,

Tradewest International, Inc., and The Leland Corporation. Tradewest was engaged

in the business of developing, publishing and distributing home games for use on

all major dedicated platform hardware systems and on personal computers. The

purchase price for the assets acquired was set at five times the average annual

pre-tax income of the acquired business during the four year period commencing

May 1, 1994 with a minimum purchase price of $14.1 million, which was paid at

the closing, and a maximum additional payment of $36.0 million during the

four-year earn-out period. Over the first two years of the earn-out period, the

Company has paid an aggregate sum of $14.4 million as additional purchase price.

 

  

     Atari Games.  In March 1996, the Company expanded its game development

capacity and library of video games through the acquisition by the Company's

wholly-owned subsidiary, Midway Interactive Inc. ("Midway Interactive"), of all

of the outstanding capital stock of Atari Games Corporation from Warner

Communications Inc. ("Warner"), a subsidiary of Time Warner Inc. Atari Games,

based in Milpitas, California, is also engaged in the business of developing,

manufacturing, licensing, publishing and distributing coin-operated video games

and interactive entertainment software for use in the home on all major

dedicated platform hardware systems and on personal computers. The Company is in

the process of integrating parts of the Atari Games business into the Company's

coin-operated video game and home game business and eliminating redundancies to

reduce Atari Games' operating costs. The integration plan in progress includes,

among other things, closing certain domestic and international facilities,

commencing coin-operated video game manufacturing under arrangements with WMS,

and eliminating operations no longer conducted by Atari Games. In addition,

sales, marketing and distribution of home games will be combined with the

Company's home games operation. The cost of integrating the operations of Atari

Games with the Company are included within an aggregate liability of $4.5

million which was recorded as part of the purchase price of Atari Games.

Revenues from discontinued operations of Atari Games have been eliminated in the

pro forma financial statements included elsewhere in this Prospectus. The

integration activities described above are intended primarily to eliminate

duplication with the Company's existing facilities and operations, and the

   

 

                                       14

<PAGE>   16

 

  

Company does not believe that its future revenues will be affected in any

material respect as a result of the termination of these operations. The pro

forma financial information gives effect to the acquisition of Atari Games as if

it had occurred on July 1, 1995 and includes certain pro forma adjustments based

on the Company's assimilation activities.

   

 

  

     The preliminary purchase price for the stock of Atari Games was $24.1

million, representing the net asset value of Atari Games as of the closing date

including $19.0 million of working capital Warner was required to provide Atari

Games. The purchase price is subject to adjustment based upon the balance sheet

of Atari Games at March 29, 1996. The balance sheet of the Company at June 30,

1996 includes a receivable in the amount of $3.2 million representing the

balance of the cash payment required to be made by Warner to increase the

working capital of Atari Games to the agreed amount. Warner has not yet accepted

the calculation of the final purchase price. In the event that Warner and the

Company cannot agree on the balance sheet of Atari Games at March 29, 1996, the

purchase agreement provides for mandatory arbitration of this matter. If the

outcome of the arbitration is unfavorable to the Company and the loss provisions

included in the March 29, 1996 balance sheet (as to which Warner has requested

additional information which the Company is in the process of preparing) are not

appropriate, then the amount of goodwill recognized in the purchase may

increase.

   

 

  

     The purchase price for Atari Games is payable as follows: (i) $2.0 million

was paid in cash at the closing, (ii) Midway Interactive delivered a

non-recourse promissory note in the principal amount of $7.9 million (the "Two

Year Note") in favor of Warner payable on March 29, 1998 and (iii) Atari Games

delivered a non-recourse promissory note in the principal amount of $14.2

million (the "Four Year Note") in favor of Warner payable in semi-annual

installments over four years (extendable by Atari Games for an additional three

years under certain conditions) but payable only from 50% of any cash gross

profit from the sale or distribution of certain products and intellectual

property with respect thereto owned by Atari Games as of the closing date. The

Two Year Note is secured by the capital stock of Atari Games. The obligations of

Midway Interactive under the Two Year Note and related security agreement may be

satisfied by relinquishing the capital stock of Atari Games to Warner. The Four

Year Note is secured by the products and intellectual property owned by Atari

Games as of the closing date. The obligations of Atari Games under the Four Year

Note and related security agreement may be satisfied after the fourth

anniversary of the closing by transferring such products and intellectual

property to Warner. As a result of the foregoing arrangements, Midway has the

right, after such fourth anniversary, to either (i) transfer such products and

intellectual property to Warner if the obligations under the Four Year Note have

not been discharged out of the specific sources from which it is payable or (ii)

transfer the capital stock of Atari Games back to Warner if the Company elects

not to pay the Two Year Note. The purchase of Atari Games included the right to

use the Atari name in connection with coin-operated games, but not home games.

The right to use the Atari name for home games is held by Atari Corp., a

corporation unrelated to Warner or the Company.

   

 

                                USE OF PROCEEDS

 

  

     The net proceeds to the Company from the sale of the Shares offered hereby,

after deduction of the underwriting discounts and commissions and estimated

offering expenses payable by the Company, are estimated to be approximately

$98.8 million ($113.7 million if the Underwriters' over-allotment option is

exercised in full). The Company will use the proceeds of the Offering for

working capital to support seasonal increases in accounts receivable and

inventory and for general corporate purposes, to pay promissory notes in the

aggregate amount of $50.0 million (the "Dividend Notes"), which Dividend Notes

were distributed as a dividend to WMS as sole stockholder during fiscal 1996,

and to repay seasonal working capital borrowings from WMS. The Divided Notes

bear interest at a rate of 6% per annum and are payable on demand. A portion of

the net proceeds may also be used to fund acquisitions related to the Company's

business. The Company is not currently negotiating, nor does it have any

commitments or understandings with respect to, any acquisitions. Pending the use

of the net proceeds for such purposes, the Company will invest such net proceeds

in short-term, interest bearing securities.

   

 

                                       15

<PAGE>   17

 

                                    DILUTION

 

     The net tangible book value (deficit) of the Company's Common Stock as of

June 30, 1996 (after giving effect to a 33,400 for one stock split to be

effected immediately prior to the Offering) was approximately $(17.3 million) or

$(.52) per share of Common Stock. "Net tangible book value" represents the total

amount of the Company's tangible assets less the total amount of the Company's

liabilities; "net tangible book value per share" means such amount divided by

the number of shares of Common Stock outstanding. After giving effect to the

sale by the Company of the Shares in the Offering assuming an initial public

offering price of $21.00 per share, and the application of the estimated net

proceeds therefrom, the net tangible book value as adjusted of the Common Stock

as of June 30, 1996 would have been approximately $81.5 million, or $2.12 per

share. This represents an immediate increase in net tangible book value of $2.64

per share to the Company's current sole stockholder and an immediate dilution of

$18.88 per share to new investors purchasing Shares in the Offering.

 

     The following table illustrates the dilution per share described above:

 

<TABLE>

    <S>                                                                   <C>       <C>

    Assumed initial public offering price...............................            $21.00

                                                                                    -------

                                                                                         -

      Net tangible book value (deficit) before the Offering.............  $(.52)

      Increase in net tangible book value per share attributable to new

         investors......................................................  $2.64

                                                                          ------

                                                                             --

    Net tangible book value as adjusted after the Offering..............            $ 2.12

                                                                                    -------

                                                                                         -

    Dilution to new investors...........................................            $18.88

                                                                                    ========

</TABLE>

 

                                DIVIDEND POLICY

 

     The Company currently intends to retain any earnings for the development

and expansion of its business. Accordingly, except for payment of the Dividend

Notes to WMS out of the net proceeds of the Offering, the Company does not

anticipate paying dividends on its Common Stock in the foreseeable future. Any

future determination as to the payment of dividends will be at the discretion of

the Board of Directors of the Company and will be dependent upon the Company's

results of operations, financial condition, contractual restrictions, if any,

and other factors deemed relevant by the Board. The Company expects that the

bank line of credit it intends to enter into prior to completion of the Offering

will contain limitations on the ability of the Company to pay dividends.

 

                                       16

<PAGE>   18

 

                                 CAPITALIZATION

 

     The following table sets forth the capitalization of the Company as of June

30, 1996 and such capitalization as adjusted to give effect to the Offering and

the application of the estimated net proceeds therefrom. See "Use of Proceeds."

This table should be read in conjunction with "Management's Discussion and

Analysis of Financial Condition and Results of Operations," and the Combined

Financial Statements of the Company, the Unaudited Pro Forma Condensed Combined

Statement of Income of the Company, the Unaudited Condensed Consolidated

Financial Statements of Atari Games and the Consolidated Financial Statements of

Atari Games included elsewhere in this Prospectus.

 

<TABLE>

<CAPTION>

                                                                             JUNE 30, 1996

                                                                        ------------------------

                                                                        ACTUAL     AS ADJUSTED

                                                                        -------   --------------

                                                                             (IN THOUSANDS)

<S>                                                                     <C>       <C>

DEBT:

Short-term debt:

  Atari Games accrued payment.........................................  $ 3,286      $  3,286

  Dividend notes......................................................   50,000            --

                                                                        -------

Long-term debt:

  Atari Games purchase note...........................................  $ 7,863      $  7,863

                                                                        -------      --------

     Total debt.......................................................  $61,149      $ 11,149

STOCKHOLDERS' EQUITY:

  Stockholder's net investment........................................  $ 5,488

  Preferred stock, $.01 par value, 5,000,000 shares authorized........       --            --

  Common stock, $.01 par value, 100,000,000 shares authorized,

     33,400,000 shares outstanding and 38,500,000 shares outstanding

     as adjusted, respectively........................................                    385

  Additional paid-in capital..........................................                103,906

  Retained earnings...................................................

                                                                        -------      --------

     Total stockholders' equity.......................................  $ 5,488      $104,291

                                                                        -------      --------

     Total capitalization.............................................  $66,637      $115,440

                                                                        =======      ========

</TABLE>

 

                                       17

<PAGE>   19

 

                            SELECTED FINANCIAL DATA

 

  

     The selected financial data set forth below for the fiscal years ended June

30, 1994, 1995 and 1996 have been derived from the audited combined financial

statements of the Company for such periods. The combined financial statements

for the fiscal years ended June 30, 1992 and 1993 have not been audited, but, in

the opinion of management, reflect all adjustments, consisting only of normal

recurring adjustments, considered necessary for a fair presentation of the

results for such periods. The historical financial statements of the Company for

the foregoing periods give effect as of July 1, 1996 to certain transfers of the

portions of the pinball operations of WMS that were conducted by the Company and

the transfer to the Company of the stock of certain subsidiaries of WMS that

conduct the home video games business and the Atari Games business. See Note 2

to the Combined Financial Statements of the Company. The pro forma statement of

income data gives effect to the acquisition of Atari Games as if it had occurred

on July 1, 1995 and includes certain pro forma adjustments relating to the

implementation of the Company's integration plan. The adjusted balance sheet

data reflect the effect of the Offering and intended use of proceeds as if the

Offering had been completed on June 30, 1996. The data should be read in

conjunction with "Management's Discussion and Analysis of Financial Condition

and Results of Operations," the Combined Financial Statements of the Company and

related notes thereto, the Unaudited Pro Forma Condensed Combined Statement of

Income of the Company and other financial information included elsewhere in this

Prospectus.

   

 

  

<TABLE>

<CAPTION>

                                                  FISCAL YEARS ENDED JUNE 30,

                            ------------------------------------------------------------------------

                                                                                              PRO

                                                                                             FORMA

                             1992         1993       1994(1)        1995       1996(2)        1996

                            -------     --------     --------     --------     --------     --------

                                             (IN THOUSANDS, EXCEPT PER SHARE DATA)

<S>                         <C>         <C>          <C>          <C>          <C>          <C>

SELECTED STATEMENT OF INCOME

  DATA:

Revenues

  Home video..............  $ 1,960     $  1,806     $ 23,959     $ 60,839     $154,102     $206,651

  Coin-operated video.....   36,370       83,825       97,923      119,640       91,321      122,798

                            -------     --------     --------     --------      -------      -------

          Total

            revenues......   38,330       85,631      121,882      180,479      245,423      329,449

Cost of sales.............   22,967       51,753       62,679      101,752      140,056      192,527

                            -------     --------     --------     --------      -------      -------

Gross profit..............   15,363       33,878       59,203       78,727      105,367      136,922

Research and development

  expense.................    3,148        4,787        8,418       14,661       32,495       48,066

Selling expense...........      654          975        1,603        9,692       22,815       34,785

Administrative expense....    1,450        2,362        3,945        7,238        9,563       13,444

                            -------     --------     --------     --------      -------      -------

Operating income..........   10,111       25,754       45,237       47,136       40,494       40,627

Interest income (expense),

  net.....................       54           --          221         (143)         271         (732)

                            -------     --------     --------     --------      -------      -------

Income before tax

  provision...............   10,165       25,754       45,458       46,993       40,765       39,895

Provision for income

  taxes...................   (3,928)      (9,915)     (17,435)     (17,854)     (15,536)     (15,188)

                            -------     --------     --------     --------      -------      -------

Net income................  $ 6,237     $ 15,839     $ 28,023     $ 29,139     $ 25,229     $ 24,707

                            =======     ========     ========     ========      =======      =======

Pro forma earnings per

  share(3)................  $   .19     $    .47     $    .84     $    .87     $    .76     $    .74

                            =======     ========     ========     ========      =======      =======

Pro forma shares

  outstanding(3)..........   33,400       33,400       33,400       33,400       33,400       33,400

                            =======     ========     ========     ========      =======      =======

</TABLE>

   

 

  

<TABLE>

<CAPTION>

                                                                                               AS

                                                                                            ADJUSTED

                                                                                            --------

<S>                         <C>         <C>          <C>          <C>          <C>          <C>

SELECTED BALANCE SHEET

  DATA:

Cash and cash

  equivalents.............  $    --     $     --     $     --     $     --     $  9,199     $ 58,002

Working capital...........    3,116       15,140       24,407       27,327      (11,618)      87,185

Total assets..............    6,649       21,010       50,993       81,106      118,262      167,065

Dividend notes(4).........       --           --           --           --       50,000           --

Long-term debt(5).........       --           --           --           --        7,863        7,863

Stockholders' equity......    3,317(6)    15,580(6)    37,677(6)    49,752(6)     5,488(6)   104,291

</TABLE>

   

 

- ---------------

(1) The operating assets and business of Tradewest were acquired on April 29,

    1994 and are being accounted for by the purchase method of accounting. See

    Note 4 to the Notes to Combined Financial Statements of the Company.

 

(2) Atari Games was acquired on March 29, 1996 and is being accounted for by the

    purchase method of accounting. See Note 4 to the Notes to Combined Financial

    Statements of the Company.

 

  

(3) Pro forma earnings per share and shares outstanding give effect to a 33,400

    for one stock split in the Company's Common Stock to be effected immediately

    prior to the Offering.

   

 

  

(4) The Dividend Notes were distributed to WMS as sole stockholder during fiscal

    1996.

   

 

  

(5) Long-term debt consists of a portion of the purchase price for Atari Games.

   

 

  

(6) Represents WMS' net investment as sole stockholder of the Company prior to

    the Offering.

   

 

                                       18

<PAGE>   20

 

                    MANAGEMENT'S DISCUSSION AND ANALYSIS OF

                 FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

OVERVIEW

 

     The Company has been in the coin-operated video game business for a number

of years. The Company began to publish home video games based on its

coin-operated video games in September 1995. Prior to that time, home video game

revenues were derived from royalties received by the Company primarily from

Acclaim Entertainment under an exclusive licensing agreement that expired in

March 1995. In anticipation of the end of this arrangement, in April 1994 the

Company acquired the operating assets and business of Tradewest, a home video

game development and distribution business. The historical financial statements

of the Company include the results of operations of the Tradewest business for

two months of fiscal 1994 and for the full 1995 and 1996 fiscal years.

Accordingly, comparisons of results of operations for such years may not be

meaningful.

 

     As part of the Company's strategy to increase the number of its

coin-operated and home video game releases, in March 1996 the Company acquired

Atari Games, a publisher and distributor of home video games and coin-operated

video games. The historical financial statements of the Company include the

results of operations of Atari Games only for the period since its acquisition

by the Company. The pro forma financial information included in this Prospectus

gives effect to the acquisition of Atari Games as if it had occurred on July 1,

1995 and includes certain pro forma adjustments relating to the implementation

of the Company's integration plan. The integration plan in progress includes,

among other things, closing certain domestic and international facilities,

commencing coin-operated video game manufacturing under arrangements with WMS,

and eliminating operations no longer conducted by Atari Games. In addition,

sales, marketing and distribution of home games will be combined with the

Company's home games operation. Neither the historical financial statements of

Atari Games nor the pro forma financial information included in this Prospectus

are necessarily indicative of future results of operations of Atari Games given

the business plan the Company is in the process of implementing for Atari Games

including, among other things, substantial additional cost savings resulting

primarily from personnel reductions completed by the Company which are not

reflected in the pro forma financial information.

 

  

     The Company believes the fluctuation in coin-operated revenues during the

last three fiscal years relates primarily to the number of units of hit games

sold rather than changes in the size of the overall market or price increases.

During fiscal 1994, 1995 and 1996, unit prices for the Company's coin-operated

video games did not change materially. The Company believes that the market for

coin-operated video games, particularly in the United States, is mature and

stable and does not offer the potential for significant future growth. During

the last three fiscal years, the Company sold a significant number of units of

three coin-operated video games, Mortal Kombat II, Mortal Kombat 3 and Cruis'n

USA.

   

 

     The Company intends to exploit the significant benefits it obtains selling

home video games based on its own coin-operated video games. In September 1995

the Company published on several dedicated platforms its first home video game

based on its own coin-operated game, Mortal Kombat 3. This game was the best

selling home video game in the United States for 1995 and significantly

increased home video revenues for the year ended June 30, 1996. The Company

believes that its growth opportunities are largely in the home video game side

of its business where the Company has significantly increased the number of

scheduled game releases for fiscal 1997 and the number of games under

development for future years.

 

     The Company sells home video games for dedicated platforms primarily in

North America and licenses foreign distribution to others. The worldwide

distribution of home video games for personal computers, as well as the

distribution outside of North America for certain next generation home video

platforms, were licensed to GT Interactive. Significant non-refundable licensing

revenue was recorded when the distribution agreements were entered into

($25,000,000 in fiscal 1995 and $10,000,000 in fiscal 1996). Such license fees

are recoupable by GT Interactive from the Company's share of future royalties

which would otherwise be earned under these agreements. Therefore, the Company

does not expect to generate significant, if any, further revenue from these

arrangements in the next two years.

 

                                       19

<PAGE>   21

 

  

     In recent years, the home video game business has been based predominantly

upon sales for the two leading dedicated platforms (Nintendo's Super Nintendo

Entertainment System and Sega's Genesis system), both of which are based on

16-bit processors. In fiscal 1996, 78.5% of the Company's home revenues were

derived from sales based on these two platforms. The Company believes that the

home video game business is in a period of transition to the next generation of

dedicated platforms based on 32- and 64-bit processors. According to reports by

the Toy Retail Sales Tracking Service ("TRSTS"), sales of home video games for

32- and 64-bit platforms in the United States increased from 8.9% of total home

video game sales for the first half of 1995 to 40.0% for the first half of 1996

and 50.9% for the month of June 1996. Sales of home video games for 16-bit

platforms decreased from 72.6% of total home video game sales for the first half

of 1995 to 48.1% for the first half of 1996 and 37.0% during the month of June

1996. While the installed base of 16-bit processor platforms continues to

substantially exceed the installed base of next generation platforms, the

Company anticipates that more than 50% of its fiscal 1997 home video revenues

will be derived from the sale of games for these next generation platforms. The

Company intends to continue to release games on each platform that becomes or

remains a significant component of the home game business.

   

 

     The Company is dependent on WMS for the manufacture of coin-operated games

as well as for certain other services including selling and administrative

activities. The allocation by WMS of the cost of certain services to the Company

is based in part on the relative revenues of and/or units produced for the

Company and the other amusement games businesses of WMS and other factors. As a

result, the cost allocated to the Company will in part be dependent upon the

performance of such other businesses. Selling expenses for coin-operated video

games (other than advertising and certain other expenses directly attributable

to the Company) are also based on an allocation to the Company of a portion of

sales and marketing expenses of WMS' amusement games business. Administrative

expenses include management, legal and accounting expenses of WMS allocated to

the Company based in part upon estimates of the percentage of time devoted to

the Company by the personnel involved.

 

     The 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 conversion of a

coin-operated video game to a home video game usually takes six to 12 months. In

contrast, the majority of sales for both coin-operated and home versions of a

game generally occur within the first few months after release. As a result, the

Company must continually develop and release new games to generate additional

revenues.

 

     The Company significantly increased its research and development expenses

in each year since fiscal 1994 primarily to expand the number of coin-operated

video games being introduced and the number of subsequent releases of home video

game versions. Research and development expenses are expensed as incurred and

include payments made to the game's designers after a game has been released

based on revenues derived from such game.

 

     Revenues reflect reductions from gross sales due to returns, discounts and

allowances. The Company generally establishes reserves at the time of shipment

to provide for potential returns and price adjustments.

 

  

     The gross profit margin associated with home video games is generally

higher than that realized by the Company for its coin-operated video games and,

as a result, a shift in the Company's product mix will affect the Company's

overall gross profit margin. The sale of home video games generally requires a

higher level of advertising and marketing expenses than that required for

coin-operated video games and, as a result, a shift in the Company's product mix

should also affect the level of selling expense as a percentage of total

revenues. A shift in the Company's product mix to home video games will

generally have a positive impact on operating income, notwithstanding an

increase in selling expense as a percentage of revenues, due to the concomitant

increase in gross profit margin.

   

 

                                       20

<PAGE>   22

 

RESULTS OF OPERATIONS

 

     The following table sets forth for the years indicated certain items in or

derived from the Company's combined statements of income expressed as a

percentage of revenues:

 

<TABLE>

<CAPTION>

                                                                               JUNE 30,

                                                                     ----------------------------

                                                                       1994       1995      1996

                                                                     --------     -----     -----

<S>                                                                  <C>          <C>       <C>

Revenues

  Home video.......................................................     19.7%      33.7%     62.8%

  Coin-operated video..............................................     80.3%      66.3%     37.2%

                                                                        ----       ----      ----

          Total revenues...........................................    100.0%     100.0%    100.0%

Cost of sales......................................................     51.5%      56.4%     57.1%

                                                                        ----       ----      ----

Gross profit.......................................................     48.5%      43.6%     42.9%

Research and development expense...................................      6.9%       8.1%     13.2%

Selling expense....................................................      1.3%       5.4%      9.3%

Administrative expense.............................................      3.2%       4.0%      3.9%

                                                                        ----       ----      ----

Operating income...................................................     37.1%      26.1%     16.5%

Interest income (expense), net.....................................      0.2%      (0.1)%     0.1%

                                                                        ----       ----      ----

Income before tax provision........................................     37.3%      26.0%     16.6%

Provision for income taxes.........................................     14.3%       9.9%      6.3%

                                                                        ----       ----      ----

Net income.........................................................     23.0%      16.1%     10.3%

                                                                        ====       ====      ====

</TABLE>

 

FISCAL 1996 COMPARED WITH FISCAL 1995

 

     Revenues increased $64,944,000 or 36.0% from $180,479,000 in fiscal 1995 to

$245,423,000 in fiscal 1996. Home video revenues include $10,000,000 in fiscal

1996 and $27,000,000 in fiscal 1995 from licensing the distribution of home

video games for use on personal computers, licensing certain foreign

distribution of home video games and certain other licensing revenues (such

licensing revenues, together with those described below with respect to fiscal

1994, are referred to herein as "Licensing Revenues") Excluding Licensing

Revenues, home video game revenues increased $110,263,000 or 326% from

$33,839,000 in fiscal 1995 to $144,102,000 in fiscal 1996. The increase in home

video game revenues was due to the fact that the Company only began to publish

home video games based on its coin-operated video games in fiscal 1996. Fiscal

1995 home video game revenues principally included revenue from those games that

were in process of development by Tradewest at the time it was acquired by the

Company in April 1994. Coin-operated video revenues decreased by 23.7% from

$119,640,000 in fiscal 1995 to $91,321,000 in fiscal 1996. The decrease in

coin-operated video revenues was primarily due to delays in the development of

certain video games in fiscal 1996 and higher unit sales of certain

coin-operated video games introduced in fiscal 1995 in comparison to unit sales

in fiscal 1996.

 

     Gross profit increased $26,640,000 or 33.8% from $78,727,000 (43.6% of

revenues) in fiscal 1995 to $105,367,000 (42.9% of revenues) in fiscal 1996.

Excluding the effects of Licensing Revenues, gross profit increased $43,131,000

or 79.1% from $54,538,000 (35.6% of related revenues) in fiscal 1995 to

$97,669,000 (41.5% of related revenues) in fiscal 1996. This increase in gross

profit margin was primarily due to a shift in the Company's product mix to home

video games.

 

     Research and development expenses increased $17,834,000 or 122% from

$14,661,000 (8.1% of revenues) in fiscal 1995 to $32,495,000 (13.2% of revenues)

in fiscal 1996. The increase is primarily due to an increased number of games

under development, including those of Atari Games in the three months ended June

30, 1996 and in part due to royalties paid to game designers as part of their

compensation.

 

     Selling expense increased $13,123,000 or 135% from $9,692,000 in fiscal

1995 to $22,815,000 in fiscal 1996 primarily due to the shift in the Company's

revenues from coin-operated video games to home video games.

 

                                       21

<PAGE>   23

 

     Administrative expense increased $2,325,000 or 32.1% from $7,238,000 (4.0%

of revenues) in fiscal 1995 to $9,563,000 (3.9% of revenues) in fiscal 1996. The

increase was primarily due to increased incentive based compensation in the home

video game business resulting from increased sales of those games.

 

     Operating income decreased $6,642,000 or 14.1% from $47,136,000 (26.1% of

revenues) in fiscal 1995 to $40,494,000 (16.5% of revenues) in fiscal 1996.

Operating income includes $7,135,000 in fiscal 1996 and $23,239,000 in fiscal

1995 from Licensing Revenues. Excluding the effects of Licensing Revenues and,

notwithstanding the $17,834,000 increase in research and development expense,

operating income increased $9,462,000 or 39.6% from fiscal 1995 to fiscal 1996,

primarily due to the increased sales of home video games.

 

     The provision for income taxes reflects federal and state income taxes and

resulted in an effective rate of 38.1% in fiscal 1996 and 38% in fiscal 1995.

 

     Net income decreased $3,910,000 or 13.4% from $29,139,000 in fiscal 1995 to

$25,229,000 in fiscal 1996. Net income includes $4,318,000 in fiscal 1996 and

$14,562,000 in fiscal 1995 relating to Licensing Revenues. Excluding the effects

of Licensing Revenues, net income increased $6,334,000 or 43.5% from $14,577,000

in fiscal 1995 to $20,911,000 in fiscal 1996. This increase in net income was

primarily the result of the sizable increase in the sale of home video games

based on the coin-operated version. The Company achieved this result

notwithstanding the increase in research and development expense.

 

FISCAL 1995 COMPARED WITH FISCAL 1994

 

     Revenues increased $58,597,000 or 48.1% from $121,882,000 in fiscal 1994 to

$180,479,000 in fiscal 1995. Home video revenues in fiscal 1995 include

$27,000,000 of Licensing Revenues the distribution of home video games for use

on personal computers, licensing certain foreign distribution of home video

games and certain other licensing revenues. Home video revenues in fiscal 1994

include Licensing Revenues received from the Company's arrangements with

Nintendo and certain other Licensing Revenues totaling $13,000,000. Excluding

Licensing Revenues, home video revenues increased $22,880,000 or 209% from

$10,959,000 in fiscal 1994 to $33,839,000 in fiscal 1995, primarily as a result

of the acquisition of Tradewest. Coin-operated revenue increased $21,717,000 or

22.2% from $97,923,000 in fiscal 1994 to $119,640,000 in fiscal 1995 due to

strong sales of three coin-operated video games introduced in fiscal 1995.

 

     Gross profit increased $19,524,000 or 33.0% from $59,203,000 (48.5% of

revenues) in fiscal 1994 to $78,727,000 (43.6% of revenues) in fiscal 1995.

Excluding the effects of Licensing Revenues, gross profit would have increased

$8,335,000 or 18.0% from $46,203,000 (42.4% of related revenue) in fiscal 1994

to $54,538,000 (35.6% of related revenue) in fiscal 1995 as a result of

increased sales. As a percentage of revenue, however, gross profit (excluding

Licensing Revenues) decreased from 42.4% of related revenue in fiscal 1994 to

35.6% of related revenue in fiscal 1995 primarily as a result of significant

royalty payments to the developer of one particular coin-operated video game

sold in fiscal 1995.

 

     Research and development expense increased $6,243,000 or 74.2% from

$8,418,000 (6.9% of revenues) in fiscal 1994 to $14,661,000 (8.1% of revenues)

in fiscal 1995. The increase was primarily due to the increased number of games

under development which resulted in part from the acquisition of Tradewest.

 

     Selling expense increased $8,089,000 or 505% from $1,603,000 (1.3% of

revenues) in fiscal 1994 to $9,692,000 (5.4% of revenues) in fiscal 1995. The

increase in selling expense as a percentage of revenue was primarily the result

of a shift in the Company's product mix to home video games (19.7% of revenues

in fiscal 1994 and 33.7% of revenues in fiscal 1995).

 

     Administrative expense increased $3,293,000 or 83.5% from $3,945,000 (3.2%

of revenues) in fiscal 1994 to $7,238,000 (4.0% of revenues) in fiscal 1995

primarily as a result of increased administrative expenses of the Company's

Tradewest home video game business which was owned by the Company for the full

year of fiscal 1995 and for only two months of fiscal 1994.

 

     Operating income increased $1,899,000 or 4.2% from $45,237,000 (37.1% of

revenues) in fiscal 1994 to $47,136,000 (26.1% of revenues) in fiscal 1995.

Operating income in fiscal 1995 includes $23,239,000 from the effects of

Licensing Revenues. Operating income in fiscal 1994 includes $13,000,000 from

the effects of

 

                                       22

<PAGE>   24

 

Licensing Revenues. Excluding the effects of Licensing Revenues, operating

income decreased by $8,340,000 or 25.9% from $32,237,000 in fiscal 1994 to

$23,897,000 in fiscal 1995. This decrease was primarily from the fact that the

home video game business operated at a loss in fiscal 1995 and, as mentioned

above, the lower gross profit on one coin-operated video game in fiscal 1995

requiring significant royalty payments.

 

     The provision for income taxes reflects federal and state income taxes and

resulted in an effective rate of 38% in fiscal 1995 and 38.4% in fiscal 1994.

 

     Net income increased $1,116,000 or 4.0% from $28,023,000 in fiscal 1994 to

$29,139,000 in fiscal 1995. Net income in fiscal 1995 includes $14,562,000

relating to Licensing Revenues and net income in fiscal 1994 includes $8,320,000

from Licensing Revenues. Excluding the effects of Licensing Revenues, net income

decreased $5,126,000 or 26.0% from $19,703,000 in fiscal 1994 to $14,577,000 in

fiscal 1995. The primary reasons for this decrease were the facts that the home

video game business operated at a loss in fiscal 1995 and that there was lower

gross profit on one licensed coin-operated video game sold in fiscal 1995.

 

                                       23

<PAGE>   25

 

QUARTERLY RESULTS OF OPERATIONS

 

     The following tables set forth the Company's combined statement of income

data for each of the quarters in the years ended June 30, 1996 and June 30,

1995. The historical financial information of the Company include the results of

operations of Atari Games only for the period since its acquisition by the

Company. This unaudited quarterly information has been prepared on the same

basis as the Company's year end combined financial statements and, in the

opinion of management, reflects all adjustments, consisting only of normal

recurring adjustments necessary for a fair presentation of the information for

the periods presented. The operating results for any quarter are not necessarily

indicative of results for any future period.

 

  

<TABLE>

<CAPTION>

                                                               FISCAL 1996 QUARTER ENDED

                                                      -------------------------------------------

                                                      9/30/95     12/31/95    3/31/96     6/30/96

                                                      -------     -------     -------     -------

                                                         (IN THOUSANDS, EXCEPT PER SHARE DATA)

<S>                                                   <C>         <C>         <C>         <C>

Revenues

  Home video........................................  $46,717     $72,173     $22,092     $13,120

  Coin-operated video...............................   21,221      16,989      20,983      32,128

                                                      -------     -------     -------     -------

     Total revenues.................................   67,938      89,162      43,075      45,248

Cost of sales.......................................   40,622      48,547      23,516      27,371

                                                      -------     -------     -------     -------

Gross profit........................................   27,316      40,615      19,559      17,877

Research and development expense....................    5,851       9,541       5,459      11,644

Selling expense.....................................    7,562       9,723       2,115       3,415

Administrative expense..............................    2,272       2,243       2,176       2,872

                                                      -------     -------     -------     -------

Operating income....................................   11,631      19,108       9,809         (54)

Interest income (expense), net......................      (47)       (372)        286         404

                                                      -------     -------     -------     -------

Income before tax provision.........................   11,584      18,736      10,095         350

Provision for income taxes..........................   (4,414)     (7,138)     (3,846)       (138)

                                                      -------     -------     -------     -------

Net income..........................................  $ 7,170     $11,598     $ 6,249     $   212

                                                      =======     =======     =======     =======

Pro forma earnings per share........................  $   .21     $   .35     $   .19     $   .01

                                                      =======     =======     =======     =======

Pro forma shares outstanding........................   33,400      33,400      33,400      33,400

                                                      =======     =======     =======     =======

</TABLE>

   

 

  

<TABLE>

<CAPTION>

                                                               FISCAL 1995 QUARTER ENDED

                                                      -------------------------------------------

                                                      9/30/94     12/31/94    3/31/95     6/30/95

                                                      -------     -------     -------     -------

                                                         (IN THOUSANDS, EXCEPT PER SHARE DATA)

<S>                                                   <C>         <C>         <C>         <C>

Revenues

  Home video........................................  $25,597     $12,869     $18,909     $ 3,464

  Coin-operated video...............................    8,656      42,932      22,678      45,374

                                                      -------     -------     -------     -------

     Total revenues.................................   34,253      55,801      41,587      48,838

Cost of sales.......................................   20,985      35,265      17,795      27,707

                                                      -------     -------     -------     -------

Gross profit........................................   13,268      20,536      23,792      21,131

Research and development expense....................    2,938       4,223       3,184       4,316

Selling expense.....................................    4,166       2,085       1,536       1,905

Administrative expense..............................    1,273       1,551       1,952       2,462

                                                      -------     -------     -------     -------

Operating income....................................    4,891      12,677      17,120      12,448

Interest income (expense), net......................      (89)        (31)         37         (60)

                                                      -------     -------     -------     -------

Income before tax provision.........................    4,802      12,646      17,157      12,388

Provision for income taxes..........................   (1,825)     (4,805)     (6,520)     (4,704)

                                                      -------     -------     -------     -------

Net income..........................................  $ 2,977     $ 7,841     $10,637     $ 7,684

                                                      =======     =======     =======     =======

Pro forma earnings per share........................  $   .09     $   .23     $   .32     $   .23

                                                      =======     =======     =======     =======

Pro forma shares outstanding........................   33,400      33,400      33,400      33,400

                                                      =======     =======     =======     =======

</TABLE>

   

 

                                       24

<PAGE>   26

 

  

     Revenues for the quarters ended December 31, 1994, March 31, 1995, June 30,

1995 and March 31, 1996 included certain Licensing Revenues of $10,000,000,

$15,000,000, $2,000,000 and $10,000,000, respectively, that increased net income

by $5,184,000, $8,130,000, $1,248,000, and $4,318,000, respectively.

   

 

     The June 30, 1996 quarter included the operations of Atari Games after its

acquisition on March 29, 1996. Research and development expense increased to

$11,644,000 in the June 30, 1996 quarter in comparison to $5,459,000 in the

March 31, 1996 quarter due primarily to inclusion of Atari Games.

 

LIQUIDITY AND CAPITAL RESOURCES

 

     The Company, except for its Atari Games subsidiary, has participated in the

WMS central cash management system, pursuant to which all cash receipts are

transferred to WMS and all cash disbursements are made by WMS. Seasonal cash

needs have been provided by WMS. After completion of the Offering, the Company

will conduct its own treasury activities.

 

     During fiscal 1996 and 1995, cash provided by operating activities, less

cash used for investing activities, was $28,692,000 and $17,064,000,

respectively, of which, $19,493,000 and $17,064,000, respectively, was retained

by WMS. The $9,199,000 of cash at June 30, 1996 is cash at Atari Games.

 

     Cash provided by operating activities before changes in operating assets

and liabilities, was $29,117,000 in fiscal 1996 and $39,151,000 in fiscal 1995.

The decrease was primarily the result of a $7,664,000 decrease in deferred

taxes, and to a lesser extent, lower net income.

 

     The changes in the operating assets and liabilities, as shown in the

combined statements of cash flows, resulted in $6,162,000 of cash inflow in

fiscal 1996, primarily due to a reduced receivables balance at June 30, 1996,

compared with a cash outflow of $15,204,000 in fiscal 1995, which outflow was

primarily due to an increased receivables balance at June 30, 1995, in part

offset by higher accounts payable and accruals.

 

     Cash used by investing activities was $6,587,000 in fiscal 1996 and

$6,883,000 in fiscal 1995. Cash used for the purchase of property and equipment

was approximately the same in fiscal 1996 and 1995. Cash used for the additional

purchase price of Tradewest was $11,476,000 in fiscal 1996 and $3,024,000 in

fiscal 1995. On the date of acquisition Atari Games had cash in excess of the

amount used for its acquisition resulting in a $7,996,000 increase in cash

during fiscal 1996.

 

     During fiscal 1996 the Board of Directors of the Company declared a

dividend and the Company issued $50,000,000 of Dividend Notes payable to WMS

which bear interest at 6%. The net proceeds of the Offering are expected to be

approximately $98,800,000 and will be used in part to pay the previously

declared $50,000,000 Dividend Notes and all other amounts, if any, payable to

WMS. The balance of the proceeds will be used for working capital.

 

     The home video business is highly seasonal and significant working capital

is required to finance high levels of inventories and accounts receivable during

certain months of the fiscal year. In addition, certain platform manufacturers

that manufacture home video games for the Company require letters of credit for

the full purchase price at the time a purchase order is accepted.

 

  

     The Company has been dependent upon WMS for its cash requirements. The

Company has received a commitment letter from a bank, subject to certain

conditions including completion of the Offering, for the establishment of a line

of credit for $50,000,000 and an additional letter of credit line of up to

$30,000,000. The line of credit is expected to be finalized prior to the

completion of the Offering and after the negotiation of a lending agreement

containing usual bank line of credit terms. Management believes that cash and

cash equivalents, cash flow from operations, cash from the Offering added to

working capital and amounts available under the line of credit will be adequate

to fund the anticipated levels of inventories and accounts receivable required

in the operation of the business and the Company's other presently anticipated

needs, as well as pay any amounts due under the Tradewest and Atari Games

acquisition agreements.

   

 

     The Company anticipates that capital expenditures in fiscal 1997 for

property and equipment will not exceed $4,500,000. Such expenditures will be

primarily for equipment used in research and development activities. Since WMS

manufactures coin-operated video games for the Company in WMS' own facilities,

the

 

                                       25

<PAGE>   27

 

Company does not expect to make significant capital expenditures for

manufacturing equipment or facilities in the immediate future.

 

IMPACT OF INFLATION

 

     During the past three years, the level of inflation affecting the Company

has been relatively low. The ability of the Company to pass on future cost

increases in the form of higher sales prices will continue to be dependent on

the prevailing competitive environment and the acceptance of the Company's

products in the market place.

 

SEASONALITY

 

     The home video game business is highly seasonal and historically has

resulted in higher revenues and net income in the first and second quarters of

the June 30 fiscal year due to customer purchases preceding the year-end retail

holiday selling season. The coin-operated video game business has not

historically been seasonal but quarterly revenues and net income usually

increase when a coin-operated video game that achieves significant player appeal

is introduced. See "Risk Factors -- Fluctuations in Operating Results;

Seasonality."

 

                                       26

<PAGE>   28

 

                               INDUSTRY OVERVIEW

 

     Video games are sold in two primary formats -- coin-operated games

distributed to arcades and route operators and home games for dedicated hardware

platforms (Nintendo, Sony and Sega), portable game systems (Nintendo's Game Boy

and Sega's Game Gear), 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. The Company estimates that sales to route operators

generally comprise between 45% and 50% of the coin-operated video game market.

 

     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.

 

     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,

if at all, in emerging markets rather than developed countries where the

coin-operated video game market is also mature. The Company believes that Japan

is the second largest market for coin-operated video games after the United

States. However, United States manufacturers of coin-operated games have not as

yet achieved meaningful sales in the Japanese market.

 

                                       27

<PAGE>   29

 

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. 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.

 

     According to a market study entitled U.S. and European Markets for Video

Games and PC Entertainment Software conducted by Packaged Facts, in 1995

consumers spent approximately $4.1 billion in the United States and $733.9

million in Europe on video games for dedicated hardware platforms.

 

     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. The aggregate installed base of the Super Nintendo

Entertainment System and the Genesis system in the United States at the end of

1995 was approximately 39.7 million units. Today, the competition in the market

for hardware platforms has intensified, with the introduction of 32-bit video

game systems, planned introduction in the United States of the new 64-bit video

game systems and the rising installed base of multimedia-enabled home computers.

 

     Sega and Sony each began distribution of their next generation 32-bit and

64-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. The installed base of the Saturn system and

the PlayStation system in the United States as of May 1996 was approximately

700,000 units and 1.4 million units, respectively. Nintendo shipped the Nintendo

64 system in Japan in June 1996 and in North America in September 1996. The

Company believes that content providers with demonstrated capability for

developing successful games will be in a position to develop games for whatever

platforms achieve significant consumer acceptance.

 

     Most software products for dedicated platforms are currently sold in

cartridge form. However, compact discs have recently become increasingly popular

because they have substantially greater data storage capacity and substantially

lower manufacturing costs than games in cartridge form. The newer Sony

PlayStation and Sega Saturn platforms are based on CD-ROM technology.

 

     As the 16-bit cartridge market has matured, related hardware and software

sales have declined and are expected to decline significantly further in fiscal

1997. The Company expects that the transition from 16-bit cartridge-based game

machines to the advanced systems described above will continue.

 

     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 games available were dedicated to a single game.

Sega's color Game Gear hand-held system, released in 1991, competes directly

with the Nintendo Game Boy. It is estimated that at the end of 1995, the

installed base of hand held game systems was approximately 13 million and the

number of software titles available for use with the Game Boy and the Game Gear

were over 320 and 100, respectively. The market for video games on these

platforms has declined in recent years and today does not comprise a material

component of the video game business.

 

                                       28

<PAGE>   30

 

     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 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.

 

                                       29

<PAGE>   31

 

                                    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 Mortal Kombat (which line of games has sold over 10 million copies in

the home market), Cruis'n USA, NBA Jam, Joust, Defender, Pacman and Space

Invaders, and, through its recently acquired Atari Games subsidiary, such

leading games as Area 51, Gauntlet, Centipede, Asteroids and Pong. Midway's

games are available for play on all major dedicated home video game platforms,

including Nintendo, Sony and Sega, and personal computers.

 

  

     Midway 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 according to TRSTS reports.

Prior to that time, Midway had granted Acclaim Entertainment 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 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 $32.5

million in fiscal 1996, up from $14.7 million in fiscal 1995. As a result of

these efforts, in fiscal 1997 Midway expects to release approximately 12

coin-operated video games and publish approximately 20 home video games compared

to four new coin-operated video games and eight new video home games in fiscal

1996.

   

 

  

     Midway's revenue increased to $245.4 million in fiscal 1996, from $180.5

million in fiscal 1995 and $121.9 million in fiscal 1994. Such growth resulted

from the growth in Midway's revenues from home games which increased to $154.1

million in fiscal 1996 (63% of revenues), from $60.8 million in fiscal 1995 (34%

of revenues) and $24.0 million in fiscal 1994 (20% of revenues). In fiscal 1997,

Midway plans to release approximately 12 coin-operated video games, including

Mortal Kombat 4, Cruis'n World and War Gods, and approximately 20 home video

games, including Ultimate Mortal Kombat 3, Mortal Kombat Trilogy, Mortal Kombat

Mythologies, Doom 64, Final Doom, War Gods, Area 51, The NHLPA & NHL Present

Wayne Gretzky's 3D Hockey and NBA Hangtime.

   

 

     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 dedicated platform

versions of 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 Best Buy, 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 250 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 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 advanced audio effects.

       Midway produces games in the action, simulation, adventure and sports

       categories.

 

                                       30

<PAGE>   32

 

     - 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 spend 50c almost every

       two minutes. 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 that (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 releasing the game 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. Midway is a leading developer of video games for the

       next generation of 32- and 64-bit game platforms which are currently

       being marketed by hardware manufacturers. According to TRSTS reports, the

       Company was ranked sixth among 52 companies in sales of 32- and 64- bit

       home video games for each month during the period April 1996 through July

       1996 (except for May 1996 when the Company ranked eighth). In August

       1996, the Company ranked seventh in sales for these platforms. In fiscal

       1997, based on publicly announced release date schedules, Midway expects

       to release 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 four

       different coin-operated games under the Mortal Kombat title and published

       or licensed home versions of each of those games. Midway has also

       licensed a film adaptation of Mortal Kombat and granted merchandising

       licenses in the toy, clothing, comic book, strategy guides and other

       product lines. In fiscal 1997, Midway plans to release a new

       coin-operated game, Mortal Kombat 4, and three additional home games,

       Ultimate Mortal Kombat 3, Mortal Kombat Trilogy and an adventure game

       tentatively entitled Mortal Kombat Mythologies. An animated television

       series based on Mortal Kombat is scheduled to air in the fall of 1996,

       and a sequel to the movie version of Mortal Kombat is scheduled to be

       released in the summer of 1997. 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 plans to

       release three collections of arcade classic games and Robotron X, a new

       version of a classic arcade game.

 

     - DEVELOP 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

       consistently 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.

 

     - 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

 

                                       31

<PAGE>   33

 

       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 to encourage players of a coin-operated

version to spend 50c almost every two minutes. 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 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 $1.0 million and, depending

on the specific hardware and software requirements, may cost up to $3.5 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. Converters are

compensated in a variety of methods, including through participation in the

success of the particular game. 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 dedicated

platforms.

 

     The Company is testing its own proprietary multi-player interactive video

game playing network known as Wavenet, allowing players to play against others

located at remote coin-operated locations. This technology has consistently

resulted in greater player utilization and profitability of games.

 

     During the fiscal years ended June 30, 1996, 1995 and 1994, approximately

$32.5 million ($48.1 million on a pro forma basis), $14.7 million and $8.4

million, respectively, were expended 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.

 

                                       32

<PAGE>   34

 

     Under the Company's arrangements with GT Interactive, the Company and GT

Interactive share equally the cost to develop personal computer CD-ROM versions

of those of the Company's video games that GT Interactive elects to release to

the home market.

 

     The Company endeavors to comply with the rules established by a domestic

ratings board voluntarily established by the home game industry 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 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, NBA Jam, Terminator 2, Joust,

Robotron:2084, Ms. Pacman, Defender, Pacman and Space Invaders, and, through its

recently acquired Atari Games subsidiary, such titles as Area 51, Hard Drivin,

Gauntlet, Centipede, Missile Command, Break Out, Asteroids and Pong. In fiscal

1997, the Company plans to release approximately 12 new coin-operated video

games, including Mortal Kombat 4, Cruis'n World and War Gods. During fiscal

1996, four coin-operated video games were introduced under the Midway

name -- NBA Hangtime, Killer Instinct 2, Wrestlemania and Open Ice, and Atari

Games released one coin-operated video game called Area 51. Also during fiscal

1996, the Company introduced TouchMaster, a touchscreen countertop game

containing multiple game options. During fiscal 1995, three coin-operated video

games were introduced under the Midway name -- Mortal Kombat 3, Cruis'n USA and

Killer Instinct.

 

     At the March 1996 Amusement Operators Expo, Play Meter Magazine named

Cruis'n USA the Best Dedicated Video Game and Mortal Kombat 3 the Best Video

Game Conversion Kit. Additionally, the American Amusement Machine Association

("AAMA") named the Company its 1996 Manufacturer of the Year. Midway's Mortal

Kombat 3 coin-operated video game conversion kit was awarded the AAMA 1996

Diamond Sales Achievement Award -- the highest category of award presented in

any given year -- and several of the Company's other games won Platinum and Gold

sales awards in 1996. At the September 1995 Amusement and Music Operators

Association ("AMOA") trade show, Cruis'n USA was named Most Played Dedicated

Video Game and Mortal Kombat 3 was named Most Played Conversion Kit.

Additionally, the Company's Cruis'n USA and Area 51 have been nominated for the

Most Innovative Video Game Award and its Mortal Kombat 3 and Area 51 have been

nominated for the Most Innovative Conversion Kit Award, which awards will be

presented at the Fall 1996 AMOA trade show. All three coin-operated video games

introduced in fiscal 1995 received the AAMA 1995 Diamond Sales Achievement

Award. Platinum and Gold awards went to two other Midway games.

 

     Coin-operated games are sold to distributors at prices ranging from $3,000

to $15,000. 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.

 

     Home Games.  The fiscal 1997 home game product line features approximately

20 titles, including Ultimate Mortal Kombat 3, Mortal Kombat Trilogy, Mortal

Kombat Mythologies, NBA Hangtime, Doom 64, Final Doom, War Gods, Robotron X, The

NHLPA & NHL Present Wayne Gretzky's 3D Hockey, Area 51 and several collections

of arcade classics. During fiscal 1996, the Company published eight video games

for the home market, including Mortal Kombat 3 and two games developed by Atari

Games and released after its acquisition by the Company. During fiscal 1995, the

Company published four video games for the home market which video games were

developed for Tradewest and released after the acquisition of the Tradewest

business by the Company. 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 the next

generation platforms.

 

     Most of the Company's home games have suggested retail prices ranging from

$49.95 to $79.95.

 

                                       33

<PAGE>   35

 

                         1996 MIDWAY HOME GAME RELEASES

 

     The following table sets forth the games that were released by the Company

(including games released by Atari Games after its acquisition by the Company)

for the home market, directly or under licensing arrangements, during fiscal

1996, and the platforms on which each title may currently be used:

 

<TABLE>

<CAPTION>

                  GAME                    CATEGORY                     PLATFORM(S)

    ---------------------------------    ----------    -------------------------------------------

    <S>                                  <C>           <C>

    Arcades Greatest Hits*               Classic       PlayStation

    Doom                                 Action        Super Nintendo Entertainment System

    Doom Special PlayStation Edition     Action        PlayStation

    The Getaway*                         Action        Game Boy

    Island Casino                        Simulation    Personal Computer

    Mortal Kombat 3*                     Action        Super Nintendo Entertainment System

                                                       Game Boy

                                                       PlayStation

                                                       Genesis

                                                       Personal Computer

    Primal Rage*                         Action        Saturn

    Return Fire                          Action        PlayStation

    Ultimate Mortal Kombat 3*            Action        Saturn

    Williams Arcade Classics*            Classic       Personal Computer

</TABLE>

 

- ---------------

* Based upon one or more previously released coin-operated games.

 

     In fiscal 1996, Atari Games released five home video games prior to its

acquisition by the Company.

 

                                       34

<PAGE>   36

 

                    1997 MIDWAY HOME GAME SCHEDULED RELEASES

 

     The following table sets forth the games that are scheduled to be released

by the Company for the home market, directly or under licensing arrangements,

during fiscal 1997, and the platforms on which each title are intended for

initial release:

 

<TABLE>

<CAPTION>

                  GAME                    CATEGORY                     PLATFORM(S)

    ---------------------------------    ----------    -------------------------------------------

    <S>                                  <C>           <C>

    Arcades Greatest Hits*               Classic       Super Nintendo Entertainment System

                                                       Saturn

                                                       Genesis

    Arcades Greatest Hits II*            Classic       PlayStation

    Arcades Greatest Hits III*           Classic       PlayStation

    Area 51*                             Action        PlayStation

                                                       Saturn

                                                       Personal Computer

    Doom 64                              Action        Nintendo 64

    Final Doom                           Action        PlayStation

    The NHLPA & NHL Present              Sports        Nintendo 64

      Wayne Gretzky's 3D Hockey*

    Mortal Kombat Mythologies            Adventure     PlayStation

    Mortal Kombat Trilogy*               Action        Nintendo 64

                                                       PlayStation

                                                       Personal Computer

    Ms. Pacman*                          Classic       Super Nintendo Entertainment System

    NBA Hangtime*                        Sports        Nintendo 64

                                                       Super Nintendo Entertainment System

                                                       PlayStation

                                                       Saturn

                                                       Genesis

                                                       Personal Computer

    Open Ice*                            Sports        PlayStation

                                                       Personal Computer

    Robotron X*                          Action        Nintendo 64

                                                       PlayStation

                                                       Personal Computer

    Ultimate Mortal Kombat 3*            Action        Super Nintendo Entertainment System

                                                       Genesis

    War Gods*                            Action        Nintendo 64

                                                       PlayStation

                                                       Personal Computer

</TABLE>

 

- ---------------

* Based upon one or more previously released coin-operated 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 40 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.

 

                                       35

<PAGE>   37

 

     Coin-operated games are 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 $25.3 million (10.3% of revenues) for the fiscal year ended June

30, 1996 compared with $40.0 million (22.2% of revenues) for the fiscal year

ended June 30, 1995 and $29.9 million (25.5% of revenues) for the fiscal year

ended June 30, 1994. 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.  The Company's home video games have been marketed under the

Williams and Tradewest trademarks and Atari Games home games have been marketed

under the Tengen and Time Warner Interactive trademarks. Commencing with the

Company's fall 1996 product line, all home video games will be marketed under

the Midway trademark.

 

     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 Acclaim Entertainment the right to publish

home video game versions of most coin-operated video games released by the

Company. In fiscal 1997 Midway plans to release approximately 20 home video

games.

 

     Home games are marketed in the United States through the Company's internal

sales staff and through independent sales representatives to approximately

15,000 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.

 

     The Company's principal customers for its home video games are mass

merchandisers such as Toys-R-Us, Wal-Mart and Best Buy. Sales to Toys-R-Us in

fiscal 1996 represented 12.6% of total revenues. It is customary for the sales

representatives and the distributors of the Company's home games who are

assigned specific territories 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 established

personality 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 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 on several of the

next generation platforms now being introduced, such as Sega Saturn 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

advances remain unrecouped. 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

 

                                       36

<PAGE>   38

 

renewal provisions as the other agreements. Advances 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 is required to pay non-refundable license fees in the aggregate

amount of $35.0 million, of which $21.7 million has previously been paid. GT

Interactive will not be required to pay 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 two years. 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. See "Management's

Discussion and Analysis of Financial Condition and Results of Operations."

   

 

     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 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 being

developed by Nintendo. To date, no home video games have been released through

this joint venture.

 

     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 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.

 

MANUFACTURING

 

     Coin-operated Games.  The Company's coin-operated games are manufactured by

WMS at WMS' factories in Illinois pursuant to the Manufacturing and Services

Agreement. See "Arrangements With WMS." 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.

 

     Coin-operated games had a backlog of orders at fiscal year end June 30,

1996, valued at approximately $7.9 million. 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 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 games

are manufactured by WMS' subsidiary Lenc-Smith Inc. pursuant to the

Manufacturing and Services Agreement (See "Arrangements With WMS"), as well as

by other outside suppliers. The Company believes that the sources of supply of

component parts and raw materials are adequate and that substitute sources of

materials are available.

 

                                       37

<PAGE>   39

 

     Software Products for Home Games.  Manufacturing of home games for next

generation 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 50 to 75 days

to manufacture. Reorders generally require 50 days to manufacture although

reorders of CD-ROM based platforms 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.

 

     Upon arrival in the United States, products are inspected by customs agents

and transferred to a bonded public warehouse facility where they are unpacked

and shipped to the Company's customers. Products ordered for inventory are

stored at the warehouse facility and used to fill additional orders as received.

The Company is in the process of establishing its own leased warehouse facility

from which to distribute its home games.

 

     The Company participates in the electronic data interchange program

maintained by most of its largest customers for home games. This program allows

the Company to monitor store inventory and schedule production to meet

anticipated re-orders. Re-orders 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 share equally

the cost to develop personal computer CD-ROM versions of those of the Company's

coin-operated video games that GT Interactive elects to release to the home

market. Once GT Interactive so elects, 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.

 

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 and Game Boy platforms, (ii)

Sony's PlayStation, and (iii) Sega's Genesis, Saturn and Game Gear 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 the 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

developed under its agreements with each of the dedicated platform

manufacturers. Dedicated platform manufacturers charge the Company a fixed

amount for each software cartridge or CD-ROM manufactured by such dedicated

platform manufacturer. This charge 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

 

                                       38

<PAGE>   40

 

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, the

Company's bankruptcy or insolvency, 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. See "Risk

Factors -- Dependence on Dedicated Platform Manufacturers" and "-- Competition."

 

INTELLECTUAL PROPERTY LICENSES

 

     Certain of the Company's products relate to properties licensed from third

parties, such as the NBA, NFL and NHL and their respective players'

associations. Typically, the Company is obligated to make certain minimum

guaranteed royalty payments over the term of the license and to advance payment

against such guarantees. License agreements generally extend for a term of two

to three years, are terminable in the event of material breach (including

failure to pay any amounts owing to the licensor in a timely manner) by, or

bankruptcy or insolvency of, the Company and certain other events, and, in some

cases, are renewable upon payment of certain minimum guarantees or the

attainment of specified sales levels during the term of the license. Certain

licenses are limited to specific territories or platforms. Each license

typically provides that the licensor retains the right to exploit the 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.

 

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.

 

                                       39

<PAGE>   41

 

     The Company has over 300 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. The Company uses certain

precautions to discourage unauthorized copying of its personal computer software

products, including internal copy protection, which prevents or hinders normal

copy routines. In addition, 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 these protections, the Company believes that these

techniques 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.

 

     In the home market, the Company competes 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 currently

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, Activision, Capcom,

Disney Interactive, Electronic Arts, Konami, Lucas Arts, Namco and Viacom New

Media. Additionally, the Company's games which are sold for use on personal

computers compete with entertainment software sold by companies such as

Broderbund Software, CUC International, Electronic Arts, GT Interactive, Maxis

and Spectrum Holobyte, 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.

 

                                       40

<PAGE>   42

 

     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,

operating results and financial condition.

 

EMPLOYEES

 

     At June 30, 1996, the Company had approximately 326 non-union employees.

 

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 properties,

all of which are leased facilities.

 

<TABLE>

<CAPTION>

                                                              APPROXIMATE                      LEASE

                                             PRINCIPAL          SQUARE                       EXPIRATION

               LOCATION                         USE             FOOTAGE     ANNUAL RENT($)      DATE

- --------------------------------------  -------------------   -----------   --------------   ----------

<S>                                     <C>                   <C>           <C>              <C>

2727 W. Roscoe Street.................  Game Design and           47,500        136,000        06/30/98

Chicago, IL                             Development

675 Sycamore Drive....................  Game Design and           84,501        593,196        07/31/05

Milpitas, CA                            Development and

                                        Sales and Marketing

10110 Mesa Rim Road...................  Game Design and           27,512        250,664        06/01/02

San Diego, CA                           Development

2400 S. Business 45...................  Office/Warehouse           5,000         30,000        05/01/99

Corsicana, TX

1800 S. Business 45...................  Sales and Marketing        6,000         38,400        09/01/97

Corsicana, TX

2820 Merrell Road.....................  Warehouse                 28,234         84,702        07/31/99

Dallas, TX

</TABLE>

 

     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.

 

LEGAL PROCEEDINGS

 

     The Company currently and from time to time is involved in litigation

incidental to the conduct of its business. The Company is not currently a party

to any lawsuit or proceeding which, in the opinion of the Company, is likely to

have a material adverse effect on the Company.

 

                                       41

<PAGE>   43

 

                                   MANAGEMENT

 

DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY

 

  

     The following table sets forth certain information with respect to each

director and executive officer of the Company and each person intended to become

a director of the Company upon completion of the Offering other than the

additional independent director the Company intends to designate. 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.

Each director serves, and each person intended to become a director upon

completion of the Offering will serve, as a director until the Company's next

annual meeting of stockholders and until their respective successors are duly

elected and qualify. Each officer of the Company serves at the pleasure of the

Board of Directors and until their respective successors are duly elected and

qualify. Information given relates to calendar years.

   

 

  

<TABLE>

<CAPTION>

           NAME              AGE                           POSITION

- ---------------------------  ---     ----------------------------------------------------

<S>                          <C>     <C>

Neil D. Nicastro...........   39     Chairman of the Board of Directors, President, Chief

                                     Executive Officer and Chief Operating Officer

Harold H. Bach, Jr. .......   64     Executive Vice President -- Finance, Treasurer and

                                     Chief Financial Officer and Director

Byron C. Cook..............   42     Executive Vice President -- Home Video and Director

Kenneth J. Fedesna.........   46     Executive Vice President -- Coin-Op Video and

                                     Director

Barbara M. Norman..........   58     Vice President, Secretary and General Counsel

William C. Bartholomay.....   68     Director

William E. McKenna.........   77     Director

Norman J. Menell...........   64     Director

Louis J. Nicastro..........   68     Director

Harvey Reich...............   67     Director

Ira S. Sheinfeld...........   58     Director

Richard D. White...........   42     Director

</TABLE>

   

 

  

     The following directors comprise the Company's current Board of Directors:

   

 

     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 is also the President, Chief Executive Officer and

Chief Operating Officer and a Director of WMS. Mr. Nicastro was elected

President of WMS June 18, 1991 and Co-Chief Executive Officer August 29, 1994.

He has also served as Chief Operating Officer of WMS since September 1990 and

has been a Director of WMS since 1986. Additionally, Mr. Nicastro has served WMS

as Treasurer (1986-1994), Executive Vice President (1988-1991), Senior Vice

President (1987-1988), Vice President (1986-1987) and Director of Stockholder

Relations (1981-1986).

 

     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 served

as Secretary of WMS from July 5, 1990 to June 15, 1992. He also assumed the

positions of Treasurer of WMS effective September 13, 1994 and Vice

President -- Finance, Chief Financial and Chief Accounting Officer of WMS

effective September 30, 1990. 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.

 

                                       42

<PAGE>   44

 

     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 been a Director of WMS since 1993 as well as Vice

President and General Manager of Williams Electronics Games, Inc., a

wholly-owned subsidiary of WMS, for in excess of five years.

 

     Barbara M. Norman has served as Vice President, Secretary and General

Counsel to the Company since June 15, 1992, and she has also served as Vice

President, Secretary and General Counsel of WMS since June 15, 1992. Prior

thereto she was associated with the law firm of Whitman & Ransom, New York, New

York (1990-1992) and served the Company and WMS as Vice President, Secretary and

General Counsel during the periods 1988-1990 and 1986-1990, respectively.

 

  

     Louis J. Nicastro became a Director of the Company on August 30, 1996. Mr.

Nicastro also served as a Director of the Company from 1988 until June 26, 1996.

Mr. Nicastro also served as 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). 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).

   

 

     WMS has designated the following directors whose election to the Board of

Directors of the Company will be effective upon completion of the Offering:

 

     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., Atlanta, Georgia 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.

 

     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., Calprop Corporation, Drexler Technology

Corporation and Safeguard Health Enterprises, Inc. Mr. McKenna has also served

as a director of WMS since 1981.

 

     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.

 

     Harvey Reich has been 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. He has also served as a director of WMS since 1983.

 

     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.

 

     Richard D. White has been a Managing Director of Oppenheimer & Co., Inc.,

one of the Representatives of the Underwriters of the Offering, for in excess of

five years.

 

     WMS intends to designate one additional independent director, not otherwise

affiliated with WMS or the Company, whose election to the Board of Directors of

the Company will be effective upon completion of the Offering.

 

COMMITTEES OF THE BOARD OF DIRECTORS

 

     The Board of Directors of the Company has established, effective upon

consummation of the Offering, two standing committees: an Audit Committee and a

Compensation and Stock Option Committee.

 

                                       43

<PAGE>   45

 

     The Audit Committee is charged with meeting periodically with the

independent auditors and Company personnel with respect to the adequacy of

internal accounting controls, receiving and reviewing the recommendations of the

independent auditors, recommending the appointment of auditors and reviewing the

scope of the audit and the compensation of the independent auditors, reviewing

consolidated financial statements and, generally, reviewing the Company's

accounting policies and resolving potential conflicts of interest. The initial

members of the Audit Committee will be Messrs. McKenna, Bartholomay, Sheinfeld

and White.

 

     The Negotiating Committee of the Company's Board of Directors will be

responsible for the review and authorization of any agreement to be entered into

in the future, and any modification to any existing agreement, between the

Company and WMS. See "Arrangements With WMS." The initial members of the

Negotiating Committee will be Mr. White and the additional independent director

to be named prior to completion of the Offering.

 

     The Compensation and Stock Option Committee has general responsibility for

determining the compensation and benefit policies and procedures of the Company

and administers the Stock Option Plan, including the grant of awards under such

plan. The initial members of the Compensation and Stock Option Committee will be

Messrs. Reich and McKenna.

 

COMPENSATION OF DIRECTORS

 

     Upon consummation of the Offering, the Company will pay a fee of $22,500

per annum to each director who is not also an employee of the Company or any of

its subsidiaries. Each such director who serves as the chairman of any committee

of the Board of Directors will receive a further fee of $2,500 per annum for his

services in such capacity and each other member of the Company's Audit Committee

will receive an additional fee of $2,500 per annum.

 

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

 

     Mr. Harvey Reich will serve as Chairman of the Company's Compensation and

Stock Option Committee and Mr. William E. McKenna will serve as the sole

additional member, neither of whom are employees or officers of the Company or

any of its subsidiaries or had any relationship requiring disclosure herein by

the Company other than that both serve on the Board of Directors of WMS.

 

                                       44

<PAGE>   46

 

EXECUTIVE COMPENSATION

 

     The executive officers of the Company (other than Mr. Byron C. Cook)

received no compensation from the Company during the fiscal years ended June 30,

1996, 1995 or 1994. The Summary Compensation Table below sets forth the cash

compensation paid by WMS (or in the case of Mr. Cook, by the Company) for

service in all capacities (including on behalf of the Company) during the fiscal

years ended June 30, 1996, 1995 and 1994 to each of the Company's executive

officers who served during such period and whose compensation from WMS or the

Company exceeded $100,000. After the Offering, compensation to Mr. Neil D.

Nicastro for services on behalf of the Company will be paid directly by the

Company. See "Employment Agreements" for a discussion of the employment

agreement between the Company and Mr. Nicastro that will take effect upon the

completion of the Offering. Pursuant to the Manufacturing and Services

Agreement, after the Offering the compensation paid by WMS to the executive

officers of the Company (other than Messrs. Nicastro and Cook) will be allocated

to the Company based upon estimates by management of WMS of the percentage of

time devoted to the Company. Management of the Company estimates that such

executive officers will devote approximately 50% of their time to the Company.

The results of operations for each of the fiscal years ended June 30, 1996, 1995

and 1994 include an allocation of the compensation of the Company's executive

officers based on estimates by management of WMS. See "Arrangements With WMS."

 

                         SUMMARY COMPENSATION TABLE(1)

 

<TABLE>

<CAPTION>

                                                                               OTHER

                                             ANNUAL COMPENSATION               ANNUAL         ALL OTHER

         NAME AND PRINCIPAL           ---------------------------------     COMPENSATION     COMPENSATION

              POSITION                YEAR     SALARY ($)     BONUS ($)         ($)              ($)

- ------------------------------------  ----     ----------     ---------     ------------     ------------

<S>                                   <C>      <C>            <C>           <C>              <C>

Neil D. Nicastro....................  1996       532,500       267,600             --            35,791(4)

  Chairman of the Board,              1995       532,500       489,100             --            35,762(4)

  Chief Executive Officer,            1994       532,500       741,600             --            35,742(4)

  President and Chief Operating

Officer

Harold H. Bach, Jr..................  1996       262,500        67,800             --                --

  Executive Vice President --         1995       250,000        67,800             --                --

  Finance, Treasurer and              1994       250,000       100,000             --                --

  Chief Financial Officer

Byron C. Cook.......................  1996       250,000       150,000             --                --

  Executive Vice                      1995       250,000            --             --                --

  President -- Home Video             1994        41,667            --             --                --

Kenneth J. Fedesna..................  1996       267,500        66,000             --             2,500(5)

  Executive Vice                      1995       250,000        66,000             --             2,500(5)

  President -- Coin-Op Video          1994       250,000       100,000             --                --

Barbara M. Norman...................  1996       157,500        27,200             --                --

  Vice President, Secretary           1995       150,000        27,200             --                --

  and General Counsel                 1994       150,000        40,000             --                --

Louis J. Nicastro...................  1996       832,500            --          6,127(3)        629,971(6)

  Director(2)                         1995       682,500       300,000          4,775(3)        409,784(6)

                                      1994       682,500       600,000          4,173(3)        327,252(6)

</TABLE>

 

- ---------------

(1) Does not include options to purchase shares of WMS granted in fiscal 1994

    and held by Mr. Neil D. Nicastro (700,000 shares), Mr. Bach (75,000 shares),

    Mr. Cook (200,000 shares), Mr. Fedesna (100,000 shares), Ms. Norman (75,000

    shares) and Mr. Louis J. Nicastro (500,000). See "-- Stock Option Plan" for

    a discussion of options to acquire shares of Common Stock of the Company

    that will become effective upon the completion of the Offering.

 

(2) Mr. Louis J. Nicastro served as Chairman of the Board and Co-Chief Executive

    Officer of the Company until June 26, 1996.

 

(3) Amount shown is for tax gross-up payments.

 

(4) Amount shown for Mr. Neil D. Nicastro includes for fiscal 1996, 1995 and

    1994 insurance premiums of $691, $662 and $642, respectively, and $35,100

    each for fiscal 1996, 1995 and 1994 accrual for contractual retirement

    benefits.

 

(5) Amount shown for Mr. Fedesna includes insurance premiums.

 

(6) Amount shown is the accrual for contractual retirement benefits for Mr.

    Louis J. Nicastro.

 

                                       45

<PAGE>   47

 

EMPLOYMENT AGREEMENTS

 

     The Company has entered into an employment agreement with Mr. Neil D.

Nicastro which will become effective July 1, 1996, subject to the completion of

the Offering. Pursuant to the employment agreement, Mr. Nicastro will be

employed as the Company's President and Chief Executive Officer. The employment

agreement provides for salaried compensation at the rate of $300,000 per annum,

or such greater amount as may be determined by the Board of Directors, plus

bonus compensation in an amount equal to two percent of the pre-tax income of

the Company multiplied by the percentage of Common Stock outstanding which is

not owned by WMS. The portion of Mr. Nicastro's bonus from WMS that is

attributable to the pre-tax income of the Company will be charged to the Company

pursuant to the Manufacturing and Services Agreement. The employment agreement

will expire five years from the closing of the Offering, subject to automatic

extensions in order that the term of Mr. Nicastro's employment shall at no time

be less than three years. Upon Mr. Nicastro's retirement or death and for a

period of seven years thereafter, the Company is required to pay to Mr. Nicastro

or his designee, or if no designation is made, to his estate, for a period equal

to the greater of the balance of the remaining term of the agreement or seven

years, an annual benefit equal to one-half of the annual base salary being paid

to him on such retirement or death, as the case may be, but in no event less

than $150,000 per annum. Such benefits are payable notwithstanding Mr.

Nicastro's termination of employment for any reason.

 

     The employment agreement provides that Mr. Nicastro shall devote such time

to the business and affairs of the Company as is reasonably necessary to perform

the duties of his position, except that he is not required to perform any duties

or responsibilities which would be likely to result in non-compliance with or

breach or violation of his employment agreement with WMS. Mr. Nicastro currently

spends approximately 50% of his working time on the affairs of the Company and

approximately 50% of his working time on the affairs of WMS.

 

     Mr. Nicastro is employed by WMS pursuant to an employment agreement which

provides for, among other things, full participation in all benefit plans

available to senior executives of WMS and for reimbursement of all medical and

dental expenses incurred by him or his spouse and incurred by his children under

the age of twenty-one. Mr. Nicastro's employment agreement with the Company

provides that should WMS fail for any reason to provide the aforementioned

benefits to Mr. Nicastro, the Company will provide such benefits to him at its

expense. Additionally, the Company will provide Mr. Nicastro with $1,000,000 of

life insurance coverage in addition to the standard amount provided to Company

employees. The agreement further provides for full compensation during periods

of illness or incapacity; however, the Company may give 30 days' notice of

termination if such illness or incapacity disables Mr. Nicastro from performing

his duties for a period of more than six months. Such termination notice becomes

effective if full performance is not resumed within 30 days after such notice

and maintained for a period of two months thereafter. The employment agreement

may be terminated at the election of Mr. Nicastro upon the occurrence without

his consent or acquiescence of any one or more of the following events: (i) the

placement of Mr. Nicastro in a position of lesser stature or the assignment to

Mr. Nicastro of duties, performance requirements or working conditions

significantly different from or at variance with those presently in effect; (ii)

the treatment of Mr. Nicastro in a manner which is in derogation of his status

as a senior executive; (iii) the cessation of service of Mr. Nicastro as a

member of the Board of Directors of the Company; (iv) the discontinuance or

reduction of amounts payable or personal benefits available to Mr. Nicastro

pursuant to such agreement; or (v) the requirement that Mr. Nicastro work

outside his agreed upon metropolitan area. In any such event, and in the event

the Company is deemed to have wrongfully terminated Mr. Nicastro's employment

agreement under the terms thereof, the Company is obligated (a) to make a lump

sum payment to Mr. Nicastro equal in amount to the sum of the aggregate base

salary during the remaining term of his employment agreement (but in no event

less than three times the highest base salary payable to him during the one-year

period prior to such event), the bonus (assuming pre-tax income of the Company

during the remainder of the term of the employment agreement is earned at the

highest level achieved in either of the last two full fiscal years prior to such

termination) and the retirement benefit (assuming the date of termination is his

retirement date) otherwise payable under the terms of the employment agreement

and (b) to purchase at the election of Mr. Nicastro all stock options held by

him with respect to the Company's Common Stock at a price equal to the spread

between the option price and the fair market price of such stock as defined in

the agreement. The

 

                                       46

<PAGE>   48

 

employment agreement may also be terminated at the election of Mr. Nicastro if

individuals who presently constitute the Board of Directors, or successors

approved by such Board members, cease for any reason to constitute at least a

majority of the Board. Upon such an event, the Company may be required to

purchase the stock options held by Mr. Nicastro and make payments similar to

those described above.

 

     If payments made to Mr. Nicastro pursuant to the employment agreement after

a change of control are considered "excess parachute payments" under the

Internal Revenue Code Section 280G, additional compensation is required to be

paid to Mr. Nicastro to the extent necessary to eliminate the economic effect on

him of the resulting excise tax. Pursuant to Section 280G, in addition to income

taxes, the recipient is subject to a 20% nondeductible excise tax on excess

parachute payments. An excess parachute payment is a payment in the nature of

compensation which is contingent on a change of ownership or effective control

and which exceeds the portion of the base amount (i.e., the average compensation

for the five-year period prior to the change of control) allocable to the

payment. These rules apply only if the present value of all payments of

compensation (including non-taxable fringe benefits) at the time of a change of

control is at least equal to three times the base amount. Excess parachute

payments are not deductible by the Company.

 

     Midway Home Entertainment Inc. ("Midway Home"), a wholly-owned subsidiary

of the Company, has entered into an employment agreement with Mr. Byron C. Cook,

pursuant to which Mr. Cook serves as President and Chief Operating Officer of

Midway Home. The agreement expires May 1, 1998 and was entered into in

connection with the Company's acquisition of Tradewest. Mr. Cook's current base

salary is $300,000 per annum. During fiscal 1996, Mr. Cook also received a bonus

of $150,000. Mr. Cook is entitled to participate in the Company's employee

benefit plans generally available to executives of the Company. In addition,

pursuant to the agreement on May 2, 1994, Mr. Cook was awarded non-qualified

stock options to purchase 200,000 shares of WMS common stock. Mr. Cook has

agreed not to engage in any competitive business with the Company in North

America until May 2, 1999 so long as the Company continues to make salary

payments pursuant to the agreement.

 

STOCK OPTION PLAN

 

     The Company's Stock Option Plan (the "Stock Option Plan") provides for the

granting of stock options to directors, officers and employees and consultants

and advisors of the Company and its subsidiaries. The Stock Option Plan is

intended to encourage stock ownership by directors, officers, employees,

consultants and advisors of the Company and its subsidiaries and thereby enhance

their proprietary interest in the Company. The Stock Option Plan will be

administered by the Compensation and Stock Option Committee of the Board of

Directors. Subject to the provisions of the Stock Option Plan, the Compensation

and Stock Option Committee shall have sole authority to determine which of the

eligible directors, officers, employees consultants and advisors of the Company

shall receive stock options, the terms, including applicable vesting periods, of

such options, and the number of shares for which such options shall be granted.

 

     The total number of shares of the Company's Common Stock that may be

purchased pursuant to stock options under the Stock Option Plan shall not exceed

in the aggregate 2,000,000 shares. The option price per share with respect to

each such option shall be determined by the Compensation and Stock Option

Committee but shall not be less than 100% of the fair market value of the

Company's Common Stock on the date such option is granted as determined by the

Committee. The Stock Option Plan terminates in 2006 unless terminated earlier.

 

     Prior to the Offering, WMS, as sole stockholder of the Company, approved

the adoption of the Stock Option Plan following approval by WMS' Stock Option

Committee (the "WMS Committee") and Board of Directors.

 

                                       47

<PAGE>   49

 

     The following table summarizes options granted by the Company immediately

prior to the Offering to the executive officers and directors of the Company.

All the options set forth below were granted pursuant to the Company's Stock

Option Plan and are exercisable at the initial public offering price.

 

                       OPTIONS GRANTED PRIOR TO OFFERING

 

<TABLE>

<CAPTION>

                                                                           NUMBER OF SHARES

                                                                           OF COMMON STOCK

                                                                              SUBJECT TO

                                    NAME                                       OPTIONS

    ---------------------------------------------------------------------  ----------------

    <S>                                                                    <C>

    Neil D. Nicastro.....................................................         500,000

    Harold H. Bach, Jr...................................................         100,000

    Byron C. Cook........................................................         100,000

    Kenneth J. Fedesna...................................................         100,000

    Barbara M. Norman....................................................          25,000

    Louis J. Nicastro....................................................          25,000

</TABLE>

 

     Each of the non-employee directors of the Company will be granted options

pursuant to the Stock Option Plan to acquire 25,000 shares of the Company's

Common Stock at an exercise price equal to the initial public offering price.

The total number of options granted or to be granted prior to the Offering

pursuant to the Stock Option Plan is 1,455,000.

 

                              CERTAIN TRANSACTIONS

 

     Mr. Byron C. Cook, Executive Vice President -- Home Video and a Director of

the Company, owns a one-third interest in each of the three commonly owned

companies which constitute Tradewest, the operating assets and business of which

were acquired by the Company in April 1994.

 

     The purchase price for the assets acquired from Tradewest was set at five

times the average annual pre-tax income of the acquired business during the four

year period commencing May 1, 1994 with a minimum purchase price of $14.1

million, which was paid at the closing, and a maximum additional payment of

$36.0 million to be paid during the four-year earn-out period. Over the first

two years of the earn-out period, the Company has paid an aggregate sum of $14.4

million as additional purchase price. Over the remaining two years of the

contract, the Company may be required to pay up to an additional $21.6 million

in additional payments.

 

     Mr. Ira S. Sheinfeld is a member of the law firm of Squadron, Ellenoff,

Plesent & Sheinfeld LLP which the Company and WMS retained to provide tax

services during the 1996 fiscal year and which each proposes to retain for such

services during the current fiscal year.

 

     Mr. Richard D. White, a nominee for election to the Board of Directors of

the Company, is a Managing Director of Oppenheimer & Co., Inc., which is one of

the Representatives of the Underwriters of the Offering and which will receive

compensation in connection therewith. See "Underwriting."

 

                                       48

<PAGE>   50

 

                             PRINCIPAL STOCKHOLDERS

 

CAPITAL STOCK OF THE COMPANY

 

  

     The following table sets forth certain information with respect to the

ownership of Common Stock as of the date hereof, and as adjusted to reflect the

sale of the Shares, for each of (i) WMS, (ii) each Director of the Company and

each person intended to become a Director of the Company upon completion of the

Offering (other than the additional independent Director the Company intends to

designate) and (iii) such Directors and Executive Officers of the Company as a

group.

   

 

<TABLE>

<CAPTION>

                                        SHARES BENEFICIALLY OWNED        SHARES BENEFICIALLY OWNED

                                          PRIOR TO THE OFFERING              AFTER THE OFFERING

                                       ----------------------------     ----------------------------

          BENEFICIAL OWNER             NUMBER(1)      PERCENTAGE(1)     NUMBER(1)      PERCENTAGE(1)

- -------------------------------------  ----------     -------------     ----------     -------------

<S>                                    <C>            <C>               <C>            <C>

WMS Industries Inc...................  33,400,000         100.0%        33,400,000          86.8%(5)

  3401 N. California Avenue

  Chicago, IL 60618

Neil D. Nicastro.....................          --            --            200,000(2)      *

Harold H. Bach, Jr. .................          --            --             40,000(2)      *

Byron C. Cook........................          --            --             40,000(2)      *

Kenneth J. Fedesna...................          --            --             40,000(2)      *

Louis J. Nicastro....................          --            --             25,000(3)      *

William C. Bartholomay...............          --            --             25,000(4)      *

William E. McKenna...................          --            --             25,000(4)      *

Norman J. Menell.....................          --            --             25,000(4)      *

Harvey Reich.........................          --            --             25,000(4)      *

Ira S. Sheinfeld.....................          --            --             25,000(4)      *

Richard D. White.....................          --            --             25,000(4)      *

Directors and Executive Officers as a

  Group (12 persons).................          --            --            505,000           1.4%(6)

</TABLE>

 

- ---------------

 *  Less than 1% of the number of outstanding shares of Common Stock on the date

    hereof.

 

(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) Prior to and subject to the completion of the Offering, Messrs. Neil D.

    Nicastro, Bach, Cook and Fedesna were granted 500,000, 100,000, 100,000 and

    100,000 options to purchase shares of Common Stock, respectively, of which

    40% are immediately exercisable and the balance of which become exercisable

    in the future. See "Management -- Stock Option Plan."

 

(3) Prior to and subject to the completion of the Offering, Mr. Louis J.

    Nicastro was granted 25,000 options to purchase shares of Common Stock, all

    of which are immediately exercisable.

 

(4) Represents options to acquire 25,000 shares of Common Stock to be granted

    upon completion of the Offering.

 

(5) 85.1% if the Underwriters' over-allotment option is exercised in full.

 

(6) 1.3% if the Underwriters' over-allotment option is exercised in full.

 

                                       49

<PAGE>   51

 

CAPITAL STOCK OF WMS

 

  

     The following table sets forth certain information with respect to the

beneficial ownership of the capital stock of WMS owned by persons known to be

the beneficial owner of more than five percent of such stock, and each Director

(and each person intended to become a Director of the Company upon completion of

the Offering other than the additional independent Director the Company intends

to designate) and Executive Officer of the Company or WMS as of June 30, 1996.

   

 

<TABLE>

<CAPTION>

                                                              NUMBER OF SHARES OF

                                                              COMMON STOCK OF WMS      PERCENT OF

                           NAME                              BENEFICIALLY OWNED(1)      CLASS(2)

- -----------------------------------------------------------  ---------------------     ----------

<S>                                                          <C>                       <C>

Sumner M. Redstone and

  National Amusements, Inc.................................         5,929,100(3)          24.5%

  200 Elm Street

  Dedham, MA 02026

FMR Corp...................................................         2,439,579(4)          10.1%

  82 Devonshire St.

  Boston, MA 02109

The Capital Group Companies, Inc.

  and Capital Research and Management Company..............         1,902,000(5)           7.9%

  333 South Hope Street

  Los Angeles, CA 90071

State of Wisconsin Investment Board........................         1,329,200(6)           5.5%

  P.O. Box 7842

  Madison, WI 53707

Neil D. Nicastro...........................................         6,791,100(7)          27.2%

Louis J. Nicastro..........................................         6,433,732(8)          25.8%

Harold H. Bach, Jr. .......................................            77,000(9)          *

Byron C. Cook..............................................           127,285(10)         *

Kenneth J. Fedesna.........................................           130,058(11)         *

Barbara M. Norman..........................................            90,000(9)          *

William C. Bartholomay.....................................            68,800(12)         *

William E. McKenna.........................................            52,594(12)         *

Norman J. Menell...........................................            52,216(12)         *

Harvey Reich...............................................            51,190(12)         *

Ira S. Sheinfeld...........................................            62,000(13)         *

Richard D. White...........................................                --            --

George R. Baker............................................            50,800(12)         *

</TABLE>

 

- ---------------

  *  Less than 1% of the number of outstanding shares of WMS common stock on

     June 30, 1996.

 

 (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. Certain of such options as reported herein also

     require that WMS' common stock attain a market price of $35.00 per share

     prior to exercise (herein referred to as "Target Price Options").

 

 (2) For purposes of calculating the percentage of shares of WMS common stock

     owned by each director or officer, shares beneficially owned and issuable

     upon the exercise of his or her options exercisable within 60 days have

     been deemed to be outstanding.

 

 (3) The number of shares reported is based upon information contained in

     Amendment No. 19, dated September 21, 1995, to the Schedule 13D filed by

     Mr. Sumner M. Redstone with the Securities and Exchange Commission.

     Pursuant to such Schedule as amended, Mr. Redstone and National Amusements,

     Inc., a Maryland corporation, reported beneficial ownership of and sole

     investment power with respect to 3,033,800 and 2,895,300 shares,

     respectively, of the common stock of WMS and shared voting power with

     respect to such shares pursuant to a voting proxy agreement entered into

     with WMS and Messrs. Louis J. and Neil D. Nicastro. Mr. Redstone is the

     beneficial owner of 66 2/3% of the issued and outstanding shares of the

     common stock of National Amusements, Inc. In order for WMS to be permitted

     to manufacture and sell slot machines in Nevada, WMS and certain of its

     subsidiaries and Mr. Louis J. Nicastro and Mr. Neil D. Nicastro were

     required to be licensed or found suitable and were licensed or found

     suitable by the Nevada gaming regulators. Under applicable Nevada law and

     administrative procedure, as a greater than 10% stockholder of WMS, Mr.

     Sumner M. Redstone was required to apply and has an application pending

     with the Nevada gaming

 

                                       50

<PAGE>   52

 

     regulators for a finding of suitability as a stockholder of WMS. Pending

     completion of the processing of Mr. Redstone's application, Mr. Redstone

     and National Amusements, Inc. have granted to Mr. Louis J. Nicastro and, if

     he is unable to perform his duties, Mr. Neil D. Nicastro, a voting proxy

     for all of the shares of WMS common stock which they beneficially own.

 

 (4) The number of shares reported is based upon information contained in a

     Schedule 13G/A dated August 9, 1996 filed with the Securities and Exchange

     Commission by FMR Corp. Pursuant to such Schedule, FMR Corp. reported that

     Fidelity Management & Research Company, a wholly-owned subsidiary of FMR

     Corp. and an investment adviser registered under Section 203 of the

     Investment Advisers Act of 1940, as amended, is the beneficial owner of

     2,439,579 shares or 10.1% of WMS common stock as a result of acting as

     investment adviser to various investment companies registered under Section

     8 of the Investment Company Act of 1940. FMR Corp. reported it has sole

     power to dispose of or direct the disposition of all of such shares but no

     power to vote such shares.

 

 (5) The number of shares reported is based upon information contained in a

     Schedule 13G dated February 9, 1996 filed with the Securities and Exchange

     Commission by The Capital Group Companies, Inc. ("CGC"). Pursuant to such

     Schedule 13G and accompanying documentation, CGC reported that Capital

     Research and Management Company, an Investment Adviser registered under

     Section 203 of the Investment Advisers Act of 1940, and Capital Guardian

     Trust Company, a bank as defined in Section 3(a)(6) of the Securities

     Exchange Act of 1934, as amended, operating subsidiaries of CGC, exercised

     as of December 31, 1995, investment discretion with respect to 1,300,000

     and 602,000 shares, respectively, or a combined total of 7.9% of the WMS'

     common stock which was owned by various institutional investors at that

     time.

 

 (6) The number of shares reported is based upon information contained in a

     Schedule 13G dated February 3, 1996 filed with the Securities and Exchange

     Commission by the State of Wisconsin Investment Board ("SWIB"), a

     governmental agency which manages public pension funds subject to

     provisions comparable to ERISA. The SWIB reported it had sole voting and

     dispositive power with respect to 1,329,200 shares of the WMS' common

     stock.

 

 (7) The number of shares reported as beneficially owned includes 5,929,100

     shares owned by Sumner M. Redstone and National Amusements, Inc. for which

     the reporting person has shared voting power but no dispositive power.

     Additionally, the number of shares reported as beneficially owned includes

     862,000 shares for which the reporting person has sole voting and sole

     dispositive power, 800,000 of which may be acquired pursuant to stock

     options, 500,000 of such options being Target Price Options.

 

 (8) The number of shares reported as beneficially owned includes 5,929,100

     shares owned by Sumner M. Redstone and National Amusements, Inc. for which

     the reporting person has shared voting power but no dispositive power.

     Additionally, the number of shares reported as beneficially owned includes

     500,000 shares for which the reporting person has sole voting and sole

     dispositive power, all of which may be acquired pursuant to Target Price

     Options.

 

 (9) Includes 75,000 shares of Target Price Options.

 

(10) Includes 100,000 shares of common stock which Mr. Cook has the right to

     acquire upon the exercise of stock options.

 

(11) Includes 130,000 shares of common stock which Mr. Fedesna has the right to

     acquire upon the exercise of stock options, 100,000 of which are Target

     Price Options.

 

(12) Includes 50,000 shares of Target Price Options.

 

(13) Includes 62,000 shares of common stock which Mr. Sheinfeld has the right to

     acquire upon the exercise of stock options, 50,000 of which are Target

     Price Options.

 

                                       51

<PAGE>   53

 

                             ARRANGEMENTS WITH WMS

 

     Prior to the Offering, the Company was a wholly-owned subsidiary of WMS. As

a result of the Offering, WMS' beneficial ownership of Common Stock will be

reduced from 100.0% to 86.8% (85.1% if the Underwriters' over-allotment option

is exercised in full). A majority of the Company's directors are directors

and/or officers of WMS. Additionally, several of the executive officers of the

Company are officers and/or directors of WMS and will maintain such

relationships with WMS after the closing of the Offering. See

"Management -- Directors and Executive Officers of the Company."

 

     In contemplation of the Offering, the Company and WMS entered into the

following agreements.

 

MANUFACTURING AND SERVICES AGREEMENT

 

     The Company and WMS have entered into a Manufacturing and Services

Agreement (the "Manufacturing and Services Agreement") with respect to various

aspects of their future relationship. The Manufacturing and Services Agreement

became effective as of July 1, 1996 and will continue in effect unless

terminated (a) by either party for any reason upon 180 days' notice or (b) in

the event of a material default, immediately at the election of the

non-defaulting party. The Company also has the right, upon 180 days' notice, to

terminate the manufacturing and related services provided by WMS while retaining

WMS' other services. The Manufacturing and Services Agreement provides, among

other things, that WMS will provide the Company with management, legal and

administrative services and certain services for its coin-operated video games

including, without limitation, (i) manufacturing; (ii) engineering support;

(iii) sales and marketing; (iv) warranty and field services; and (v) creative

services. The aforementioned services will be provided to the Company upon terms

which the Company believes are fair and reasonable. The parties have agreed that

with respect to matters not specifically covered in the Manufacturing and

Services Agreement, or if changes in business circumstances should cause the

method of handling matters specifically covered to be unfair to either party,

such matters will be referred to a negotiating committee consisting of two

designees of each party.

 

     All of the Company's coin-operated video games will be manufactured and

assembled by WMS at its facilities in Cicero and Waukegan, Illinois. Materials

used in the manufacture of coin-operated video games will be purchased by Midway

at its expense. Certain other manufacturing costs will be allocated based upon

units produced for the Company and the other amusement games businesses of WMS.

All labor costs associated with the manufacturing of coin-operated video games

will be charged to the Company at actual cost to WMS. Certain management, legal

and administrative expenses and sales and marketing expenses will be allocated

based upon the revenues of and/or units produced for the Company and the other

amusement games businesses of WMS or other methods appropriate for the

allocation of the particular expense.

 

     For so long as the Manufacturing and Services Agreement remains in effect

and for a period of five years thereafter, (i) WMS is precluded from engaging,

directly or indirectly, in the business of designing, developing, manufacturing,

marketing or distributing coin-operated or home video games (except for its

activities on behalf of the Company) and (ii) the Company is precluded from

engaging, directly or indirectly, in the business of designing, developing,

manufacturing, marketing or distributing coin-operated pinball games, novelty

games, video lottery terminals or gaming machines such as slot machines.

 

     The foregoing description of the Management and Services Agreement is

qualified by reference to the Management and Services Agreement, a copy of which

is filed as an exhibit to the Registration Statement of which this Prospectus is

a part.

 

TAX SHARING AGREEMENT

 

     The Company has been a member since 1988 of the WMS Group. Therefore, the

Company is jointly and severally liable for any federal tax liability incurred

by the WMS Group. The Company and WMS have entered into the Tax Sharing

Agreement whereby WMS and the Company have agreed upon a method for (i)

determining the amount which the Company must pay to WMS in respect of federal

income taxes; (ii) compensating any member of the WMS Group for use of its net

operating losses, tax credits and other tax benefits in arriving at the WMS

Group tax liability as determined under the federal consolidated return

 

                                       52

<PAGE>   54

 

regulations; and (iii) providing for the receipt of any refund arising from a

carryback of net operating losses or tax credits from subsequent taxable years

and for payments upon subsequent adjustments. If any two or more members of the

WMS Group are required to elect, or WMS elects to cause two or more members of

the WMS Group to file combined or consolidated income tax returns under state or

local income tax law, the financial consequences of such filings among such

members shall be determined in a manner as similar as practicable to those

provided for under the Tax Sharing Agreement for federal taxes. The Tax Sharing

Agreement is not binding on the IRS or upon state, local or foreign taxing

authorities. The effectiveness of the Tax Sharing Agreement is therefore

dependent on each member of the WMS Group having the ability to pay its relative

share of taxes. Because the IRS or other taxing authorities can be expected to

seek payment from WMS prior to seeking payment from the individual group

members, it is likely that the Company would seek to enforce any rights it may

have against WMS for sharing at a time when WMS was unable to pay its

proportionate share of taxes. The foregoing description of the Tax Sharing

Agreement is qualified by reference to the Tax Sharing Agreement, a copy of

which is filed as an exhibit to the Registration Statement of which this

Prospectus is a part.

 

REGISTRATION RIGHTS AGREEMENT

 

     Prior to the consummation of the Offering, the Company entered into a

registration rights agreement (the "Registration Rights Agreement") with WMS,

pursuant to which the Company has agreed, upon the request of WMS, to file up to

two registration statements under the Securities Act in order to permit WMS to

offer and sell shares of Common Stock that WMS or its affiliates may

beneficially own. The Company will pay all registration fees and expenses in

connection with any requested registration, except that WMS will pay any

underwriting discounts or commissions relating to shares owned by it and

included in any such registration. WMS may not exercise these rights until 180

days after the closing of the Offering. The Company will not be required to

comply with any request for registration unless the request involves at least 5%

of the total number of the then outstanding shares of Common Stock. The

Registration Rights Agreement also provides WMS the right to include its Common

Stock holdings in certain Registration Statements covering offerings by the

Company and the Company will pay all fees and expenses of such offerings other

than underwriting discounts or commissions as they relate to WMS' shares. The

Company will indemnify WMS and its officers, directors and controlling persons

against certain liabilities in respect of any registrations or other offerings

covered by the Registration Rights Agreement. WMS will indemnify the Company

against any liability arising as a result of information provided by WMS and

included in any offering document covered by the Registration Rights Agreement.

The Company has the right to request WMS to delay any exercise by WMS of its

rights to require registration and other actions for a period of up to 60 days

under certain circumstances. WMS has further agreed that it will not include any

Common Stock in any Registration Statement of the Company which, in the judgment

of the underwriters for such offering, would adversely affect such offering by

the Company. The rights of WMS under the Registration Rights Agreement are

transferable to an assignee of WMS at its option. The foregoing description of

the Registration Rights Agreement is qualified by reference to the Registration

Rights Agreement, a copy of which is filed as an exhibit to the Registration

Statement of which this Prospectus is a part.

 

PATENT LICENSE AGREEMENT

 

     The Company and WMS have entered into a patent license agreement pursuant

to which the Company and WMS each licensed to the other, on a perpetual,

royalty-free basis, certain patents used in the development and manufacture of

both coin-operated video games and video lottery terminals and other gaming

machines.

 

                                       53

<PAGE>   55

 

                          DESCRIPTION OF CAPITAL STOCK

 

     Immediately prior to the consummation of the Offering, the Company will

amend and restate its Certificate of Incorporation (the "Certificate of

Incorporation") to, among other things, change its authorized capital stock to

100,000,000 shares of Common Stock, $.01 par value per share, of which

38,500,000 shares will be outstanding upon completion of the Offering

(39,265,000 if the Underwriters' over-allotment option is exercised in full),

and 5,000,000 shares of preferred stock, $.01 par value per share (the

"Preferred Stock"), of which no shares will be outstanding upon completion of

the Offering, although shares of Series A Preferred Stock will be designated and

reserved for issuance in connection with the Rights Agreement between the

Company and The Bank of New York (the "Rights Agreement").

 

     The following summary description of the capital stock of the Company is

qualified by reference to the Certificate of Incorporation and the Company's

Bylaws (the "Bylaws"), a copy of each of which is filed as an exhibit to the

Registration Statement of which this Prospectus forms a part.

 

COMMON STOCK

 

     Holders of shares of Common Stock vote as a single class on all matters

submitted to a vote of the stockholders, including the election of directors,

with each share of Common Stock entitled to one vote. There is no cumulative

voting with respect to the election of directors, with the result that the

holders of more than 50% of the shares voting for the election of directors can

elect all of the directors. Immediately following the Offering, WMS will have

approximately 86.8% of the voting power of the outstanding shares of Common

Stock (85.1% if the Underwriters' over-allotment is exercised in full). As a

result, WMS will retain the voting power required to elect and remove all

directors and approve all other matters required to be voted upon by the

stockholders of the Company. See "Risk Factors -- Voting Control by WMS" and

"Arrangements With WMS." Under the DGCL, so long as it owns a majority of the

outstanding shares of Common Stock, WMS is permitted to effectuate any

stockholder action by its written consent only, followed by written notice

thereof to other stockholders. See "-- Certain Provisions of the Delaware

General Corporation Law."

 

     Holders of Common Stock on the applicable record date are entitled to share

ratably in such dividends, if any, as may be declared from time to time by the

Board of Directors out of funds legally available therefor, subject to the

rights of the holders of any series of Preferred Stock. See "Dividend Policy."

Upon the liquidation, dissolution or winding up of the Company, each holder of

Common Stock will be entitled to share ratably in any distribution of the

Company's assets after the payment of all debts and other liabilities, subject

to any superior rights of the holders of any outstanding shares of Preferred

Stock.

 

     Other than the Rights Plan, holders of the shares of Common Stock do not

have preemptive or other subscription rights and there are no conversion rights

or redemption or sinking fund provisions with respect to such shares. All of the

outstanding shares of Common Stock are, and the shares of Common Stock offered

hereby will be when issued, fully paid and non-assessable.

 

     Special meetings of stockholders may be called by the Company's Board of

Directors, the Chairman of the Board of Directors or the President. Except as

otherwise required by law, stockholders, in their capacity as such, are not

entitled to request or call a special meeting of stockholders.

 

     Stockholders of the Company are required to provide advance notice of

nominations of directors to be made at, and of business proposed to be brought

before, a meeting of stockholders. The failure to deliver proper notice within

the period specified in the Bylaws will result in the denial to the stockholder

of the right to make such nominations or propose such action at the meeting.

 

PREFERRED STOCK

 

     The Company's Board of Directors has authority (without action by the

stockholders) to issue up to 5,000,000 authorized and unissued shares of

Preferred Stock in one or more series, to designate the number of shares

constituting any series, and to fix, by resolution, the voting powers,

designations, preferences and relative, optional or other special rights

thereof, including liquidation preferences and the dividend, conversion and

redemption rights of each such series. If the resolutions establishing the

series so provide, holders of any

 

                                       54

<PAGE>   56

 

series of Preferred Stock may have the right to receive a liquidating

distribution before any distribution is made to holders of Common Stock upon

liquidation, and holders of Preferred Stock may be entitled to receive all

dividends to which they are entitled before any dividends may be paid to holders

of Common Stock. Holders of each series of Preferred Stock will have such voting

rights (which may include special rights regarding election of directors) as may

be provided in the resolutions establishing such series. The proposed Preferred

Stock will not be set aside for any specified purpose, but will be subject to

issuance at the discretion of the Board from time to time for any proper

corporate purposes and without any further stockholder approval. Any Preferred

Stock which is issued will rank senior to the Common Stock.

 

     In addition, a new class of Preferred Stock can be used to make more

difficult a change in control of the Company. Under certain circumstances the

Board could create impediments to, or frustrate persons seeking to effect, a

takeover or transfer of control of the Company by causing such shares to be

issued to a holder or holders who might side with the Board in opposing a

takeover bid that the Board determines is not in the best interest of the

Company and its stockholders. Such action may have an adverse impact on

stockholders who may want to accept such takeover bid. In this connection, the

Board could, publicly or privately issue shares of Preferred Stock with full

voting rights to a holder that would thereby have sufficient voting power to

insure that certain types of proposals (including any proposal to remove

directors, to accomplish certain business combinations opposed by the Board, or

to alter, amend or repeal provisions in the Certificate of Incorporation or

Bylaws relating to any such action) would not receive the requisite stockholder

vote. Furthermore, the existence of such shares might have the effect of

discouraging any attempt by a person or entity to acquire control of the Company

since the issuance of such shares could dilute the ownership of such person or

entity. Other than the preferred stock issuable pursuant to the Rights

Agreement, the Company is not contemplating the issuance of any Preferred Stock

which may make more difficult a change in control of the Company, nor is the

Company aware of any proposals relating to a possible change in control of the

Company.

 

STOCKHOLDER RIGHTS AGREEMENT

 

     The following description of the Company's rights agreement (the "Rights

Agreement") is qualified in its entirety by reference to the Rights Agreement, a

copy of which is filed as an Exhibit to the Registration Statement of which this

Prospectus is a part.

 

     The Board of Directors of the Company plans to adopt the Rights Agreement

prior to the Offering. The Rights Agreement provides that one Right will be

issued with each share of the Common Stock issued (whether originally issued or

from the Company's treasury) on or after the effective date of the Offering and

prior to the Rights Distribution Date (as defined). The Rights are not

exercisable until the Rights Distribution Date and will expire at the close of

business on December 31, 2006 (the "Final Expiration Date") unless previously

redeemed by the Company as described below. When exercisable, each right

entitles the owner to purchase from the Company one one-hundredth ( 1/100) of a

share of the Company's Series A Preferred Stock at an exercise price of $100.00,

subject to certain antidilution adjustments. The Rights will not, however, be

exercisable, transferable separately or trade separately from the shares of

Common Stock, until (a) the tenth business day after the "Stock Acquisition

Date" (i.e., the date of a public announcement that a person or group is an

"Acquiring Person") or (b) the tenth business day (or such later day as the

Company's Board of Directors, with the concurrence of a majority of Continuing

Directors, determines) after a person or group announces a tender or exchange

offer, which, if consummated, would result in such person or group beneficially

owning 10% or more of the Company's Common Stock (the earlier of such dates

being the "Rights Distribution Date").

 

     In general, any person or group of affiliated persons (other than the

Company, any of its subsidiaries, WMS, certain of the Company's benefit plans

and any person or group of affiliated persons whose acquisition of 10% or more

is approved by the Board in advance) who, after the date of adoption of the

Rights Agreement, acquires beneficial ownership of 10% or more of the

outstanding shares of Common Stock will be considered an "Acquiring Person."

 

     If a person or group of affiliated persons becomes an Acquiring Person,

then each Right (other than Rights owned by such Acquiring Person and its

affiliates and associates, which will be null and void) will

 

                                       55

<PAGE>   57

 

entitle the holder thereof to purchase, for the exercise price, a number of

shares of the Company's Common Stock having a then current market value of twice

the exercise price. Accordingly, at the original exercise price, each Right

would entitle its registered holder to purchase $200.00 worth of Common Stock

for $100.00.

 

     If at any time after the Stock Acquisition Date, (a) the Company merges

into another entity, (b) an acquiring entity merges into the Company and the

Common Stock of the Company is changed into or exchanged for other securities or

assets of the acquiring entity or (c) the Company sells more than 50% of its

assets or earning power, then each Right will entitle the holder thereof to

purchase, for the exercise price, the number of shares of common stock of such

other entity having a current market value of twice the exercise price. The

foregoing will not apply to (i) a transaction approved by a majority of the

Board of Directors (or from and after the Stock Acquisition Date, a majority of

the Continuing Directors) or (ii) a merger which follows a cash tender offer

approved by the Board of Directors (or after the Stock Acquisition Date, a

majority of Continuing Directors) for all outstanding shares of Common Stock so

long as the consideration payable in the merger is the same in form and not less

than the amount as was paid in the tender offer. A Continuing Director is a

director in office prior to the distribution of the Rights and any director

recommended or approved for election by such directors but does not include any

representative of an Acquiring Person.

 

     Subject to the limitations summarized below, the Rights are redeemable at

the Company's option, at any time prior to the earlier of the Stock Acquisition

Date or the Final Expiration Date, for $.01 per Right, payable in cash or shares

of Common Stock. Under certain circumstances, the decision to redeem requires

the concurrence of a majority of the Continuing Directors. In the event a

majority of the Board of Directors of the Company is changed by vote of the

Company's stockholders, the Rights shall not be redeemable for a period of ten

business days after the date that the new directors so elected take office and

it shall be a condition to such redemption that any tender or exchange offer

then outstanding be kept open within such ten business day period. At any time

after any person becomes an Acquiring Person, the Board of Directors of the

Company may exchange the Rights (other than Rights owned by the Acquiring Person

and associates, which will be null and void), in whole or in part, for Common

Stock on the basis of an exchange ratio of one share of Common Stock for each

Right (subject to adjustment).

 

     As long as the Rights are attached to the Common Stock, each share of

Common Stock issued by the Company will also evidence one Right. Until the

Rights Distribution Date, the Rights will be represented by the Common Stock

certificates and will be transferred only with the Common Stock certificates;

separate certificates representing the Rights will be mailed, however, to

holders of the Common Stock as of the Rights Distribution Date. The holders of

Rights will not have any voting rights or be entitled to dividends until the

Rights are exercised.

 

     The purchase price payable, and the number of shares of Preferred Stock or

other securities or property issuable, upon exercise of the Rights are subject

to adjustment from time to time to prevent dilution in the event of certain

stock dividends on, or subdivisions, combinations or reclassification of, the

shares of Common Stock prior to the Rights Distribution Date, and in certain

other events.

 

     The Board of Directors of the Company may amend the Rights Agreement in any

manner prior to the Rights Distribution Date. After the Rights Distribution

Date, the Board may amend the Rights Agreement only to cure ambiguities, to

shorten or lengthen any time period (subject to certain limitations) or if such

amendment does not adversely affect the interests of the Rights Holders and does

not relate to any principal economic term of the Rights.

 

CERTAIN PROVISIONS OF THE DELAWARE GENERAL CORPORATION LAW

 

     Generally, Section 203 of the DGCL prohibits a publicly held Delaware

corporation from engaging in a broad range of "business combinations" with an

"interested stockholder" (defined generally as a person owning 15% of more of a

corporation's outstanding voting stock) for three years following the time such

person became an interested stockholder unless (i) before the person becomes an

interested stockholder, the transaction resulting in such person becoming an

interested stockholder or the business combination is approved by the board of

directors of the corporation; (ii) upon consummation of the transaction which

resulted in the stockholder becoming an interested stockholder, the interested

stockholder owns at least 85% of

 

                                       56

<PAGE>   58

 

the outstanding voting stock of the corporation (excluding shares owned by

directors who are also officers of the corporation or shares held by employee

stock plans that do not provide employees with the right to determine

confidentially whether shares held subject to the plan will be tendered in a

tender offer or exchange offer); or (iii) at or subsequent to such time the

business combination is approved by the Board of Directors and authorized at an

annual or special meeting of stockholders, and not by written consent, by the

affirmative vote of at least two-thirds of the outstanding voting stock

excluding shares owned by the interested stockholders.

 

     Section 203 of the DGCL may discourage persons from making a tender offer

for or acquisitions of substantial amounts of the Common Stock. This could have

the effect of inhibiting changes in management and may also prevent temporary

fluctuations in the Common Stock that often result from takeover attempts.

 

     Section 228 of the DGCL allows any action which is required to be or may be

taken at a special or annual meeting of the stockholders of a corporation to be

taken without a meeting with the written consent of holders of outstanding stock

having not less than the minimum number of votes that would be necessary to

authorize or take such action at a meeting at which all shares entitled to vote

thereon were present and voted, provided that the certificate of incorporation

of such corporation does not contain a provision to the contrary. The

Certificate of Incorporation contains no such provision, and therefore

stockholders holding a majority of the voting power of the Common Stock will be

able to approve a broad range of corporate actions requiring stockholder

approval without the necessity of holding a meeting of stockholders.

 

LIMITATION OF LIABILITY OF DIRECTORS AND OFFICERS; INDEMNIFICATION

 

     The Certificate of Incorporation limits personal liability for directors to

the fullest extent permitted under the DGCL. Section 102(b)(7) of the DGCL

permits a corporation to eliminate or limit the personal liability of a

corporation or its stockholders for monetary damages for breach of fiduciary

duty as a director, provided that such provision shall not eliminate or limit

the liability of a director (i) for any breach of the director's duty of loyalty

to the corporation or its stockholders, (ii) for acts or omissions not in good

faith or which involve intentional misconduct or a knowing violation of laws,

(iii) under Section 174 of the DGCL relating to unlawful payment of dividends,

stock purchases or redemptions, or (iv) for any transaction from which the

director derived an improper personal benefit.

 

     Section 102(b)(7) of the DGCL is designed, among other things, to encourage

qualified individuals to serve as directors of Delaware corporations. The

Company believes this provision will assist it in maintaining and securing the

services of qualified directors who are not employees of the Company. This

provision has no effect on the availability of equitable remedies, such as

injunction or rescission. If equitable remedies are found not to be available to

stockholders in any particular case, stockholders may not have any effective

remedy against actions taken by directors that constitute negligence or gross

negligence.

 

     Section 145 of the DGCL permits the Company to, and the Certificate of

Incorporation provides that the Company shall, indemnify and hold harmless any

director, officer or incorporator of the Company and any person serving at the

request of the Company as a director, officer, incorporator, employee, partner,

trustee or agent of another corporation, partnership, joint venture, trust or

other enterprise (including an employee benefit plan) from and against any and

all expenses (including counsel fees and disbursements), judgments, fines

(including excise taxes assessed on a person with respect to an employee benefit

plan) and amounts paid in settlement that may be imposed upon or incurred by him

or her in connection with, or as a result of, any proceeding, whether civil,

criminal, administrative or investigative (whether or not by or in the right of

the Company), in which he or she may become involved, as a party or otherwise,

by reason of the fact that he or she is or was such a director, officer or

incorporator of the Company or is or was serving at the request of the Company

as a director, officer, incorporator, employee, partner, trustee or agent of

another corporation, partnership, joint venture, trust or other enterprise

(including an employee benefit plan), whether or not he or she continues to be

such at the time such expenses and judgments, fines and amounts paid in

settlement shall have been imposed or incurred, to the fullest extent permitted

by the laws of the State of Delaware, as they may be amended from time to time.

Such right of indemnification shall inure whether or not the claim asserted is

based on matters which antedate the adoption of the Certificate of

Incorporation. Such right of

 

                                       57

<PAGE>   59

 

indemnification shall continue as to a person who has ceased to be a director,

officer or incorporator and shall inure to the benefit of the heirs and personal

representatives of such a person. The indemnification provided by the

Certificate of Incorporation shall not be deemed exclusive of any other rights

which may be provided now or in the future under any provision currently in

effect or hereafter adopted of the Certificate of Incorporation, by any

agreement, by vote of stockholders, by resolution of directors, by provision of

law or otherwise. Insofar as indemnification for liabilities arising under the

Securities Act may be permitted to directors of the Company pursuant to the

foregoing provision, or otherwise, the Company has been advised that in the

opinion of the Securities and Exchange Commission (the "Commission") such

indemnification is against public policy as expressed in the Securities Act and

is, therefore, unenforceable.

 

     The Company has entered into indemnity agreements with each of its

directors and executive officers whereby the Company will, in general, indemnify

such directors and executive officers, to the extent permitted by the laws of

the State of Delaware, against any expenses (including attorneys' fees),

judgments, fines and amounts paid in settlement incurred in connection with any

actual or threatened action or proceeding to which such director or officer is

made or threatened to be made a party by reason of the fact that such person is

or was a director or officer of the Company. The foregoing description of the

indemnity agreements is qualified in its entirety by reference to the Company's

form of indemnity agreement, a copy of which is filed as an exhibit to the

Registration Statement of which this Prospectus forms a part.

 

TRANSFER AGENT AND REGISTRAR

 

     The Transfer Agent and Registrar for the Common Stock is The Bank of New

York, with an address at 101 Barclay Street, 22W, New York, New York 10286.

 

                                       58

<PAGE>   60

 

                        SHARES ELIGIBLE FOR FUTURE SALE

 

     Upon completion of the Offering, the Company will have outstanding

38,500,000 shares of Common Stock (39,265,000 shares if the Underwriters'

over-allotment option is exercised in full), of which all of the 5,100,000

shares of Common Stock (5,865,000 shares if the Underwriters' over-allotment

option is exercised in full) sold in the Offering will be freely tradable

without restriction under the Securities Act, unless purchased by "affiliates"

of the Company as that term is defined in Rule 144 promulgated under the

Securities Act. WMS owns 33,400,000 shares of Common Stock, all of which will be

"restricted shares" for purposes of the Securities Act and may not be sold in

the absence of registration other than through Rule 144 or another exemption

from registration under the Securities Act.

 

     In general, under Rule 144 as currently in effect, a person (or persons

whose shares are required to be aggregated) who has beneficially owned shares of

Common Stock that have been outstanding and not held by an "affiliate" of the

Company for a period of two years is entitled to sell within any three-month

period a number of shares that does not exceed the greater of one percent

(approximately 385,000 shares immediately after completion of the Offering) of

the then outstanding shares of Common Stock or the average weekly reported

trading volume of the Common Stock during the four calendar weeks preceding the

date on which notice of such sales is given, provided certain manner of sale and

notice requirements and requirements as to the availability of current public

information concerning the Company are satisfied (which requirements, as to the

availability of current public information, are expected to be satisfied

commencing 90 days after the date of this Prospectus). Affiliates of the Company

must comply with the restrictions and requirements of Rule 144, other than the

two-year holding period requirement, in order to sell shares of Common Stock

that are not "restricted securities" (such as shares acquired by affiliates in

the Offering). Under Rule 144(k), a person who is not deemed an "affiliate" of

the Company at any time during the three months preceding a sale by him, and who

has beneficially owned shares of Common Stock that were not acquired from the

Company or an "affiliate" of the Company within the previous three years, would

be entitled to sell such shares without regard to volume limitations, manner of

sale provisions, notification requirements or the availability of current public

information concerning the Company. As defined in Rule 144, an "affiliate" of an

issuer is a person that directly or indirectly through the use of one or more

intermediaries controls, or is controlled by, or is under common control with,

such issuer. The Commission has recently proposed an amendment to Rule 144

which, if adopted, would shorten the general two-year holding period under Rule

144 to one year and shorten the three year holding period under Rule 144(k) to

two years.

 

     WMS has agreed not to offer, sell or otherwise dispose of shares of Common

Stock in the public market for a period of 180 days after the date of this

Prospectus without the written consent of Oppenheimer & Co., Inc., but such

shares thereafter may be sold in the public market pursuant to Rule 144 under

the Securities Act or pursuant to an effective registration statement. The

Company has entered into the Registration Rights Agreement with WMS pursuant to

which the Company has agreed to file registration statements under certain

circumstances and take other steps requested by WMS in order to enable WMS to

sell its shares of Common Stock. See "Arrangements With WMS -- Registration

Rights Agreement." Sales of a substantial number of shares of Common Stock in

the public market could adversely affect the market price of the Common Stock.

An additional 2,000,000 shares of Common Stock are reserved for issuance under

the Company's Stock Option Plan, of which options for approximately 1,455,000

shares have been or will be granted prior to the Offering, subject to

consummation of the Offering. It is the Company's intention to register the

shares underlying options granted under the Company's Stock Option Plan under

the Securities Act shortly after the date of this Prospectus, and such shares

may be sold in the public market at any time thereafter, subject to certain

restrictions under Rule 144 with respect to shares held by affiliates of the

Company.

 

                                       59

<PAGE>   61

 

                                  UNDERWRITING

 

     Subject to the terms and conditions of the Underwriting Agreement, the

Company has agreed to sell to each of the Underwriters named below, and each of

the Underwriters, for whom Oppenheimer & Co., Inc., Hambrecht & Quist LLC, UBS

Securities LLC and Wasserstein Perella Securities, Inc., are acting as

Representatives, has severally agreed to purchase from the Company, the

respective number of, shares of Common Stock set forth opposite the name of such

Underwriter below:

 

<TABLE>

<CAPTION>

                                                                              NUMBER OF

                                                                              SHARES OF

                                  UNDERWRITER                                COMMON STOCK

    -----------------------------------------------------------------------  ------------

    <S>                                                                      <C>

    Oppenheimer & Co., Inc.................................................

    Hambrecht & Quist LLC..................................................

    UBS Securities LLC.....................................................

    Wasserstein Perella Securities, Inc....................................

                                                                                 -------

      Total................................................................    5,100,000

                                                                                 =======

</TABLE>

 

     The Underwriters propose to offer the shares of Common Stock directly to

the public initially at the public offering price set forth on the cover page of

this Prospectus and in part to certain securities dealers at such price less a

concession of $          per share. The Underwriters may allow, and such dealers

may reallow, a concession not in excess of $          per share to certain

brokers and dealers. After the shares of Common Stock are released for sale to

the public, the offering price and other selling terms may from time to time be

changed by the Representatives. The Underwriters are obligated to take and pay

for all of the shares of Common Stock offered hereby (other than those covered

by the over-allotment option described below) if any are taken. Mr. Clark

Schubach, a Managing Director of Bear, Stearns & Co. Inc., acting on his own

behalf and not as a representative of Bear, Stearns & Co. Inc., will be paid a

finder's fee by the Representatives of the Underwriters.

 

     The Company has granted the Underwriters an option, exercisable for up to

30 days after the date of this Prospectus, to purchase up to an aggregate of

765,000 additional shares of Common Stock to cover over-allotments, if any. If

the Underwriters exercise such option, the Underwriters have severally agreed,

subject to certain conditions, to purchase approximately the same percentage

thereof that the number of shares to be purchased by each of them as shown in

the foregoing table bears to the 5,100,000 shares of Common Stock offered

hereby. The Underwriters may exercise such option only to cover over-allotments

made in connection with the sale of the shares of Common Stock offered hereby.

The Representatives have advised the Company that the Underwriters do not intend

to confirm sales in excess of 5% of the shares offered hereby to any account

over which they exercise discretionary authority.

 

  

     The Common Stock has been approved for listing on the New York Stock

Exchange under the symbol MWY, subject to official notice of issuance. In order

to meet one of the requirements for listing the Common Stock on the New York

Stock Exchange, the Underwriters will undertake to sell lots of 100 or more

shares to a minimum of 2,000 beneficial holders.

   

 

     The Company has agreed to indemnify the Representatives of the Underwriters

and the several Underwriters against certain liabilities, including, without

limitation liabilities under the Securities Act.

 

  

     The Company's officers and directors and WMS, the Company's sole

stockholder prior to the Offering, have agreed not to offer, sell, contract to

sell, pledge or grant any option to purchase or otherwise dispose of such

securities for 180 days after the date of this Prospectus, without the prior

written consent of Oppenheimer & Co., Inc. The Company has also agreed not to

offer, sell, contract to sell, or otherwise dispose of any shares of Common

Stock or any securities convertible into or exercisable or exchangeable for

Common Stock or any rights to acquire Common Stock (other than shares issuable

upon exercise of outstanding options) for a period of 180 days after the date of

this Prospectus, without the prior written consent of Oppenheimer & Co., Inc.

See "Shares Eligible for Future Sale."

   

 

     Oppenheimer & Co., Inc. is currently rendering financial advisory services

to WMS in connection with its corporate restructuring, of which this Offering is

a part, and is receiving customary compensation in connection therewith.

Additionally, Oppenheimer & Co., Inc. has rendered financial advisory services

to

 

                                       60

<PAGE>   62

 

  

WMS in the past and received customary compensation in connection therewith. Mr.

Richard D. White, a Managing Director of Oppenheimer & Co., Inc., will become a

director of the Company upon completion of the Offering. See "Management."

   

 

     Prior to the Offering, there has been no public market for the Common

Stock. The initial public offering price was determined by negotiations among

the Company and the Representatives. The principal factors considered in such

negotiations were prevailing market conditions, the results of operations of the

Company in recent periods, market valuations of companies that the Company and

the Representatives believe to be comparable to the Company, estimates of the

business potential of the Company, the history of and prospects for the industry

in which the Company competes, and such other factors as the Company and the

Representatives deemed relevant.

 

                                 LEGAL MATTERS

 

     The legality of the issuance of the shares of Common Stock offered hereby

will be passed upon for the Company by Shack & Siegel, P.C., New York, New York.

Certain legal matters will be passed upon for the Underwriters by Morgan, Lewis

& Bockius LLP, New York, New York. Stockholders of Shack & Siegel, P.C. hold

Target Price Options to purchase 50,000 shares of WMS common stock at an

exercise price per share of $26 7/8 and, subject to the completion of the

Offering, options to purchase 25,000 shares of the Company's Common Stock at an

exercise price per share equal to the initial public offering price.

 

                                    EXPERTS

 

     The combined financial statements of the Company at June 30, 1995 and 1996

and for each of the three years in the period ended June 30, 1996 and the

consolidated financial statements of Atari Games at December 31, 1995 and 1994

and for the year ended December 31, 1995, the nine month period ended December

31, 1994 and the year ended March 31, 1994 appearing in this Prospectus and

Registration Statement have been audited by Ernst & Young LLP, independent

auditors, as set forth in their reports thereon appearing elsewhere herein, and

are included in reliance upon such reports given upon the authority of such firm

as experts in accounting and auditing.

 

                             ADDITIONAL INFORMATION

 

     The Company has filed with the Commission a Registration Statement (which

term shall include any amendment thereto) on Form S-1 under the Securities Act

with respect to the Shares offered hereby. This Prospectus, which constitutes a

part of the Registration Statement, does not contain all the information set

forth in the Registration Statement and the exhibits and schedules thereto,

certain items of which are omitted in accordance with the rules and regulations

of the Commission. For further information with respect to the Company and the

Shares, reference is made to the Registration Statement, including the exhibits

and schedules to such Registration Statement, copies of which may be obtained as

noted below. Any statements contained herein concerning the provisions of any

document are not necessarily complete, and, in each instance, reference is made

to the copy of such document filed as an exhibit to the Registration Statement

or otherwise filed with the Commission. Each such statement is qualified by such

reference.

 

  

     The Registration Statement and the exhibits and schedules to such

Registration Statement filed by the Company with the Commission, as well as

reports and other information submitted by the Company to the Commission, may be

inspected and copied at the Public Reference Section of the Commission at Room

1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and at

the regional offices of the Commission located at Seven World Trade Center,

Suite 1300, New York, New York 10048 and Citicorp Center, 500 West Madison

Street, Suite 1400, Chicago, Illinois 60661. Copies of all or part of such

materials can be obtained from the Public Reference Section of the Commission at

Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549 at

prescribed rates. Such material may also be accessed electronically by means of

the Commission's home page on the Internet at http://www.sec.gov.

   

 

     Following consummation of the sale of the Shares, the Company will be

subject to the informational reporting requirements of the Securities Exchange

Act of 1934, as amended (the "Exchange Act"). In accordance with the Exchange

Act, the Company will file with the Commission the reports and other information

required to be filed under the Exchange Act.

 

                                       61

<PAGE>   63

 

                               MIDWAY GAMES INC.

 

                         INDEX TO FINANCIAL STATEMENTS

 

<TABLE>

<CAPTION>

                                                                                        PAGE

                                                                                        ----

<S>                                                                                     <C>

Midway Games Inc.

  Report of Independent Auditors......................................................   F-2

  Combined Balance Sheets as of June 30, 1996 and 1995................................   F-3

  Combined Statements of Income for the years ended June 30, 1996, 1995 and 1994......   F-4

  Combined Statements of Changes in Stockholder's Net Investment for the years ended

     June 30, 1996, 1995 and 1994.....................................................   F-5

  Combined Statements of Cash Flows for the years ended June 30, 1996, 1995 and

     1994.............................................................................   F-6

  Notes to Combined Financial Statements..............................................   F-7

Midway Games Inc.

  Unaudited Pro Forma Condensed Combined Statement of Income for the year

     ended June 30, 1996..............................................................  F-16

  Notes to Unaudited Pro Forma Condensed Combined Statement of Income.................  F-17

Atari Games Corporation

  Unaudited Condensed Consolidated Statements of Operations for the three months ended

     March 29, 1996 and March 31, 1995................................................  F-19

  Unaudited Condensed Consolidated Statements of Cash Flows for the three months ended

     March 29, 1996 and March 31, 1995................................................  F-20

  Notes to Unaudited Condensed Consolidated Financial Statements......................  F-21

Atari Games Corporation

  Report of Independent Auditors......................................................  F-22

  Consolidated Balance Sheets as of December 31, 1995 and 1994........................  F-23

  Consolidated Statements of Operations for the year ended December 31, 1995, nine

     months ended December 31, 1994 and year ended March 31, 1994.....................  F-24

  Consolidated Statements of Shareholders' Equity (Deficit)...........................  F-25

  Consolidated Statements of Cash Flows for the year ended December 31, 1995, nine

     months ended December 31, 1994 and year ended March 31, 1994.....................  F-26

  Notes to Consolidated Financial Statements..........................................  F-27

</TABLE>

 

                                       F-1

<PAGE>   64

 

                         REPORT OF INDEPENDENT AUDITORS

 

To the Stockholder and Board of Directors

Midway Games Inc.

 

     We have audited the accompanying combined balance sheets of Midway Games

Inc. as of June 30, 1996 and 1995, and the related combined statements of

income, changes in stockholder's net investment and cash flows for each of the

three years in the period ended June 30, 1996. These financial statements are

the responsibility of the Company's management. Our responsibility is to express

an opinion on these financial statements based on our audits.

 

     We conducted our audits in accordance with generally accepted auditing

standards. Those standards require that we plan and perform the audit to obtain

reasonable assurance about whether the financial statements are free of material

misstatement. An audit includes examining, on a test basis, evidence supporting

the amounts and disclosures in the financial statements. An audit also includes

assessing the accounting principles used and significant estimates made by

management, as well as evaluating the overall financial statement presentation.

We believe that our audits provide a reasonable basis for our opinion.

 

     In our opinion, the combined financial statements referred to above present

fairly, in all material respects, the combined financial position of Midway

Games Inc. at June 30, 1996 and 1995, and the combined results of its operations

and its cash flows for each of the three years in the period ended June 30,

1996, in conformity with generally accepted accounting principles.

 

                                          /s/ ERNST & YOUNG LLP

 

Chicago, Illinois

September 12, 1996

 

                                       F-2

<PAGE>   65

 

                               MIDWAY GAMES INC.

 

                            COMBINED BALANCE SHEETS

                                 (IN THOUSANDS)

 

<TABLE>

<CAPTION>

                                                                          JUNE 30,     JUNE 30,

                                                                            1996         1995

                                                                          --------     --------

<S>                                                                       <C>          <C>

ASSETS

Current assets:

Cash and cash equivalents...............................................  $  9,199     $     --

Receivables, less allowances of $995 in 1996 and $1,078 in 1995.........    48,951       33,641

Inventories

  Raw materials and work in progress....................................    16,835       14,317

  Finished goods........................................................     8,187        2,850

                                                                          --------      -------

                                                                            25,022       17,167

Other current assets....................................................     5,407        3,598

                                                                          --------      -------

Total current assets....................................................    88,579       54,406

Property and equipment, net.............................................     5,927        4,794

Excess of purchase cost over amount assigned to net assets acquired,

  net...................................................................    22,765        9,599

Other assets............................................................       991       12,307

                                                                          --------      -------

Total assets............................................................  $118,262     $ 81,106

                                                                          ========      =======

LIABILITIES AND STOCKHOLDER'S NET INVESTMENT