<PAGE>


                          SECURITIES AND EXCHANGE COMMISSION

                               Washington, D.C.  20549

                                _____________________



                                      FORM 10-Q

                      QUARTERLY REPORT UNDER SECTION 13 OR 15(D)
                        OF THE SECURITIES EXCHANGE ACT OF 1934

For Quarter Ended:  December 31, 1996       Commission File Number:  0-19463
                   -----------------
                               SPECTRUM HOLOBYTE, INC.
                               ------------------------
                 Exact Name of registrant as specified in its charter


Delaware                                                            52-1728656
--------------------------------                  ----------------------------
(State or other jurisdiction of                   (IRS Employer Identification
Incorporation or organization)                                         Number)


2490 Mariner Square Loop, Suite 100, Alameda, CA                         94501
---------------------------------------------------                  ---------
(Address of Principal Executive Offices)                             (Zip Code)


                                    (510) 522-3584
                ------------------------------------------------------
                  Registrant's telephone number, including area code

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.

Yes   X   No
    -----     -----


      27,104,106 shares of Common Stock were outstanding as of January 31, 1996.


<PAGE>


                               SPECTRUM HOLOBYTE, INC.



                                  TABLE OF CONTENTS


                                                                          Page
                                                                          ----
PART I - FINANCIAL INFORMATION

------------------------------
ITEM 1.  CONSOLIDATED FINANCIAL STATEMENTS

         Consolidated Balance Sheets at December 31 and
            March 31, 1996                                                 3

         Consolidated Statements of Operations for the three and
            nine months ended December 31, 1996 and 1995                   4

         Consolidated Statements of Cash Flows for the nine months
            ended December 31, 1996 and 1995                               5

         Notes to Consolidated Financial Statements                        6

ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF
         FINANCIAL CONDITION AND RESULTS OF OPERATIONS                     9


PART II - OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS                                                21

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K                                 21



SIGNATURES                                                                23

EXHIBITS                                                                  24


                                          2

<PAGE>

                           SPECTRUM HOLOBYTE, INC.
                         CONSOLIDATED BALANCE SHEETS
              (In thousands, except share and per share amounts)

<TABLE>
<CAPTION>
                                                       December 31,        March 31,
                                                           1996               1996
                                                     ---------------     -------------
                                                       (UNAUDITED)
<S>                                                  <C>                 <C>
                   ASSETS
Current assets:
   Cash and cash equivalents                           $   45,512         $   35,369
   Accounts receivable, less allowances of $9,490
     and $9,179                                            13,002              9,718
   Inventories                                              6,422              3,673
   Prepaid royalties                                        3,570              2,126
   Other current assets                                     1,447              2,133
                                                       -----------        -----------
      Total current assets                                 69,953             53,019

Property and equipment, net                                 8,030              5,670
Goodwill, net                                                 758                818
Investments                                                 6,050              4,300
Other assets                                                1,092              2,115
                                                       -----------        -----------
                                                       $   85,883         $   65,922
                                                       -----------        -----------
                                                       -----------        -----------

      LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)

Current liabilities:
   Notes and borrowings under lines of credit          $      -           $      504
   Accounts payable                                         6,377              5,694
   Salaries, wages and related accruals                     6,503              3,909
   Royalties payable                                        3,138              1,703
   Current portion of capital lease obligations               352                431
   Other current liabilities                                9,133              5,093
                                                       -----------        -----------
     Total current liabilities                             25,503             17,334

Capital lease obligations                                     108                384
Other liabilities                                           1,202              1,238
Long-term debt                                             32,897             50,000
                                                       -----------        -----------
     Total liabilities                                     59,710             68,956

Redeemable preferred stock, $0.001 par value, 4,000,000
  Series A shares issued and outstanding, redemption
  and liquidation amount of $5,190 and $4,980               5,881              5,881

Stockholders' equity (deficit):
  Preferred stock, $0.001 par value, 9,000,000 shares
    authorized (of which 4,000,000 shares have been
    designated Series A), 1,075,018 Series B-1
    convertible shares issued and outstanding at
    December 31, 1996                                           1                -
  Common stock, $0.001 par value, 40,000,000 shares
    authorized, 27,067,805 and 24,282,813 shares issued
    and outstanding                                            27                 24
  Additional paid-in capital                              141,835            119,923
  Accumulated deficit                                    (121,603)          (128,456)
  Foreign currency translation adjustment                      32               (406)
                                                       -----------        -----------
     Total stockholders' equity (deficit)                  20,292             (8,915)
                                                       -----------        -----------
                                                        $  85,883          $  65,922
                                                       -----------        -----------
                                                       -----------        -----------
</TABLE>

   THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL
   STATEMENTS.

                                          3
<PAGE>

                           SPECTRUM HOLOBYTE, INC.
                   CONSOLIDATED STATEMENTS OF OPERATIONS
                   (In thousands, except per share data)
                                (UNAUDITED)
<TABLE>
<CAPTION>
                                                        Three Months Ended                   Nine Months Ended
                                                           December 31,                         December 31,
                                                   ----------------------------          ---------------------------
                                                       1996             1995                1996             1995
                                                   -----------      -----------          ----------       ----------
<S>                                                <C>              <C>                  <C>              <C>
Net revenue                                        $   35,888       $   13,389           $  76,373        $  44,163
Cost of revenue                                        13,888            7,032              28,973           23,912
                                                   -----------      -----------          ----------       ----------
   Gross profit                                        22,000            6,357              47,400           20,251

Operating expenses:
   Sales and marketing                                  5,086            4,873              14,679           16,103
   General and administrative                           4,508            3,371              11,952           11,561
   Research and development                             5,959            6,339              17,862           20,883
                                                   -----------      -----------          ----------       ----------
      Total operating expenses                         15,553           14,583              44,493           48,547
                                                   -----------      -----------          ----------       ----------
Operating income (loss)                                 6,447           (8,226)              2,907          (28,296)
Interest expense, net                                    (135)            (437)               (770)            (922)
Other income (expense), net                              (256)          (1,284)              1,567           (1,718)
                                                   -----------      -----------          ----------       ----------
Net income (loss) before taxes and 
  extraordinary item                                    6,056           (9,947)              3,704          (30,936)
Income tax provision                                      398              -                   398              -
                                                   -----------      -----------          ----------       ----------
Net income (loss) before extraordinary item             5,658           (9,947)              3,306          (30,936)
Extraordinary item (note 5)                               -                -                 3,547              -
                                                   -----------      -----------          ----------       ----------
Net income (loss)                                  $    5,658       $   (9,947)          $   6,853        $ (30,936)
                                                   -----------      -----------          ----------       ----------
                                                   -----------      -----------          ----------       ----------

Net income (loss) per share:
   Net income (loss) before extraordinary item     $     0.20       $    (0.41)          $    0.11        $   (1.33)
   Extraordinary item, net of tax effect                  -                -                  0.13              -
                                                   -----------      -----------          ----------       ----------
   Net income (loss)                               $     0.20       $    (0.41)          $    0.24        $   (1.33)
                                                   -----------      -----------          ----------       ----------
                                                   -----------      -----------          ----------       ----------
   Shares used in per share computations               28,470           24,228              27,281           23,448
                                                   -----------      -----------          ----------       ----------
                                                   -----------      -----------          ----------       ----------

</TABLE>

   THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL
   STATEMENTS.

                                          4
<PAGE>

                           SPECTRUM HOLOBYTE, INC.
                   CONSOLIDATED STATEMENTS OF CASH FLOWS
                              (In thousands)
                                (UNAUDITED)


<TABLE>
<CAPTION>
                                                                     Nine Months Ended
                                                                        December 31,
                                                             ----------------------------------
                                                                   1996               1995
                                                             ---------------     --------------
<S>                                                           <C>                 <C>
Cash flows from operating activities:
   Net income (loss)                                          $    6,853           $  (30,936)
   Adjustments to reconcile net income (loss) to net cash
      provided by (used in) operating activities:
     Depreciation and amortization                                 3,291                2,565
     Minority interest in losses                                       5                  377
     Gain on the sale of investment in FASA                       (1,895)                 -
     Extraordinary gain on the extinguishment of 
       long-term debt                                             (3,547)                 -
     Exchange rate loss                                              159                  108
     Changes in certain assets and liabilities:
        Accounts receivable                                       (3,907)               8,925
        Inventories                                                 (967)                 522
        Prepaid royalties                                         (1,387)                  30
        Other current assets                                       1,106                1,907
        Other assets                                                 (46)                 442
        Accounts payable                                            (106)              (2,935)
        Salaries, wages and related accruals                       2,417                1,216
        Royalties payable                                          1,291                   43
        Other current liabilities                                  3,472                 (448)
        Other liabilities                                            (36)                (726)
                                                             -------------       --------------
           Net cash provided by (used in) operating 
             activities                                            6,703              (18,910)

Cash flows from investing activities:
   Acquisitions of property and equipment, net                    (1,992)              (1,747)
   Acquisition of German distributor, net of cash acquired          (447)                 -
   Investment in OT Sports joint venture                             -                   (801)
   Proceeds from the sale OT Sports                                  250           
   Minority investment, net of certain licensing revenue            (105)              (1,750)
   Investment in Virtual World Entertainment Group, Inc.            (570)                 -
   Proceeds from the sale of investment in FASA                      570                  -
                                                             -------------       --------------
           Net cash used in investing activities                  (2,294)              (4,298)

Cash flows from financing activities:
   Extinguishment of long-term debt                               (2,959)                 -
   Proceeds from issuance of common stock, net of 
     issuance costs                                               10,058               22,220
   Borrowings under notes and lines of credit                        -                    751
   Repayments under notes and lines of credit                       (734)             (12,225)
   Principal payments on capital lease obligations                  (361)                (972)
   Proceeds from issuance of convertible notes                       -                 50,000
   Payment of convertible note issuance costs                        -                 (1,811)
                                                             -------------       --------------
           Net cash provided by financing activities               6,004               57,963
           Effect of exchange rate changes on cash                  (270)                (165)
                                                             -------------       --------------
             Increase in cash and cash equivalents                10,143               34,590
Cash and cash equivalents at beginning of period                  35,369                7,723
                                                             -------------       --------------
Cash and cash equivalents at end of period                     $  45,512            $  42,313
                                                             -------------       --------------
                                                             -------------       --------------

Supplemental disclosures of cash flow information:
   Cash paid for interest                                      $   1,148            $     649
   Cash paid for income taxes                                         56                  -

</TABLE>

   THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL
   STATEMENTS.


                                          5
<PAGE>


                               SPECTRUM HOLOBYTE, INC.

                      NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                     (UNAUDITED)


NOTE 1.  BASIS OF PRESENTATION

The consolidated financial statements are the unaudited historical financial
statements of Spectrum HoloByte, Inc. and subsidiaries (the "Company") and
reflect all adjustments (consisting only of normal recurring accruals) that, in
the opinion of management, are necessary for a fair presentation of interim
period results.  The consolidated financial statements should be read in
conjunction with the financial statements and notes thereto included in the
Company's Annual Report on Form 10-K for the fiscal year ended March 31, 1996,
as filed with the Securities and Exchange Commission on June 28, 1996.  The
March 31, 1996 consolidated balance sheet included herein was derived from
audited financial statements, but does not include all disclosures, including
notes, required by generally accepted accounting principles.

The results of operations for the current interim period are not necessarily
indicative of results to be expected for the entire current year or other future
interim periods.

For the purposes of presentation, the Company has indicated its interim fiscal
periods as ending on December 31, 1996 and 1995.  As the Company's annual fiscal
period is accounted for on a 52-53 week year, the interim period financial
statements included herein represent interim results through December 29, 1996
and December 31, 1995, respectively.

Certain amounts in the consolidated financial statements have been reclassified
to conform with the current period's presentation.  These reclassifications had
no effect on previously reported earnings or stockholders' equity (deficit).

NOTE 2.  NET INCOME (LOSS) PER SHARE OF COMMON STOCK

Net income (loss) per share has been computed by dividing the net income (loss)
by the weighted average number of common shares and dilutive common stock
equivalents outstanding for the period.  Net income (loss) has been adjusted for
cumulative but undeclared dividends on Series A preferred stock.

NOTE 3.  ACQUISITIONS AND INVESTMENTS

OT SPORTS

The Company entered into a Limited Liability Company ("LLC") agreement with
Capital Cities/ABC, Inc. ("ABC") effective July 1, 1995.  The LLC (subsequently
named "OT Sports") was formed for the purpose of developing a sports-based line
of products. In May 1996, the Company sold its interest in OT Sports to ABC.
Under the terms of the agreement, the Company received a note for $250,000 which
was paid in full in November 1996.  The Company is not obligated to make future
contributions to OT Sports.

FASA AND VIRTUAL WORLD

In fiscal 1995 and 1996, the Company invested a total of $1.5 million in FASA
Interactive Technologies, Inc. ("FASA"), a developer of interactive
entertainment software for PC and next-generation console platforms. This
investment was accounted for by the Company under the cost method of accounting.
In June 1996, the Company sold its investment in FASA to FASA for approximately
$3.4 million.  The Company received cash of $570,000 and a $2.8 million note
bearing interest at a rate of 6% per annum and due June 2001.  A gain of $1.9
million was recorded on the sale of this investment.


                                          6
<PAGE>


                               SPECTRUM HOLOBYTE, INC.

                      NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                     (UNAUDITED)


Proceeds from the sale of this investment were reinvested in Virtual World
Entertainment Group, Inc. ("VWEG"), a corporation formed for the purpose of
acquiring Virtual World Entertainment, Inc., a developer and operator of
location-based entertainment, and FASA.  The investment in VWEG is being
accounted for under the cost method of accounting.

German DISTRIBUTOR

In June 1996, the Company entered into an agreement to acquire certain net
assets of a German distributor of computer software and related products for
DM1.2 million (approximately $0.8 million).  The transaction was accounted for
as a purchase.  Approximately $130,000 of goodwill was recorded representing the
excess of the purchase price over the identifiable net assets acquired.
Goodwill is amortized on a straight-line basis over five years. The consolidated
financial statements contain the operating results from the date of acquisition,
which includes approximately $6.9 million in net revenue.

NOTE 4.  INVENTORIES

Inventories are stated at the lower of cost or market on a first-in, first-out
(FIFO) basis, net of allowances for write-downs.  Inventories at December 31,
1996 and March 31, 1996 consisted of (IN THOUSANDS):

                                                 December 31,    March 31,
                                                    1996           1996
                                                 -----------    ----------
         Raw materials and work in process         $   990       $   705
         Finished goods                              5,432         2,968
                                                 -----------    ----------
                                                   $ 6,422       $ 3,673
                                                 -----------    ----------
                                                 -----------    ----------

NOTE 5.  LONG-TERM DEBT AND ISSUANCE OF CONVERTIBLE PREFERRED STOCK

In June 1996, the Company issued 750,000 shares of Series B and 1,168,860 shares
of Series B-1 convertible preferred stock in exchange for the retirement of
subordinated notes with a face value of approximately $14.9 million. An
extraordinary gain of approximately $2.7 million was realized on the retirement
of the long-term debt. Both the Series B and Series B-1 preferred stock are
convertible into an equivalent number of common shares. Prior to December 31,
1996, 750,000 and 93,842 Series B and Series B-1 preferred shares, respectively,
were converted into common shares.

Dividends on the Series B-1 preferred shares are non-cumulative and
non-accruing, and shall be paid only at such time and such rate as determined by
the Board of Directors.  As of December 31, 1996, no dividends had been
declared. Subject to the liquidation preference of the Series A preferred
shares, the Series B-1 convertible preferred shares has a liquidation preference
of $7.57 per share, plus all declared but unpaid dividends.

In July 1996, the Company repurchased subordinated notes with a face value of
$4.0 million for approximately $2.9 million.  An extraordinary gain of
approximately $0.9 million was realized on the retirement of the long-term debt.

NOTE 6.  ISSUANCE OF COMMON STOCK

In June 1996, the Company completed a private placement of 1,818,367 shares of
common stock which generated approximately $9.7 million in proceeds, after
discounts, commissions and other issuance costs.

                                          7
<PAGE>


                               SPECTRUM HOLOBYTE, INC.

                      NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                     (UNAUDITED)


NOTE 7.  CANCELLATION AND RE-GRANT OF STOCK OPTIONS

In June 1996, the Board of Directors of the Company approved the cancellation of
the majority of outstanding stock options with an exercise price in excess of
$5.375 per share and the re-grant of options to purchase an equivalent number of
shares at $5.375 per share.   A total of 1,927,408 options were canceled and
re-granted.

NOTE 8.  LICENSE AGREEMENT WITH MITSUI & CO.

In April 1996, the Company's wholly-owned Japanese subsidiary ("Spectrum Japan")
granted an exclusive license to Mitsui & Co., Ltd. ("Mitsui") for the
localization, manufacturing, marketing and distribution of certain Company
titles in Japan. The Company received an up-front license fee of approximately
$300,000, and will earn royalties based upon revenue generated by Mitsui during
the three-year term of the agreement. In connection with the license agreement,
Spectrum Japan subcontracted all of its employees to Mitsui and largely
discontinued its operations in Japan. During the nine months ended December 31,
1996, the Company recognized net revenue of $800,000 related to the license
agreement.


                                          8
<PAGE>


                               SPECTRUM HOLOBYTE, INC.


ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The following information should be read in conjunction with the consolidated
historical financial information and the notes thereto included in ITEM 1 of
this Quarterly Report and Management's Discussion and Analysis of Financial
Condition and Results of Operations contained in the Company's Annual Report on
Form 10-K for the fiscal year ended March 31, 1996, as filed with the Securities
and Exchange Commission on June 28, 1996.

This Quarterly Report on Form 10-Q contains forward-looking statements which
involve risks and uncertainties.  The Company may, from time to time, make oral
forward-looking statements.  The factors discussed in "Risk Factors" below are
important factors that could cause actual results to differ materially from
those projected in any such forward-looking statements.

OVERVIEW

Spectrum HoloByte (the "Company") develops, publishes and distributes
interactive entertainment software. The entertainment software market primarily
consists of software products published for the following platforms:

-   Compact-Disc Read-Only Memory ("CD-ROM") for the personal computer ("PC").
-   Videogame consoles, which include 32-bit and 64-bit "next-generation"
    systems.

The Company primarily generates revenue from PC CD-ROM and Sony PlayStation
products.  These products are distributed worldwide, although the majority of
revenue is generated in North America and Europe.

See additional discussion in "Risk Factors" below.


OPERATING RESULTS

Consolidated net revenue generated in North America and the rest of the world
consisted of the following (DOLLARS IN THOUSANDS):


<TABLE>
<CAPTION>


                                                            Net Revenue                               % of Total
                                                       ---------------------                   ------------------------
    Three Months Ended December 31                      1996         1995         % CHANGE         1996         1995
                                                       ---------------------    -----------    ------------------------
<S>                                                    <C>         <C>           <C>           <C>             <C>
       North America                                   $ 11,594    $  4,512        157.0%          32.3%        33.7%

       International                                     24,294       8,877        173.7%          67.7%        66.3%
                                                       ----------------------                  ------------------------

          Consolidated                                 $ 35,888    $ 13,389        168.0%         100.0%       100.0%
                                                       ----------------------                  ------------------------
                                                       ----------------------                  ------------------------

    Nine Months Ended December 31

       North America                                   $ 26,381    $ 24,031          9.8%          34.5%        54.4%

       International                                     49,992      20,132        148.3%          65.5%        45.6%
                                                       ----------------------                  ------------------------

          Consolidated                                 $ 76,373    $ 44,163         72.9%         100.0%       100.0%
                                                       ----------------------                  ------------------------
                                                       ----------------------                  ------------------------

</TABLE>

                                          9


<PAGE>


                               SPECTRUM HOLOBYTE, INC.


The following table sets forth the components of net revenue in dollars and as a
percentage of net revenue (DOLLARS IN THOUSANDS):

<TABLE>
<CAPTION>


                                                           Net Revenue                                % of Total
                                                      ---------------------                   ------------------------
    Three Months Ended December 31                      1996         1995        % CHANGE          1996         1995
                                                      ---------------------     ----------    ------------------------
<S>                                                   <C>         <C>           <C>           <C>              <C>
       PC CD-ROM                                      $  28,819   $   9,537        202.2%          80.3%        71.2%

       PlayStation (PSX)                                  3,050       1,761         73.2%           8.5%        13.2%

       Other                                              4,019       2,091         92.2%          11.2%        15.6%
                                                      -----------------------                  ------------------------

           Consolidated                               $  35,888   $  13,389        168.0%         100.0%       100.0%
                                                      -----------------------                  ------------------------
                                                      -----------------------                  ------------------------

    Nine Months Ended December 31

       PC CD-ROM                                      $  59,949   $  35,000         71.3%          78.5%        79.2%

       PlayStation (PSX)                                  8,527       1,761        384.2%          11.2%         4.0%

       Other                                              7,897       7,402          6.7%          10.3%        16.8%
                                                      -----------------------                  ------------------------

          Consolidated                                $  76,373   $  44,163         72.9%         100.0%       100.0%
                                                      -----------------------                  ------------------------
                                                      -----------------------                  ------------------------

</TABLE>

The increases in net revenue for the third quarter and first nine months of 
fiscal 1997 as compared to the same periods of the prior year were due 
principally to the strategic focus on fewer, higher-quality titles. In the 
first nine months of fiscal 1997, the Company's top three titles (GRAND PRIX 
II, SID MEIER'S CIVILIZATION II AND MASTER OF ORION II) generated 
substantially more net revenue than the top three titles in the comparable 
period of the prior year.

Net revenue from both CD-ROM and PSX products increased in fiscal 1997 due to
the focus of the Company's development and marketing efforts on these two
platforms.  Revenue from other products in the three-month period ended December
31, 1996, also increased due to $2.0 million of revenue generated during this
period from the distribution of third-party hardware products through the
Company's distribution operations in Germany.

Partially offsetting the increased net revenue was a decline in domestic net 
revenue from products published by affiliated label partners. This revenue 
accounted for less than 1% of total domestic net revenue in both the third 
quarter and first nine months of fiscal 1997, as compared to 22% and 17% of 
total domestic net revenue for the third quarter and the first nine months of 
fiscal 1996, respectively.

                                          10
<PAGE>


                               SPECTRUM HOLOBYTE, INC.


The following table sets forth cost of revenue and gross profit in dollars and
as a percentage of net revenue (DOLLARS IN THOUSANDS):


<TABLE>
<CAPTION>


                                                                                                   % of Net Revenue
                                                                                              ------------------------
    Three Months Ended December 31                      1996         1995        % CHANGE          1996         1995
                                                      ---------------------     ----------    ------------------------
<S>                                                   <C>         <C>           <C>           <C>              <C>
       Net revenue                                    $  35,888   $  13,389        168.0%         100.0%       100.0%

       Cost of revenue                                   13,888       7,032         97.5%          38.7%        52.5%
                                                      -----------------------                 ------------------------

          Gross profit                                $  22,000    $  6,357        246.1%          61.3%        47.5%
                                                      -----------------------                 ------------------------
                                                      -----------------------                 ------------------------


    Nine Months Ended December 31

       Net revenue                                    $  76,373   $  44,163         72.9%         100.0%       100.0%

       Cost of revenue                                   28,973      23,912         21.2%          37.9%        54.1%
                                                      -----------------------                 ------------------------

          Gross profit                                $  47,400   $  20,251        134.1%          62.1%        45.9%
                                                      -----------------------                 ------------------------
                                                      -----------------------                 ------------------------

</TABLE>

The increases in gross profit as a percent of net revenue in the third 
quarter and first nine months of fiscal 1997 as compared to the prior year 
were primarily due to an increase in the average selling price of the 
Company's titles, reduced product costs and the shift away from lower-margin, 
affiliated label products.  In addition, the third quarter of the prior year 
included substantial product write-offs related to older, back catalog floppy 
disk and 8/16-bit cartridge inventories.

Partially offsetting the increase in gross profit was the consolidation of 
Leisuresoft's lower-margin wholesale operations, increased sales of 
lower-margin PSX titles and a higher percentage of royalties paid to 
third-party developers.

The following table sets forth operating expenses, interest and other income
(expense), and income tax provision in dollars and as a percentage of net
revenue (DOLLARS IN THOUSANDS):

<TABLE>
<CAPTION>

                                                       Costs and Expenses                     % of Net Revenue
                                                      ---------------------                   ------------------------
   Three Months Ended December 31                        1996         1995       % CHANGE          1996         1995
                                                      ---------------------     ----------    ------------------------
<S>                                                   <C>         <C>           <C>           <C>              <C>
    Sales and marketing                                $  5,086   $   4,873          4.4%          14.2%        36.4%

    General and administrative                            4,508       3,371         33.7%          12.6%        25.2%

    Research and development                              5,959       6,339         (6.0%)         16.6%        47.3%
                                                      ----------------------                  ------------------------

       Total operating expenses                         $15,553   $  14,583          6.7%          43.3%       108.9%
                                                      ----------------------                  ------------------------
                                                      ----------------------                  ------------------------


    Interest and other expense                          ($  391)  ($  1,721)       (77.3%)         (1.1%)      (12.9%)
                                                      ----------------------                  ------------------------
                                                      ----------------------                  ------------------------

    Income tax provision                                 $  398           -        100.0%           1.1%           -
                                                      ----------------------                  ------------------------
                                                      ----------------------                  ------------------------

   Nine Months Ended December 31

    Sales and marketing                                $ 14,679   $  16,103         (8.8%)         19.2%        36.5%

    General and administrative                           11,952      11,561          3.4%          15.6%        26.2%

    Research and development                             17,862      20,883        (14.5%)         23.4%        47.3%
                                                      ----------------------                  ------------------------

       Total operating expenses                         $44,493   $  48,547         (8.4%)         58.3%       109.9%
                                                      ----------------------                  ------------------------
                                                      ----------------------                  ------------------------


    Interest and other income (expense)                  $  797   ($  2,640)           -            1.0%        (6.0%)
                                                      ----------------------                  ------------------------
                                                      ----------------------                  ------------------------

    Income tax provision                                 $  398           -        100.0%            .1%            -
                                                      ----------------------                  ------------------------
                                                      ----------------------                  ------------------------

</TABLE>

                                          11
<PAGE>


                               SPECTRUM HOLOBYTE, INC.


Operating expenses increased in the third quarter of fiscal 1997 due mostly to a
provision for discretionary bonuses based upon the operating results
of the Company. Additionally, the third quarter of fiscal 1997 included
approximately $0.6 million of operating costs related to Leisuresoft which was
acquired earlier in the fiscal year. These increases were partially offset by 
lower personnel costs and variable marketing spending. The decrease in 
personnel was due to the centralization of the Company's domestic sales, 
marketing and administrative functions. The lower variable marketing spending 
was primarily due to the introduction of fewer new titles. In addition, the 
third quarter of the prior year included a $0.6 million provision to 
write-off development advances associated wtih discontinued products.

The decrease in operating expenses for the first nine months of fiscal
1997 is due primarily to reductions in the domestic sales, marketing and 
administrative staff, fewer development personnel in certain studios, and the 
$1.1 million decrease in the write-off of development advances. Additionally, 
variable marketing costs decreased due to the release of fewer new titles and 
more than $0.4 million of costs related to the launch of STAR TREK: THE NEXT 
GENERATION, "A FINAL UNITY" in fiscal 1996. Partially offsetting this 
decrease was a $12 million increase in the bad debt provision due to concerns 
regarding the credit-worthiness of certain domestic distributors and 
retailers.

The decrease in interest and other expense in the third quarter of fiscal 1997
is primarily due to the Company's equity portion of losses incurred by an equity
investee (OT Sports) in the prior year, and lower interest costs due to the
retirement of $18.9 million in debt. Interest and other income for the first
nine months of fiscal 1997 also includes a $1.9 million gain from the sale of
the Company's investment in FASA.

An extraordinary gain of $3.6 million was realized on retirement of subordinated
notes with a face value of approximately $18.9 million.

The income tax provision in the third quarter of fiscal 1997 was provided based
upon an estimate of the fiscal 1997 taxable income to be generated by the
Company's operations in Europe.

LIQUIDITY AND CAPITAL RESOURCES

Cash and cash equivalents increased by approximately $10.1 million during the
first nine months of fiscal 1997. The cash generated from operations and the
$9.7 million equity financing in June 1996 was used partially to repurchase
subordinated notes, acquire capital equipment, and to purchase certain net
assets of Leisuresoft.

As of December 31, 1996, the Company's working capital was $44.5 million
compared to $35.7 million at March 31, 1996.  Net accounts receivable increased
primarily due to strong third-quarter sales of GRAND PRIX II, SID MEIER'S
CIVILIZATION II, and MASTER OF ORION II. Reserves for bad debts and sales
returns as a percentage of gross accounts receivable decreased from 49% at March
31, 1996 to 42% at December 31, 1996, due primarily to the sell through of
in-channel inventories.

Inventories increased primarily due to the build-up of certain products and 
the launch of Master of Orion II late in the third fiscal quarter. Partially 
offsetting this increase was the return of excess inventories to a former 
affiliated label partner, and the Company's focus on maintaining fewer, 
higher quality products.

As of December 31, 1996, the Company's primary source of liquidity included cash
and cash equivalents of $45.5 million and a UK bank facility consisting of an
overdraft/line of credit based upon qualifying receivables and certain other
bank requirements. This facility has a maximum credit limit of approximately
$3.1 million, bears interest at 2.75% over the bank's base rate and expires
September 1997. The Company uses working capital to finance ongoing operations,
fund the development and marketing of new products and acquire capital
equipment.  Periodically, the Company may evaluate the acquisition of other
businesses, products or technologies that are complimentary to those of the
Company.

Management believes the existing cash and cash equivalents will be sufficient to
meet the Company's liquidity and capital needs for the foreseeable future.

RISK FACTORS

                                          12
<PAGE>


                               SPECTRUM HOLOBYTE, INC.


THE FOLLOWING RISK FACTORS SHOULD BE CAREFULLY CONSIDERED IN EVALUATING THE
COMPANY AND ITS BUSINESS PROSPECTS.

OPERATING LOSSES.  Although the Company reported net income for the quarter and
nine months ended December 31, 1996 of $5.7 million or $.20 per share, and $6.9
million or $.24 per share, respectively, the Company had net losses of
approximately $39.8 million, $18.1 million and $58.5 million for fiscal years
1996, 1995 and 1994, respectively. Since the merger with MicroProse in December
1993, the Company has not been able to achieve profitability on an annual basis.
There can be no assurance that any of the Company's business strategies and
tactics will be successful or that the Company will be able to sustain
profitability.

SIGNIFICANT LEVERAGE.  As of December 31, 1996, the Company had outstanding
indebtedness for borrowed funds of approximately $32.9 million, cumulative
manditorily redeemable preferred stock of $5.9 million, and certain additional
indebtedness. This substantial leverage will have several important consequences
for the Company's future operations, including the following: (i) a substantial
portion of the Company's cash flows from operations will be dedicated to the
payment of interest on, and principal of, its indebtedness; (ii) the Company's
ability to obtain additional financing in the future for capital expenditures,
acquisitions, general corporate purposes or other purposes may be impaired; and
(iii) the Company's ability to withstand competitive pressures, adverse economic
conditions and adverse changes in governmental regulations and to make
acquisitions or otherwise take advantage of significant business opportunities
that may arise may be negatively impacted.

The Company in the future may enter into lines of credit or other borrowing
arrangements, any of which would add to the total outstanding indebtedness of
the Company. The Company's ability to meet its debt service obligations and to
reduce its total indebtedness will be dependent upon the Company's future
performance, which will be subject to financial, business and other factors
affecting the operations of the Company, many of which are beyond its control.
If the Company is unable to generate sufficient cash flow from operations in the
future to service its debt, it may be required to convert or refinance all or a
portion of such debt, including the Notes (see below), or to obtain additional
financing. However, there can be no assurance that any refinancing would be
possible or that any additional financing could be obtained.

FLUCTUATIONS IN OPERATING RESULTS; SEASONALITY.  The Company's operating results
have varied significantly in the past, and are expected to vary significantly in
the future.  This variability is a result of factors such as: 1) volume
shipments of significant new products, 2) the degree of market acceptance of the
Company's products, 3) the introduction of products competitive with those of
the Company, 4) the timing and market acceptance of new hardware and software
product introductions, 5) the size and growth rate of the consumer software
market, 6) development and promotional expenses relating to the introduction of
new products or new versions of existing products, 7) product returns and
markdowns, 8) changes in pricing policies by the Company and its competitors, 9)
the accuracy of retailers' forecasts of consumer demand, 10) the timing of
orders from major customers, 11) order cancellations, 12) delays of shipment,
and 13) write-offs of advance royalty payments. Because a majority of the unit
sales for a product typically occurs in the first 90 to 120 days following the
introduction of the product, the Company's revenue may increase significantly in
a period in which a major product introduction occurs and may decline in
following periods or in periods in which there are no major product
introductions. The Company's expenses are based, in part, on expected future
revenue. Certain overhead and product development expenses are fixed and do not
vary directly in relation to revenue. Consequently, if net revenue is below
expectations, the Company's operating results are likely to be materially and
adversely affected. In certain past periods the Company's revenue or operating
results were below the expectations of, and certain new products were not
introduced when anticipated by, public market analysts and investors. These
circumstances could recur in future periods, and in such event, the prices of
the Company's common stock and Notes would likely be materially and adversely
affected.

The entertainment software business is highly seasonal. Typically, net revenue
is highest during the last calendar quarter (which includes the holiday buying
season), declines in the first calendar quarter, is lowest in the second and
increases in the third calendar quarter. This seasonal pattern is due primarily
to the increased demand for entertainment software products during the year-end
holiday buying season. The Company's net revenue, however, is largely dependent
on releases of major new products and, as such, may not necessarily reflect the
seasonal patterns of the industry as a whole. The Company expects that its net
revenue and operating results will continue to fluctuate significantly in the
future.


                                          13
<PAGE>


                               SPECTRUM HOLOBYTE, INC.


DEPENDENCE ON NEW PRODUCT INTRODUCTIONS; PRODUCT DELAYS.  A significant portion
of the Company's fiscal year revenue is generated by products introduced during
that fiscal year. The Company depends on both the timely introduction of
successful new products or sequels to existing products to replace declining
revenue from older products and continued revenue from back-catalog products. If
for any reason revenue from new products or other activities fails to replace
declining revenue from existing products, or if revenue from back-catalog titles
declines significantly, the Company's business, operating results and financial
condition may be materially and adversely affected.  In order to maintain or
grow its current revenue levels, the Company believes it will be necessary to
develop or obtain rights to new products that achieve and sustain market
acceptance, are developed for the appropriate platforms and are introduced in a
timely manner. The Company is continuing to devote considerable resources toward
the development of new products and has secured rights to intellectual
properties owned by third parties. As is typical in the industry, while the
Company maintains internally developed release schedules, there can be no
assurance that new products under development will be released on schedule or at
all, or that any such products will generate significant revenue. Historically,
the Company has frequently missed product release schedules. To the extent that
major new products are not released on schedule, both net revenue and gross
profit are likely to be materially and adversely affected. In addition, as
access to distribution channels and retail shelf space becomes increasingly
competitive, the Company's ability to produce and bring to market new and
compelling products in a timely fashion plays an increasingly important role in
the Company's ability to retain adequate access to these channels.

The Company's current production schedules contemplate that the Company will
commence shipments of a number of new products in fiscal 1997 and 1998. As with
any software product, however, until all aspects of the development and initial
distribution of a game are completed, there can be no assurance of its release
date. Release dates will vary depending on quality assurance testing and other
development factors. If the Company were unable to commence volume shipments of
a significant new product during the scheduled quarter, the Company's revenue
and earnings would likely be materially and adversely affected in that quarter.
In the past, the Company has experienced significant delays in the introduction
of certain new products. It is likely in the future that certain new products
will not be released in accordance with the Company's internal development
schedule or the expectations of public market analysts and investors. A
significant delay in the introduction of, or the presence of a defect in, one or
more new products could have a material adverse effect on the ultimate success
of such products and on the Company's business, operating results and financial
condition, particularly in the quarter in which such products were scheduled to
be introduced.

The process of developing software products such as those offered by the Company
is extremely complex and is expected to become more complex and expensive in the
future as consumers demand products with more sophisticated and elaborate
multimedia features and as new platforms and technologies are supported. At the
same time, the introduction of new technologies and competitive products, the
increase in competition for retail shelf space among software products and other
factors may cause the effective lives of the Company's products to become
shorter and the Company's ability to introduce new products on a timely basis to
become increasingly important. As the Company intends to focus its resources on
a smaller number of titles, its exposure to the risks of delays of any one title
will increase.

UNCERTAINTY OF MARKET ACCEPTANCE; UNPREDICTABLE PRODUCT LIFE CYCLES.  Consumer
preferences for entertainment software products are continually and rapidly
changing and are extremely difficult to predict. Few entertainment software
products achieve sustained market acceptance, for example, beyond one holiday
buying season. There can be no assurance that new products introduced by the
Company will achieve any significant degree of market acceptance, or that
acceptance, if achieved, will be sustained for any significant period. Further,
there can be no assurance that such products will not be subject to changes in
consumer preferences or that product life cycles will be sufficient to permit
the Company to recover development and other associated costs. In addition,
sales of any single title of the Company's entertainment software products will
decline over time. A majority of the unit sales for a product typically occurs
in the first 90 to 120 days after the product is introduced. Therefore, the
Company cannot rely on the sales of current products to sustain its business in
the future. Failure of new products or platforms to achieve or sustain market
acceptance would have a material and adverse effect on the


                                          14
<PAGE>


                               SPECTRUM HOLOBYTE, INC.


Company's business, operating results and financial condition. In addition, the
Company does not carry significant inventory of its new products. As a result,
significant production delays would have a material and adverse effect on the
Company's business and operating results. Further, if demand for a particular
product is greater than anticipated, the Company may not have sufficient
inventory to meet customer demands.

COMPETITION.  The entertainment software industry is intensely competitive and
in the process of consolidation. The Company's competitors vary in size from
very small companies with limited resources to very large corporations with
greater financial, marketing and product development resources than those of the
Company. The Company competes primarily with other developers of PC
entertainment and video game entertainment software. Significant competitors of
the Company in the entertainment software industry include Electronic Arts, CUC
Software, Lucas Arts, Interplay, GT Interactive, Maxis, Acclaim Entertainment,
and Broderbund Software, along with Virgin Interactive in Europe. Additionally,
the entry and participation of new industries and companies, including
diversified entertainment companies, in markets in which the Company competes
may adversely affect the Company's performance in such markets. The availability
of significant financial resources has become a major competitive factor in the
entertainment software industry, principally as a result of the technical
sophistication of advanced multimedia computer game products requiring
substantial investments in research and development and the increasing need to
license products and rights to use other intellectual properties from third
parties. Also, competitors with large product lines and popular titles typically
have greater leverage with retailers and distributors and other customers who
may be willing to promote titles with less consumer appeal in return for access
to such competitors' most popular titles.

The Company believes that large diversified entertainment, cable and
telecommunications companies, in addition to large software companies such as
Microsoft, are increasing their focus on the interactive entertainment market,
which will result in greater competition for the Company. In particular, many of
the Company's competitors are developing on-line interactive computer games and
interactive networks that will be competitive with the Company's products. As
competition increases, significant price competition and reduced profit margins
may result. In addition, competition from new technologies may reduce demand in
markets in which the Company has traditionally competed. Prolonged price
competition or reduced demand as a result of competing technologies would have a
material and adverse effect on the Company's business, financial condition and
operating results. There can be no assurance that the Company will be able to
compete successfully against current or future competitors or that competitive
pressures faced by the Company will not materially and adversely affect its
business, operating results and financial condition.

Retailers of the Company's products typically have a limited amount of shelf
space and promotional resources, and there is intense competition among consumer
software producers for adequate levels of shelf space and promotional support
from retailers. To the extent that the number of consumer software products and
computer platforms increases, this competition for shelf space may intensify.
Due to increased competition for limited shelf space, retailers and distributors
are increasingly in a better position to negotiate favorable terms of sale,
including price discounts and product return policies. Retailers often require
software publishers to pay fees in exchange for preferred shelf space. The
Company's products constitute a relatively small percentage of a retailer's
sales volume, and there can be no assurance that retailers will continue to
purchase the Company's products or provide the Company's products with adequate
levels of shelf space and promotional support.

As more consumers own multimedia PCs, the distribution channels for
entertainment software have changed, and are expected to continue to change, to
increasingly depend on mass merchandisers, on-line services and the Internet to
reach the broader market. There can be no assurance that the Company will make
this transition successfully. In addition, while this trend has increased the
number of distribution channels, it has intensified competition for shelf space
because these new channels generally carry only top-selling titles. In addition,
other types of retail outlets and methods of product distribution, such as
online services and the Internet, may become important in the future, and it
will be important for the Company to gain access to these channels of
distribution. There can be no assurance that the Company will gain such access
or that the Company's access will allow the Company to maintain its historical
levels of sales volume.

CONCENTRATION OF CUSTOMER BASE; RISK OF CUSTOMER BUSINESS FAILURE; PRODUCT
RETURNS.  The Company principally sells its products to retailers and
distributors, who in turn resell the products to consumers. During the quarter
and first nine months ended December 31, 1996, sales to the top ten such
customers represented approximately 45% and 50% of the Company's net revenue,
respectively. Sales are typically made on credit, with terms that vary


                                          15
<PAGE>

                               SPECTRUM HOLOBYTE, INC.

depending upon the customer and the nature of the product. The Company does not
hold collateral to secure payment. Retailers and distributors compete in a
volatile industry and are subject to the risk of business failure. Certain of
the Company's distributors and retailers have recently experienced financial
difficulties and the Company has increased its reserves accordingly.  However,
the business failure of a significant distributor or customer could have a
material and adverse effect on the Company's business, operating results and
financial condition.

The Company is exposed to the risk of product returns from distributors and
retailers. The Company currently maintains a stock balancing policy that allows
distributors and retailers to return products subject to certain conditions. The
Company provides reserves for returns that it believes are adequate, and the
Company's agreements with various customers place certain limits on product
returns. However, new product introductions by the Company or its competitors,
or changes in consumer demand from that anticipated, could cause customers to
seek to return inventory to the Company. Due to the unpredictability of consumer
demand and the uncertainties associated with a rapidly changing market, there
can be no assurance that the Company or its customers will be able to forecast
demand accurately. Consistent with industry trends, the Company has accepted
substantial increased product returns and markdowns on products in the last
fiscal year and the Company could continue to be forced to accept such returns
and markdowns in the distribution channel to maintain its relationships with
retailers and its access to distribution channels. These returns and markdowns
are likely to increase in periods in which the Company does not have a
significant number of new product introductions. Any significant amount of
product returns or markdowns could have a material and adverse effect on the
Company's business, operating results and financial condition.

DEPENDENCE UPON STRATEGIC RELATIONSHIPS.  The Company's business strategy relies
to a significant extent on its strategic relationships with other companies and
on its alliances with key developers. Certain agreements allow third parties to
approve a product prior to its release, and therefore, subject the product to
delay. There can be no assurance that these relationships will be successful or
that the Company will continue to maintain and develop strategic relationships,
or that licenses between the Company and any third party will be renewed or
extended at their expiration dates. The Company's failure to renew or extend a
key license or maintain its strategic relationships could materially and
adversely affect the Company's business, operating results and financial
condition. In addition, under certain key license agreements, the Company must
obtain approval on a timely basis from the licensor in order to market products
it develops under the license. There can be no assurance that the Company will
obtain such approval, and failure to do so could have a material and adverse
effect on the Company's operating results, financial condition and business
prospects.

CHANGES IN TECHNOLOGY AND PRODUCT PLATFORMS.  The market for entertainment
software, including entertainment software platforms, is undergoing rapid
technological change. As a result, the Company must continually anticipate and
adapt its products to emerging platforms and evolving consumer preferences. The
introduction of new platforms and technologies can render existing products
obsolete and unmarketable. Development of entertainment software products for
new hardware platforms requires substantial investments in research and
development for technologies such as enhanced sound, digitized speech, music and
video and requires the Company to anticipate and develop products for those
platforms that will ultimately be successful. Such research and development
efforts, which generally require 12 to 24 months, must occur well in advance of
the release of new platforms in order to introduce products on a timely basis
following the release of such platforms. In addition, the Company expects that
the trend toward more complex multimedia products and increasing product
development costs will continue for the foreseeable future.

Although the Company intends to develop and market games for certain advanced
and emerging platforms, these development and marketing efforts may require
greater financial and technical resources than those currently possessed by the
Company. In addition, there can be no assurance that the platforms for which the
Company develops products will achieve market acceptance and, as a result, there
can be no assurance that the Company's development efforts with respect to such
new platforms will lead to marketable products or products that generate
sufficient revenue to offset research and development costs incurred in
connection with their development. There can be no assurance that the Company
will be successful in developing and marketing products for new platforms.
Failure to develop products for new platforms that achieve significant market
acceptance may have a material and adverse effect on the Company's business,
operating results and financial condition. The Company is developing

                                          16
<PAGE>

                               SPECTRUM HOLOBYTE, INC.

games that may be played interactively over on-line services and the Internet,
but there can be no assurance that the market for networked videogame play will
evolve or develop as anticipated. Consumer preferences change continually and
are extremely difficult to predict. Even if a market for networked videogame
play develops, no assurance can be given that the Company's products will meet
the requirements of such market and achieve market acceptance.

The Company is heavily dependent on the success of the entertainment software 
developed for use on the PC. However, there are multiple, competing and 
incompatible formats being introduced in this new market.  PlayStation, Sega 
Saturn, and Nintendo's Ultra 64 are currently available. There can be no 
assurance that the Company's strategy of developing primarily for the PC or 
the other platforms the Company chooses to support ultimately will be 
successful. The development, marketing and distribution of products for game 
consoles the Company chooses to support will involve substantial investment 
and risks. The Company believes that the principal target audience for game 
consoles may be younger than the Company's traditional customers, and there 
can be no assurance that the Company's products will be successful with this 
different audience. In addition, the Company anticipates that products in the 
game console market will require substantially greater expenditures for 
marketing, advertising and inventory buildup, often before the market 
acceptance of a product is known. Inventory will be two or more times more 
expensive as a result of license fees that are required to be prepaid to the 
manufacturers of the hardware platforms. Further, game console products will 
be sold through channels that overlap with, but are somewhat different from, 
the retail channels currently utilized by the Company, and the Company will 
be competing in distribution against much larger organizations with greater 
financial resources. There can be no assurance that the Company will be 
successful in marketing and distributing software for game consoles.

RISK OF SOFTWARE ERRORS OR FAILURES.  Software products as complex as those
offered by the Company may contain undetected errors when first introduced or
when new versions are released. In the past, the Company has discovered software
errors in certain of its product offerings after their introduction and has
experienced delays or lost revenue during the period required to correct these
errors. The Company's products must maintain compatibility with certain
hardware, software and accessories. Any changes that result in incompatibility
could result in significant product returns and customer service costs. In
particular, the PC hardware environment is characterized by a wide variety of
nonstandard peripherals (such as sound and graphics cards) and configurations
that make prerelease testing for programming or compatibility errors very
difficult and time consuming. There can be no assurance that, despite testing by
the Company, errors will not be found in new products or releases after
commencement of commercial shipments, resulting in loss of or delay in market
acceptance, which could have a material and adverse effect on the Company's
business, operating results and financial condition. The risk of undetected
product errors can be expected to increase as products and their development
processes become more complex and as growing competition leads to increased
pressure to reduce time to market.

DEPENDENCE ON KEY PERSONNEL; MANAGEMENT CHANGES.  The Company's future success
depends in large part on the continued service of its key product development,
technical and management personnel and on its ability to continue to attract,
motivate and retain highly qualified employees, including additional management
personnel. The loss of certain key employees could have a material and adverse
effect on the Company's business. In addition, the Company depends on teams of
programmers, game designers and artists. Competition for these skilled employees
is intense, and the loss of the services of key development personnel could have
a material and adverse effect upon the Company's current business, new product
development efforts and prospects. Sid Meier, the Company's former Executive
Vice President of Product Development, resigned in May 1996. He will continue as
a consultant until the completion of MAGIC: THE GATHERING. Since January 1,
1996, the Company has hired a new Senior Vice President of Sales, Senior Vice
President of Operations, Senior Vice President of Marketing, and a Senior Vice
President of Development Studios and intends to hire other senior management
positions including a new Chief Financial Officer. The Company has also hired a
financial consultant to advise the Chief Executive Officer on financial
planning, controls and reporting structures. There can be no assurance that
qualified personnel can be readily identified and hired wherever necessary, that
any new personnel will be successfully integrated into the Company, its
operations and culture, or that new personnel, if hired, will improve the
Company's business, operations or operating results. The Company does not
currently have key person life insurance on any employees.

USE OF INDEPENDENT SOFTWARE DEVELOPERS.  In addition to marketing internally
developed software, the Company

                                          17
<PAGE>

                               SPECTRUM HOLOBYTE, INC.

also markets entertainment software created by independent software developers.
The cost to retain independent developers is increasing in the form of
guaranteed advances and royalties. Additionally, the Company has less control
over the scheduling and the quality of work of independent contractors than that
of its own employees. Furthermore, the Company's agreements to publish and
market certain independent software developers' titles will terminate after
specified dates unless renewed. The Company's business and future operating
results will depend in part on the Company's continued ability to attract and
maintain relationships with skilled independent software developers, and to
enter into and renew product development agreements with such developers. There
can be no assurance that the Company will be able to maintain such relationships
or enter into and renew such agreements.

INTERNATIONAL REVENUE.  International net revenue represented approximately 
66%, 49%, and 29% of the Company's net revenue for the first nine months of 
fiscal 1997, and for fiscal years ended March 31, 1996 and 1995, 
respectively. The Company expects that international net revenue will 
continue to account for a significant portion of its net revenue in future 
periods. International revenue is subject to inherent risks, including 
unexpected changes in regulatory requirements, tariffs and other economic 
barriers, fluctuating exchange rates, difficulties in staffing and managing 
foreign operations and the possibility of difficulty in accounts receivable 
collection. For example, the Company attempts to minimize its exposure to 
currency fluctuations, however, there can be no assurance that the Company 
will be successful at mitigating currency risks. In some markets, 
localization of the Company's products is essential to achieve market 
penetration. The Company may incur substantial costs and experience delays in 
localizing its products, and there can be no assurance that any localized 
product will ever generate significant revenue. These or other factors could 
have a material and adverse effect on the Company's future international 
revenue and, consequently, on the Company's business, operating results and 
financial condition.

RECOVERY OF PREPAID ROYALTIES AND GUARANTEES.  The Company, from time to time,
enters into agreements with licensors of intellectual property and developers of
games that involve advance payments of royalties and guaranteed minimum royalty
payments. If the sales volumes of products subject to such arrangements are not
sufficient to recover such advances and guarantees, the Company will be required
to write-off unrecovered portions of such payments. The Company has been
required to write-off a material portion of these advances in past fiscal
quarters and, if the Company must write-off additional portions of such advances
or ultimately accrue for the guarantees, its results of operations may be
materially and adversely affected.

INTELLECTUAL PROPERTY.  The Company regards the software that it owns or
licenses as proprietary and relies primarily on a combination of copyrights,
trade secret laws, patent and trademark laws, nondisclosure agreements and other
copy protection methods to protect its product and proprietary rights. It is the
Company's policy that all employees and third-party developers sign
nondisclosure agreements. There can be no assurance that these measures will be
sufficient to protect the Company's intellectual property rights against
infringement. The Company owns or licenses various trademarks and copyrights.
However, the Company has no license agreements with the end users of its
products and does not copy protect its software. Rather, the Company relies on
the copyright laws to prevent unauthorized distribution of its software.
Existing copyright laws afford only limited protection. It may be possible for
unauthorized parties to copy the Company's products or to reverse engineer or
otherwise obtain and use information that the Company regards as proprietary.
Policing unauthorized use of the Company's products is difficult, and software
piracy can be expected to be a persistent problem. Further, the laws of certain
countries in which the Company's products are or may be distributed do not
protect the Company's products and intellectual property rights to the same
extent as the laws of the United States.

The Company believes that its products, trademarks and other proprietary rights
do not infringe on the proprietary rights of parties. As the number of
entertainment software products in the industry increases, the Company believes
that software increasingly will become the subject of claims that such software
infringes upon the rights of others. From time to time, the Company has received
communications from parties asserting that features or content of certain of its
products may infringe upon intellectual property rights of such parties. The
Company believes such claims have been without merit. To date, no such claims
have had an adverse effect on the Company's ability to develop, market or sell
its products. There can be no assurance that existing or future infringement
claims against the Company will not result in costly litigation or require the
Company to license the intellectual property rights of parties. There can be no
assurance that such licenses will be available on reasonable terms or at all.

STRATEGIC RESTRUCTURING.  In fiscal 1996 and early fiscal 1997, the Company
undertook a strategic restructuring with

                                          18
<PAGE>

                               SPECTRUM HOLOBYTE, INC.

the goals of better integrating the operations of Spectrum HoloByte and 
MicroProse, streamlining product development efforts and reducing operating 
costs. Certain domestic operations were streamlined and consolidated in 
California, including marketing, operations, customer support, finance and 
product planning. The Company discontinued its Japanese operations, and 
entered into an exclusive three-year distribution agreement in Japan which is 
expected to generate royalties in future periods.  The Company's domestic 
affiliated label programs were terminated and the number of products being 
published and actively marketed was significantly reduced in order to focus 
the Company's sales and distribution efforts.  As a result of these changes, 
the Company has improved operating efficiencies, reduced headcount and 
reduced operating costs. There can be no assurance, however, that the Company 
will be successful in meeting the objectives of this restructuring. 
Furthermore, as a result of reducing the number of the Company's products, 
there can be no assurance that the Company's expected revenue will be 
sufficient to generate operating profits.

NASDAQ LISTING.  The Company was notified in February 1996 by the Nasdaq Stock
Market ("Nasdaq") that the Company was no longer in compliance with the net
tangible assets requirement of the National Association of Securities Dealers'
ByLaws for listing on the Nasdaq National Market.  Nasdaq granted the Company a
temporary exemption from the net tangible assets requirement.  The exemption
required that the Company achieve compliance with the listing on or before July
12, 1996.

The Company regained compliance with the Nasdaq National Market listing
requirements as of the end of the fiscal quarter ended June 30, 1996. There can
be no assurance that the Company will be able to maintain compliance with the
listing requirements of the Nasdaq National Market in the future.  If the
Company is unable to maintain compliance, it may qualify for listing under the
Nasdaq SmallCap Market.  If for any reason the Company is unable to achieve and
maintain compliance with the SmallCap listing requirements and is delisted from
both the Nasdaq National Market and the Nasdaq SmallCap Market, the holders of
the Company's 61/2 % Convertible Subordinated Notes Due 2002 (the "Notes") would
be entitled to require the Company to repurchase all or any portion of such
holders' Notes for cash at a price equal to the principal amount plus accrued
interest.  In such event, the Company's business, results of operations and
financial condition would be materially and adversely affected.

VOLATILITY OF PRICE OF STOCK AND NOTES.  There has been a history of significant
volatility in the market prices of companies engaged in the entertainment
software industry, including the Company. It is likely that the market price of
the Company's common stock will continue to be highly volatile and the price of
the Company's Notes will also be subject to such fluctuations. Factors such as
the timing and market acceptance of new product introductions by the Company,
the introduction of new products by the Company's competitors, loss of key
personnel of the Company, variations in quarterly operating results or changes
in market conditions in the entertainment software industry may have a
significant impact on the market price of the Company's common stock and Notes.
In the past, the Company has experienced fluctuations in its operating results,
and it is likely that in some future quarter the Company's revenue or operating
results will be below the expectations of, and certain new products will not be
introduced when anticipated by, public market analysts and investors. In such
event, the price of the Company's common stock would likely be materially
adversely affected. Volatility in the price of the Company's common stock,
changes in prevailing interest rates and changes in perceptions of the Company's
creditworthiness may in the future adversely affect the price of the Notes.


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<PAGE>


                               SPECTRUM HOLOBYTE, INC.


PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

On July 9, 1996, a lawsuit entitled Acclaim Entertainment, Inc. v. Spectrum
HoloByte California, Inc. No. 96-2462 WHO, was filed in the United States
District Court for the Northern District of California.  MicroProse Software,
Inc. was also named as a defendant.  The complaint alleged various causes of
action related to an exclusive license Acclaim holds from Wizard of the Coast,
Inc. ("WOTC") to develop certain computer game products based on the world and
characters of the Magic: The Gathering card game.  Acclaim alleged that its
license is being infringed by the Magic: The Gathering computer game being
developed by the Company, which also holds an exclusive license from WOTC.

On September 20, 1996, the Company filed an answer and counterclaim denying the
allegations in the complaint and asserting claims for unfair competition,
copyright infringement, and interference with contract against Acclaim.

On November 4, 1996, the Company, MicroProse and Acclaim entered into an
agreement settling the lawsuit.  Under the terms of the settlement, the Company
is not required to make any monetary payment or alter its computer game product.
The parties have agreed to differentiate their respective titles in the
marketplace.  Acclaim will market its product for Windows 95 under the name
Magic: The Gathering-BattleMage.  The title will be positioned as a real-time,
multi-player strategy game, based on the characters and scenarios of the fantasy
adventure world of Magic: The Gathering.  The Company's title will be released
under the MicroProse brand name and will be positioned as an interactive version
of the Magic: The Gathering card game.  The Company's title will feature a
fantasy world developed by the Company to simulate the features of the Magic:
The Gathering card game, including card collection, deck-building and dueling.

The parties have also agreed to coordinate the release dates for their
respective products.  Acclaim will have the right to release its title on or
before January 10, 1997, and the Company has agreed not to release its product
until after such date.  In the event Acclaim releases its title on or before
January 10, 1997, then the Company will release its title no earlier than
February 1, 1997.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a)  THE FOLLOWING EXHIBITS ARE FILED HEREWITH:


       EXHIBIT
       NUMBER       DESCRIPTION
       -------     -----------------------------------------------------------
         3.1+      Certificate of Incorporation of the Registrant

         3.2+      Amended Bylaws of Registrant

         4.1+      Specimen Common Stock Certificate of the Registrant

         4.2+      Warrants issuable to the Grotech Investors and Corporate
                   Venture Partners, L.P., dated as of October 17, 1991

         4.3+      Form of Warrant issuable to Paragon Investors, dated July
                   1992

         4.4+      Form of Warrant, issued to Ince & Co. (incorporated by
                   reference to Exhibit 2.3 of Spectrum HoloByte, Inc.'s
                   Quarterly Report on Form 10-Q, File No. 0-19463, filed on
                   December 31, 1994)

         4.5+      Registration Rights Agreement, dated June 12, 1995 by and
among Spectrum HoloByte, Inc. and Stephen Barcia and Maria Barcia (incorporated
by reference to Exhibit 2.3 of Spectrum HoloByte, Inc.'s Current Report on Form
8-K, File No. 0-19463, filed on June 27, 1995)

         4.6+      Registration Rights Agreement, dated as of May 16, 1995, by
                   and among Spectrum


                                          20
<PAGE>


                               SPECTRUM HOLOBYTE, INC.


       EXHIBIT
       NUMBER       DESCRIPTION
       -------     -----------------------------------------------------------

                   HoloByte, Inc. and IPWEL LTD (incorporated by reference to
                   Exhibit 4.7 of Spectrum HoloByte, Inc.'s Registration on
                   Form S-3, File No. 33-94580, filed October 24, 1995)

         4.7+      Registration Rights Agreement, dated as of May 16, 1995, by
                   and among Spectrum HoloByte, Inc. and GFL Advantage Fund
                   Limited (incorporated by reference to Exhibit 4.8 of
                   Spectrum HoloByte, Inc.'s Registration on Form S-3, File No.
                   33-94580, filed October 24, 1995)

         4.8+      Registration Rights Agreement, dated as of August 28, 1995,
                   by and among Spectrum HoloByte, Inc. and GFL Advantage Fund
                   Limited (incorporated by reference to Exhibit 4.9 of
                   Spectrum HoloByte, Inc.'s Registration on Form S-3, File No.
                   33-94580, filed October 24, 1995)

         4.9+      Registration Rights Agreement, dated as of June 27, 1995, by
                   and among Spectrum HoloByte, Inc. and Banque Scandinave en
                   Suisse (incorporated by reference to Exhibit 4.10 of
                   Spectrum HoloByte, Inc.'s Registration on Form S-3, File No.
                   33-94580, filed October 24, 1995)

         4.10+     Registration Rights Agreement, dated as of August 25, 1995,
                   by and among Spectrum HoloByte, Inc. and PJP International,
                   Ltd. (incorporated by reference to Exhibit 4.11 of Spectrum
                   HoloByte, Inc.'s Registration on Form S-3, File No.
                   33-94580, filed October 24, 1995)

         4.11+     Registration Rights Agreement, dated as of May 16, 1995, by
                   and among Spectrum HoloByte, Inc. and Tanner, Owen & Co.
                   Incorporated (incorporated by reference to Exhibit 4.12 of
                   Spectrum HoloByte, Inc.'s Registration on Form S-3, File No.
                   33-94580, filed October 24, 1995)

         4.12+     Registration Rights Agreement, dated as of September 6,
                   1995, by and among Spectrum HoloByte, Inc. and Tanner, Owen
                   & Co. Incorporated (incorporated by reference to Exhibit
                   4.13 of Spectrum HoloByte, Inc.'s Registration on Form S-3,
                   File No. 33-94580, filed October 24, 1995)

         4.13+     Indenture, dated as of September 15, 1995, between Spectrum
                   HoloByte, Inc. and Chemical Trust Company of California
                   (incorporated by reference to Exhibit 3 of Spectrum
                   HoloByte, Inc.'s Current Report on Form 8-K, File No.
                   0-19463, filed October 17, 1995)

         4.14+     Registration Rights Agreement, dated as of September 26,
                   1995, by and among Spectrum HoloByte, Inc. and Robertson,
                   Stephens & Company, L.P., Jeffries & Company, Inc. and Piper
                   Jaffray Inc. (incorporated by reference to Exhibit 4 of
                   Spectrum HoloByte, Inc.'s Current Report on Form 8-K, File
                   No. 0-19463, filed October 17, 1995)

         4.15+     Certificate of Designation for Series B Convertible
                   Preferred Stock

         4.16+     Certificate of Designation for Series B-1 Convertible
                   Preferred Stock

         10.1+     Form of Purchase Agreement, by and between Spectrum
                   HoloByte, Inc. and certain investors, effective June 26,
                   1996 (incorporated by reference to Exhibit 4.3 of Spectrum
                   HoloByte, Inc.'s Registration on Form S-3, File No.
                   333-08385, filed July 18, 1996)

         11.1      Statement Re: Computation of Net Income (Loss) Per Share

         27.1      Statement Re: Financial Data Schedule


         +         Previously filed.

(b)  REPORTS ON FORM 8-K:

None.


                                          21
<PAGE>


                               SPECTRUM HOLOBYTE, INC.


                                      SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, on February 14, 1997.




                                  SPECTRUM HOLOBYTE, INC.




                                  By: /s/ Stephen M. Race
                                      ------------------------------
                                       Stephen M. Race
                                       CHIEF EXECUTIVE OFFICER, ACTING CHIEF
                                       FINANCIAL OFFICER AND DIRECTOR


                                          22