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                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                            ------------------------
 
                                   FORM 10-K
(MARK ONE)
 
[X]   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
      SECURITIES EXCHANGE ACT OF 1934
 
                    FOR THE FISCAL YEAR ENDED JUNE 30, 1997
 
                                       OR
 
[ ]   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
      SECURITIES EXCHANGE ACT OF 1934
 
                         FOR THE TRANSITION PERIOD FROM
                               --------------- TO
                                ---------------
 
                         COMMISSION FILE NUMBER 0-28676
 
                               GRAPHIX ZONE, INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
 
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                   DELAWARE                                     33-0697932
       (STATE OR OTHER JURISDICTION OF                       (I.R.S. EMPLOYER
        INCORPORATION OR ORGANIZATION)                     IDENTIFICATION NO.)
  2915 DAIMLER STREET, SANTA ANA, CALIFORNIA                      92705
   (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)                     (ZIP CODE)
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       REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (714) 833-3838
 
          SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
                                      NONE
 
          SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
 
                          COMMON STOCK, $.01 PAR VALUE
                                (TITLE OF CLASS)
 
     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 ninety days.     Yes [X]     No [ ]
 
     Indicated by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (Section 229.405 of this Chapter) is not contained herein,
and will not be contained, to the best of Registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K.  [X]
 
     Based on the last sale price, the aggregate market value of the voting
stock held by non-affiliates of the Registrant on September 29, 1997 was
$1,911,480.
 
     As of September 29, 1997, 15,929,004 shares of the Registrant's only class
of Common Stock, $.01 par value per share, were outstanding.
 
                      DOCUMENTS INCORPORATED BY REFERENCE
 
     Portions of the Registrant's Proxy Statement prepared in connection with
the Annual Meeting of Stockholders to be held in 1997 are incorporated by
reference into Part III in this Report on Form 10-K.
 
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                               TABLE OF CONTENTS
 
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PART I
  Item 1.     Business.............................................................    1
  Item 2.     Properties...........................................................    7
  Item 3.     Legal Proceedings....................................................    7
  Item 4.     Submission of Matters to a Vote of Security Holders..................    7
PART II
  Item 5.     Market for Registrant's Common Equity and Related Stockholder            8
              Matters..............................................................
  Item 6.     Selected Consolidated Financial Data.................................   11
  Item 7.     Management's Discussion and Analysis of Financial Condition and         11
              Results of Operations................................................
  Item 7A.    Quantitative and Qualitative Disclosures About Market Risk...........   17
  Item 8.     Financial Statements and Supplementary Data..........................   17
  Item 9.     Changes in and Disagreements with Accountants on Accounting and         46
              Financial Disclosure.................................................
PART III
  Item 10.    Directors and Executive Officers of the Registrant...................   46
  Item 11.    Executive Compensation...............................................   46
  Item 12.    Security Ownership of Certain Beneficial Owners and Management.......   46
  Item 13.    Certain Relationships and Related Transactions.......................   46
PART IV
  Item 14.    Exhibits, Financial Statement Schedules, and Reports on Form 8-K.....   46
SIGNATURES.........................................................................   51
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                                     PART I
 
ITEM 1. BUSINESS
 
OVERVIEW
 
  Background
 
     Graphix Zone, Inc., a Delaware corporation (the "Company"), was
incorporated on January 17, 1996 for the purpose of acquiring GZ Multimedia,
Inc. (formerly Graphix Zone, Inc.), a California corporation ("GZ-CA"), and
StarPress, Inc., a Colorado corporation ("StarPress"). Both GZ-CA and StarPress
were publishers of entertainment-oriented interactive multimedia software. On
June 28, 1996, the Company acquired GZ-CA and StarPress in reverse triangular
mergers and the companies became wholly-owned subsidiaries of the Company (the
"Reorganization"). Upon the consummation of the Reorganization, the stockholder
interests in the Company of the former StarPress shareholders were larger than
those of the former GZ-CA shareholders, and therefore, StarPress was deemed to
be the acquiring entity for financial accounting purposes. Accordingly, the
historical financial statements presented herein, prior to the effective date of
the Reorganization, are the financial statements of StarPress. The historical
shares of StarPress presented therein have been adjusted to reflect a .14666 for
1 stock exchange in connection with the Reorganization. All references to the
"Company" prior to June 28, 1996 relate to StarPress.
 
     Following the consummation of the Reorganization, the Company's principal
business was developing, producing and marketing CD-ROM and on-line interactive
entertainment products for the personal computer industry. In addition,
following the Reorganization, the Company operated certain other businesses,
including developing and operating WILMA, an Internet site for live music venues
and developing and marketing certain Internet access and exploration products.
 
  Current Status of Company/Restructuring Plan
 
     In March 1997, the Company hired a new executive management team for the
purpose of evaluating the business and financial condition of the Company and,
if necessary, restructuring the Company. The management team reviewed the
Company's history of operating losses, current financial condition, current
strategic position within the entertainment software industry, competitors in
such industry and capital requirements for new product development. Based upon
its review, the management team reached the following conclusions with respect
to the Company's primary businesses and its financial condition:
 
     - Entertainment Software Products. During the fiscal year ended June 30,
       1997 ("Fiscal 1997"), the Company earned approximately 61% of its net
       revenues from the sale of two entertainment software products which were
       licensed to the Company under a license agreement with Sony Interactive
       Entertainment, Inc. ("Sony"). The Company's license agreement with Sony
       expired on September 1, 1997, and after such date, the Company no longer
       had the right to sell products under such license other than liquidating
       its inventory of Sony products during the 6 month period following
       September 1, 1997. In addition, the Company does not have the resources
       necessary to develop new entertainment software products which would
       produce sufficient revenues to allow the Company to profitably operate in
       the entertainment software industry.
 
     - Interactive Music. The Company has not been able to obtain the interest
       of music or computer retailers and consumers for its interactive music
       products, and therefore, the Company has not been able to develop a
       market which can support this business.
 
     - Internet Access and Accessories. The Company has not been able to
       maintain the profitability of its Internet access products due to the
       large number of competitive products which are available, including free
       promotional programs provided by large Internet access providers to their
       customers.
 
     - World Wide Web Content. The Company does not have the resources necessary
       to develop World Wide Web content which would produce sufficient revenues
       to support this business.
 
     - General Financial Condition. The Company is insolvent and does not have
       the funds necessary to continue its current operations.
 
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     Based upon their conclusions, the management team decided that it was in
the best interests of the Company and its stockholders and creditors to attempt
to restructure the Company, and in June 1997, proposed to the Board of Directors
of the Company a restructuring plan (as described below, the "Restructuring
Plan"), which included terminating the Company's existing business operations.
On June 3, 1997, the Board of Directors adopted the Restructuring Plan. By June
24, 1997, the Company had taken steps to cease its principal business operations
and had terminated all employees other than Mr. David Hirschhorn, the Chairman
of the Board, President, Chief Executive Officer and Chief Financial Officer of
the Company.
 
     As approved by the Board of Directors, the Restructuring Plan contained the
following elements:
 
     - Business -- Divest or dispose of the Company's existing businesses
      related to the personal computer industry and explore opportunities to
      enter into new businesses and industries.
 
     - Senior Secured Debt -- Renegotiate the terms of the Company's senior
      secured loan and the related collateral agreements to extend the term of
      the loan, reduce the interest rate thereof and provide for later payments
      of amounts due thereunder and to reduce the senior lender's warrant
      position in the Company.
 
     - Outstanding Unsecured Debt -- Pay to unsecured creditors of the Company
      $0.30 for each $1.00 of debt outstanding.
 
     - Outstanding Convertible Preferred Stock -- Exchange outstanding shares of
      the Company's Series B and Series C Convertible Preferred Stock, each $.01
      par value per share (collectively, "Preferred Stock"), for shares of the
      Company's common stock, $.01 par value per share ("Common Stock"), at an
      exchange price of approximately $0.75 per share.
 
     - Additional Capital -- Evaluate alternative methods for raising additional
       funds for the Company.
 
     Since July 1997, the Company's business activities have consisted of
licensing and attempting to enter into licenses for certain of the entertainment
software products held in its library, divesting or disposing of its businesses
and products related to the personal computer industry, and attempting to
restructure its debt obligations, equity structure and business operations. The
Common Stock was delisted from The Nasdaq Stock Market, Inc. ("Nasdaq") SmallCap
Market on June 19, 1997 because the Company no longer complied with the criteria
established by Nasdaq for continuation of listing.
 
     On July 14, 1997, the Company received a Notice of Default and Demand for
Payment from its senior secured lender, Madeleine L.L.C. ("Madeleine"), based
upon the Company's failure to make certain interest payments when due under the
terms of the loan agreement, as amended (the "Amended Loan Agreement"), between
the Company and Madeleine. The notice stated that the Company was in default
under the terms of the Amended Loan Agreement and demanded that all pastdue
amounts be paid by July 18, 1997. The Company did not pay the past-due amounts
by the July 18, 1997 deadline. On August 29, 1997, the Company received a second
Notice of Default and Demand for Payment (the "August Notice") from Madeleine.
The August Notice stated that in the event that the Company failed to pay all
past due amounts by September 5, 1997, Madeleine would exercise its rights to
declare all obligations under the Amended Loan Agreement immediately due and
payable. The Company did not pay the past due amounts by the September 5, 1997
deadline. As of October 13, 1997, Madeleine has not declared all obligations
under the Amended Loan Agreement immediately due and payable. The Company has
had preliminary oral discussions with Madeleine concerning obtaining a waiver of
existing defaults of the Company under the terms of the Amended Loan Agreement
and renegotiating the terms of the Amended Loan Agreement and the related
collateral agreements. Madeleine has indicated to the Company that if the
Company is able to reach agreements with its unsecured creditors regarding the
repayment of their debt at a reduced basis and with its preferred stockholders
regarding the conversion of their shares of Preferred Stock into shares of
Common Stock, the senior lender may be willing to waive the existing defaults
under the Amended Loan Agreement, extend the term of its loan, reduce the
interest rate charged to the Company thereunder and reduce its current warrant
position of approximately 25% of the restructured Company, determined on a
fully-diluted basis. The amount of the reductions relating to interest rate and
warrant position are still subject to negotiation. To the extent that the
Restructuring Plan is unsuccessful, Madeleine has indicated that it will
foreclose upon its interest and liquidate all of the assets of the Company.
 
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<PAGE>   5
 
     The Company is negotiating with its unsecured creditors to pay $.30 for
each $1.00 of debt outstanding. In order for the Restructuring Plan to proceed,
the unsecured creditors (a) holding approximately 90% of the aggregate dollar
amount of the Company's unsecured debt and (b) comprising over 65% of the number
of the unsecured creditors must agree to the repayment plan. The Company does
not intend to negotiate different payment terms with any of its current
unsecured creditors. If all of the Company's unsecured creditors agree to the
repayment plan, the Company estimates that its total payments to creditors would
be approximately $1,800,000.
 
     The Company also is negotiating exchange agreements with its holders of
Series B Convertible Preferred Stock, $.01 par value per share ("Series B
Stock"), and Series C Convertible Preferred Stock, $.01 par value per share
("Series C Stock"), pursuant to which all outstanding shares of Preferred Stock
would be converted into shares of Common Stock at an exchange price of
approximately $0.75 per share. The Company has entered into exchange agreements
with several, but not all, of the holders of Series B Stock and has not entered
into exchange agreements with the holders of Series C Stock. As of September 29,
1997, the outstanding shares of Preferred Stock of the Company consisted of the
following: 1,806 shares of Series B Stock and 1,185,185 shares of Series C
Stock. The Company estimates that under the terms of the Restructuring Plan,
such outstanding shares of Preferred Stock will be converted into approximately
8 million shares of Common Stock. As of September 29, 1997, the Company has
approximately 15,929,000 shares of Common Stock outstanding, and after effecting
the exchange of shares of Preferred Stock described above, the Company will have
approximately 23,929,000 shares of Common Stock outstanding.
 
     In order to facilitate the Restructuring Plan, management must raise a
minimum of $3,000,000 in new capital. There is no assurance that management will
be successful in attracting new capital given the Company's financial history
and current financial position.
 
  Forward-Looking Statements
 
     This Annual Report on Form 10-K includes a number of forward-looking
statements that are subject to certain risks and uncertainties that could cause
the Company's actual results and financial position to be affected negatively as
events unfold. These events include, but are not limited to, the risk that the
Restructuring Plan is not successful and, even if successful, the risks inherent
in starting a new business venture. The Company will not update or revise any
such forward-looking statements to reflect events or circumstances that may
arise after this Report is filed and that may have an effect on the Company's
overall performance. A more thorough discussion of these factors is presented in
this Item 1 under the caption "Risk Factors," below, and elsewhere in this
Annual Report on Form 10-K.
 
RISK FACTORS
 
  Success of Restructuring/Going Concern
 
     The Company is in default under the terms of its loan agreements with its
senior secured lender and is in default under other agreements with numerous
other creditors. From a financial viewpoint, the Company is insolvent. The
Company's future will depend significantly on its ability to successfully
complete the Restructuring Plan. If the Company fails to complete any step in
its Restructuring Plan, it is likely that the Company's senior secured lender
will foreclose on all of the assets of the Company and pursue the dissolution of
the Company. Based upon the current assets of the Company, there would be
insufficient assets to satisfy the secured lender's claims and, accordingly,
there would be no assets remaining to satisfy the unsecured creditors' claims.
There can be no assurance that the Company will successfully complete its
restructuring or that the senior secured lender will not foreclose on the assets
of the Company at any time or that the Company will continue as a going concern.
 
  No Current Operations; No Current Business Arrangements
 
     Since July 1997, the Company's business activities have consisted of
licensing and attempting to enter into licenses for certain of the entertainment
software products held in its library, divesting or disposing of its businesses
and products related to the personal computer industry, and attempting to
restructure its debt
 
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obligations, equity structure and business operations. After October 31, 1997,
the Company intends to cease its efforts to enter into new licenses for
entertainment software products in its library. The Company is considering
several strategic business alternatives in industries which the Company has not
operated in the past, including but not limited to, the financial service
industry. The Company has no understandings, commitments, agreements or
arrangements (collectively, "arrangements") with respect to the business
alternatives being considered. Accordingly, the Company has no operating history
or current business arrangements upon which an evaluation of the Company and its
prospects can be based. There can be no assurance that the Company will be able
to begin operating a new business or that the Company will attain profitability.
 
  Employees; Financial and Management Controls
 
     Since June 24, 1997, the Company has had only one employee, Mr. David
Hirschhorn, Chairman of the Board, President, Chief Executive Officer, Chief
Financial Officer and Treasurer, and several non-employee consultants. As the
Company begins operations in new businesses, the Company's success will depend
significantly upon its ability to attract and retain skilled employees and to
develop financial and management controls, reporting systems and procedures.
There can be no assurance that the Company will be able to attract and retain
skilled employees or develop such controls, systems or procedures effectively or
on a timely basis.
 
  Dilution to Stockholders
 
     If the Company successfully completes the proposed exchange of outstanding
shares of Preferred Stock of the Company for shares of Common Stock, the number
of outstanding shares of Common Stock will increase by approximately 50%. As a
result, the holders of Common Stock will incur substantial dilution. In
addition, the Company is evaluating alternatives for raising additional funds
for the Company and certain of these alternatives may result in additional
dilution of the holders of Common Stock.
 
PRIOR BUSINESS
 
     Prior to June 1997, the principal business operations of the Company
consisted of developing, producing and marketing interactive entertainment and
multimedia products for the personal computer industry. The Company developed,
produced and marketed (collectively, "developed") products in four primary
categories: (a) entertainment software (b) interactive music, (c) Internet
access and accessories and (d) World Wide Web content.
 
  Entertainment Software
 
     During Fiscal 1997, sales of two personal computer entertainment software
products made up approximately 61% of the Company's net revenues. The rights to
sell these two products, Wheel of Fortune and Jeopardy!, were licensed to the
Company under the terms of a license agreement with Sony (the "Sony License").
During Fiscal 1997, the Company attempted to negotiate a new license with Sony,
but Sony would not enter into a new license agreement. The Sony License expired
on September 1, 1997 (the "Expiration Date"). Under the terms of the Sony
License, following the Expiration Date, the Company is not allowed to sell Wheel
of Fortune and Jeopardy! other than in connection with liquidating its existing
inventory of such products during the 6 month period following the Expiration
Date.
 
     During Fiscal 1997, the Company sold a variety of other personal computer
entertainment software products including: The Guided Tour of Multimedia,
Lights! Camera! Interaction! and Travis Jett's Real Extreme CD-Room, both based
on the America's Funniest Home Videos Television show; Nixon, based upon the
Oliver Stone film; and The Crow, based upon the film The Crow. The Company also
published and distributed titles featuring household names such as MTV's Beavis
and Butthead, CNN, Highlights, the Improv and Playboy.
 
     On February 24, 1997, the Company entered into an agreement with Inscape, a
Delaware general partnership among Home Box Office and corporations owned by
Warner Music Group, Inc. ("WMG") and
 
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Nash New Media, Inc., and WMG (collectively, "Inscape"), to purchase certain
assets from and assume certain liabilities of Inscape. The purchased assets
consisted of all rights, title and interest in twelve existing personal computer
game products and seven personal computer game products in development; all
rights, title and interest in the Inscape name; certain furniture and equipment;
and certain leases and other agreements. The liabilities assumed consisted of
accrued compensation costs associated with those Inscape employees offered
employment with the Company. In exchange for the Inscape assets, the Company
issued to Inscape 948,148 shares of the Company's Series C Stock, which had a
stated liquidation value of $3,200,000 but which the Company valued at
$2,193,066 due to the restricted nature of the securities.
 
     On February 26, 1997, the Company entered into an agreement with Trimark
Holdings, Inc. and its subsidiary, Trimark Interactive, Inc. ("Trimark"), to
purchase certain assets from and assume certain liabilities of Trimark. The
purchased assets consisted of all rights, title and interest in seven existing
personal computer game products and three personal computer game products in
development, related inventories and certain other agreements. The liabilities
assumed consisted primarily of liabilities related to the products in
development. In exchange for the Trimark assets, the Company issued to Trimark
237,037 shares of the Company's Series C Stock, which had a stated liquidation
value of $800,000 but which the Company valued at $548,267 due to the restricted
nature of the securities.
 
  Interactive Music
 
     The Company was one of the first companies to develop interactive music
products. In June 1994, the Company released its initial interactive music
product, Prince Interactive, featuring the artist formerly known as Prince.
During the fiscal year ended June 30, 1995 ("Fiscal 1995"), the Company released
its second interactive music product, Highway 61 Interactive, featuring Bob
Dylan. During the fiscal year ended June 30, 1996 ("Fiscal 1996"), the Company
did not release any new interactive music products. During Fiscal 1997, the
Company released three interactive music products: Willie, based on the work of
country western star Willie Nelson; Living Jazz, the first of a proposed series
of interactive jazz products to be developed jointly with Herbie Hancock; and
Under the Covers, a historical music product which explored the rock scene of
the 1960's through the lens of photographer Henry Diltz. The three titles
released in Fiscal 1997 had limited financial success due to a lack of retailer
and consumer interest.
 
  Internet Access and Accessories
 
     During Fiscal 1996, the Company developed an Internet access product named
ExpressNet Suite which was a collection of internet software that included
Netscape Navigator 2.0, Internet Phone and other third party modules and which
linked with Earthlink, Inc. as the Internet service provider. The ExpressNet
Suite had limited financial success. During Fiscal 1997, the Company developed a
second edition of ExpressNet Suite. In addition, during Fiscal 1997, the Company
developed a similar line of Internet access and exploration products under the
name SmartNet which linked with Concentric as the Internet service provider. The
Internet products released in Fiscal 1997 had little financial success due to
the large number of competitive products available, including free promotional
programs provided by large Internet access providers to their customers.
 
  World Wide Web Content
 
     In April 1996, StarPress acquired WILMA, an Internet site for live music
venues, in exchange for an aggregate purchase price of $220,876, consisting of
shares of Common Stock of StarPress and a promissory note. StarPress intended to
develop WILMA into a "virtual world" where artists, music bands, music fans and
other music oriented people could interact and exchange information about music
clubs and other secondary concert venues. Additionally, StarPress intended to
sell tickets and other products through WILMA. During the second quarter of
Fiscal 1997, the Company decided that the large amount of capital projected to
be needed by WILMA for its operations made the project unfeasible. During the
fourth quarter of Fiscal 1997, the Company entered into an agreement with the
founders of WILMA to sell WILMA to such founders in exchange for $5,000.
 
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  Distribution
 
     The Company used independent distributors to distribute its products to
computer and software outlets, music stores, large merchandisers and other
retail stores.
 
  Competition
 
     The Company's competition in its primary business industry, entertainment
software development, can be grouped into four categories: (a) large software
developers such as Davidson, Broderbund, Electronic Arts, The Learning Company
and GT Interactive Software; (b) small software publisher/developers such as 7th
Level and Interplay Productions; (c) large entertainment companies, such as The
Walt Disney Company and Sony; and (d) small to medium sized independent
publisher developers who specialize in particular niches (the "Niche Category").
The Company is considered to fall in the Niche Category. Companies in the Niche
Category typically do not have the capital required to compete with the larger
software companies and have less market acceptance because they compete in niche
markets and, as a result, are not as well known. In addition, as compared to
prior years, market conditions are requiring software developers to produce
higher-quality products at a lower cost, and therefore, companies in the Niche
Category, which sell a smaller number of products, are making less money on an
overall basis. During the calendar year ended December 31, 1996, on an
industry-wide basis, more software titles were published than in the previous
year and the average revenue per software title decreased. Accordingly, the
software market is becoming more competitive for consumer dollars spent on
software and less profitable on a per software product basis.
 
  Research and Development
 
     During Fiscal 1997, Fiscal 1996 and Fiscal 1995, the Company spent
$3,703,775, $2,008,614 and $2,032,059, respectively, on expenditures for
research and development. The Company's research and development activities
primarily are directed towards developing new entertainment software products.
The Company believes that success in the entertainment software industry is
directly dependent upon the ability to finance research and development costs in
an effort to develop new entertainment software products. The Company does not
have the financial resources necessary to finance research and development
activities in the future.
 
  Intellectual Property
 
     The Company relied on copyright and trademark protection and non-disclosure
agreements to protect its intellectual property. The Company holds no patents or
patent applications in connection with its products. The Company's logo and the
name "Graphix Zone" have been registered as service marks with the United States
Patent and Trademark Office. The Company claims copyright protection for all of
its multimedia and CD-ROM materials. From time to time, the Company licensed
from third parties video, audio and related content which it used in the
production of software products.
 
  Significant Customers
 
     During Fiscal 1997, the Company's sales to Tech Data Corporation and
Navarre Corporation represented approximately 26% and 15% of the Company's total
net revenues. Since July 1997, the Company's primary software sales related
activity has consisted of licensing two interactive pc-games to a game
distributor. Because the Company is terminating its software business
operations, software sales will terminate in the year ending June 30, 1998
("Fiscal 1998"), and during Fiscal 1998 the Company does not expect to obtain
any new software customers.
 
EMPLOYEES
 
     As of September 29, 1997, the Company had one full-time employee.
 
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ITEM 2.  PROPERTIES
 
     In June 1997, the Company entered into a lease for a 3,000 square foot
facility in Santa Ana, California consisting of office and warehouse space. The
Company leases the facility from Daimler Commerce Partners, L.P. (the
"Partnership"), an affiliated partnership. The general partner of the
Partnership is Conifer Investments, Inc. ("Conifer"). The sole shareholders of
Conifer are Thomas C.K. Yuen and Misako Yuen, as co-trustees of the Thomas Yuen
Family Trust (the "Trust"), and the executive officers of Conifer include Mr.
and Mrs. Yuen. Mr. and Mrs. Yuen, as co-trustees of the Trust, also beneficially
own as of September 29, 1997, 1.4% of the Company's outstanding Common Stock.
Until June 1997, Mr. Yuen was a director of the Company. The lease term
commenced on June 23, 1997 and can be terminated by the lessor at any time upon
30 days notice. The monthly lease payment under the lease is $2,550,
approximately $.85 per square foot, which management believes is below the per
square foot market rate for comparable space.
 
     During Fiscal 1997, the Company leased approximately 17,000 square feet of
office, multimedia production, showroom and theater space in two separate
buildings in Irvine, California. Both leases expired on June 30, 1997 and were
not renewed.
 
     The Company subleases approximately 12,100 square feet of office space in
San Francisco, California, which location formerly was used as the principal
executive offices of StarPress. The Company has assigned its sublease to a third
party, but remains liable as a guarantor of the sublease, in the event of
default by the assignee, until December 1997.
 
     In management's opinion, the Company's current facilities are adequate for
its current level of operations as well as the Company's anticipated level of
operations. However, the monthly lease rate for the Company's facility in Santa
Ana, California is below market and the lessor has the right to terminate the
lease at any time upon 30 days notice. No assurances can be made that the lease
for the Santa Ana, California facility will not be terminated or that the lease
payment will not be increased. In addition, no assurances can be made that
should either of such events occur, the Company will be able to locate a
comparable facility at a comparable lease rate.
 
ITEM 3.  LEGAL PROCEEDINGS
 
     The Company may from time to time be involved in routine legal matters
incidental to its business. In the opinion of management, the resolution of such
matters will not have a material adverse effect on its consolidated financial
condition or results of operations. Set forth below is a summary of certain
material legal proceedings to which the Company and/or any of its subsidiaries
is a party.
 
     The Company and Tunes Network, Inc. (formerly Surf Communications, Inc.)
("Tunes") currently are involved in an arbitration pending in the San Francisco,
California office of the American Arbitration Association. The arbitration was
instituted in April 1997. The arbitration relates to claims made by Tunes
against the Company in the amount of $322,000, plus unspecified additional
royalties, interest and attorneys' fees, allegedly owed under an agreement
entered into between the Company and Tunes as of November 5, 1996 (the "November
5th Agreement"). The November 5th Agreement relates to services to be performed
by Tunes in connection with creating and maintaining an Internet website for the
Company. Although the Company cannot predict the likely outcome of this
arbitration at this time, management intends to vigorously defend this
arbitration and believes that the final outcome will not have a material adverse
effect on the Company's consolidated financial condition, results of operations
or liquidity.
 
ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
     In April 1997, the Company solicited the votes of the six holders of its
Series B Convertible Preferred Stock (the "Series B Preferred") to amend the
Certificate of Designations of the Series B Preferred to establish a $1.00
conversion price floor. For the proposed amendment to become effective, a vote
of the holders of (a) the Series B Preferred, voting as a class, and (b) the
Common Stock and Series C Preferred Stock, voting together as one class, must be
obtained. In light of the Restructuring, the Company has not pursued obtaining
this vote. See "Item 1. Business -- Current Status of the Company/Restructuring
Plan."
 
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                                    PART II
 
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
 
MARKET INFORMATION
 
     During Fiscal 1996, the Common Stock of GZ-CA was listed on the Nasdaq
("Nasdaq") SmallCap Market under the symbol "GZON" and the Common Stock of
StarPress was quoted on the OTC Electronic Bulletin Board under the symbol
"GTBR." During the period beginning July 1, 1996 and continuing through June 19,
1997, the Common Stock was listed on the Nasdaq SmallCap Market under the symbol
"GZON." On June 19, 1997, the Common Stock was delisted from the Nasdaq SmallCap
Market because the Company no longer complied with the criteria established by
Nasdaq for continuation of listing. Following its delisting from the Nasdaq
SmallCap Market and continuing through the end of Fiscal 1997, the Common Stock
has been quoted on the OTC Electronic Bulletin Board under the symbol "GZON."
 
     The table below sets forth the range of high and low bid information for
the periods indicated as reported by (a) the Nasdaq SmallCap Market with respect
to the Company for the first three quarters of Fiscal 1997 and GZ-CA for all
four quarters of Fiscal 1996, (b) the OTC Electronic Bulletin Board and the
Nasdaq SmallCap Market with respect to the Company for the fourth quarter of
Fiscal 1997 and (c) the OTC Electronic Bulletin Board with respect to StarPress
for all four quarters of Fiscal 1996. These quotations reflect interdealer
prices, without retail mark-up, mark-down or commission and may not necessarily
represent actual transactions.
 
<TABLE>
<CAPTION>
                                                                   HIGH BID     LOW BID
                                                                   --------     -------
        <S>                                                        <C>          <C>
        COMPANY -- FISCAL 1997
          First quarter..........................................  $  6.875     $3.000
          Second quarter.........................................     4.000      1.875
          Third quarter..........................................     3.500      1.500
          Fourth quarter.........................................     1.500      0.031
        GZ-CA FISCAL 1996
          First quarter..........................................  $ 11.750     $4.875
          Second quarter.........................................     8.625      4.375
          Third quarter..........................................     6.750      4.750
          Fourth quarter.........................................     8.000      4.750
        STARPRESS FISCAL 1996
          First quarter..........................................  $  9.375     $3.409
          Second quarter.........................................     7.671      3.146
          Third quarter..........................................     6.392      3.835
          Fourth quarter.........................................     5.966      4.262
</TABLE>
 
HOLDERS
 
     As of September 29, 1997, there were 166 holders of record of the Company's
Common Stock.
 
DIVIDENDS
 
     The Company has never paid cash dividends on its Common Stock following a
philosophy of retaining earnings in order to finance the expansion and
development of its business. Currently, the Company is prohibited from making
cash dividend payments under the terms of the Amended Loan Agreement, the
Company's senior credit facility. See "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources," herein and "Item 8. Financial Statements and Supplementary
Data -- Notes to Consolidated Financial Statements -- Note 6."
 
                                        8
<PAGE>   11
 
SALES OF UNREGISTERED SECURITIES
 
     During Fiscal 1997, the Company sold the following unregistered securities,
which previously have not been reported in a Quarterly Report on Form 10-Q for
the Company, pursuant to exemptions under the Securities Act of 1933, as amended
(the "Act"):
 
     1. On December 12, 1996, the Company issued a warrant to purchase 100,000
shares of Common Stock to Silicon Valley Bank, which the Company believed to be
an "accredited investor" as defined in the Act, in exchange for the agreement by
Silicon Valley Bank to forbear until December 31, 1997 from taking any legal
actions to foreclose on the assets of the Company in connection with the
Company's defaults under a loan agreement with Silicon Valley Bank. The warrant
may be exercised at a price per share equal to the lowest price at which the
Company sells securities in the two equity placements immediately prior to the
time of exercise of the warrant. No underwriter was involved in the transaction.
The above-referenced securities were issued in reliance on the private offering
exemption set forth in Section 4(2) of the Act on the basis that they were
issued under circumstances not involving a public offering.
 
     2. On December 24, 1996, the Company issued 43,542 shares of Common Stock
to Cruttenden Roth Incorporated ("Cruttenden") and David J. Hirschhorn (who was
not an officer or director of the Company at the time of such issuance), both of
which the Company believed to be accredited investors, in exchange for
investment banking services, having a value of $130,625 as determined by the
Company, performed for the Company. Other than Cruttenden and Mr. Hirschhorn in
their capacities as the recipients of the shares of stock, no underwriter was
involved in the transaction. The above-referenced securities were issued in
reliance on the private offering exemption set forth in Section 4(2) of the Act
on the basis that they were issued under circumstances not involving a public
offering.
 
     3. On December 24, 1996, the Company issued 24,348 shares of Common Stock
with a fair market value of $70,000 on the date of issuance to Ronald S. Posner,
the Company's Chairman of the Board and Chief Executive Officer at the time of
issuance, as payment for accrued compensation in the amount of $70,000. No
underwriter was involved in the transaction. The above-referenced securities
were issued in reliance on the private offering exemption set forth in Section
4(2) of the Act on the basis that they were issued under circumstances not
involving a public offering.
 
     4. On January 31, 1997, the Company entered into a loan agreement in the
original principal amount of $3,740,000 (the "Madeleine Loan Agreement") with,
and issued a warrant to purchase 300,000 shares of Common Stock to, Madeleine
L.L.C. ("Madeleine"), which the Company believed to be an accredited investor.
The warrant may be exercised at a price per share equal to the lower of $2.68
per share or the fair market value of the Common Stock which shall be determined
based on the average of the last sales prices for the Common Stock over the 7
trading days immediately preceding the date of exercise (the "Fair Market Value
Calculation"). No underwriter was involved in the transaction. The
above-referenced securities were issued in reliance on the private offering
exemption set forth in Section 4(2) of the Act on the basis that they were
issued under circumstances not involving a public offering.
 
     5. On February 3, 1997, the Company issued a convertible promissory note in
the original principal amount of $200,000 (the "Note") to Middlefield Ventures,
Inc. ("Middlefield"), which the Company believed to be an accredited investor.
In connection with the issuance of the Note, the Company issued to Intel
Corporation ("Intel"), an affiliate of Middlefield, which the Company believed
to be an accredited investor, a warrant (the "Warrant") to purchase 613,718
shares of Common Stock at an exercise price of $3.46 per share. At the option of
Middlefield, the Note may be converted into shares of Common Stock under the
terms of the Warrant. Pursuant to the terms of the Warrant, shares vest as
Middlefield converts amounts under the Note or as Intel provides certain
marketing funds to the Company. No underwriter was involved in the transaction.
The above-referenced securities were issued in reliance on the private offering
exemption set forth in Section 4(2) of the Act on the basis that they were
issued under circumstances not involving a public offering.
 
     6. On March 17, 1997, the Company issued to David J. Hirschhorn, the
Chairman of the Board, President, Chief Executive Officer, Chief Financial
Officer, Treasurer and a director of the Company, an
 
                                        9
<PAGE>   12
 
option to purchase 2,500,000 shares of Common Stock at an exercise price of
$2.00 per share. The option was issued to Mr. Hirschhorn in connection with his
employment with the Company. The option vests over a period of four years. The
option may be exercised as to the vested portions at any time after the date of
vesting until the date that is five years from the individual vesting dates. No
underwriter was involved in the transaction. The above-referenced securities
were issued in reliance on the private offering exemption set forth in Section
4(2) of the Act on the basis that they were issued under circumstances not
involving a public offering.
 
     7. On June 5, 1997, the Company issued to Madeleine a warrant to purchase
25% of the Common Stock of the Company, determined on a fully diluted basis, in
connection with amending the Madeleine Loan Agreement to provide for an
additional loan in the principal amount of $1,300,000 under the terms of the
Madeleine Loan. The warrant may be exercised at a price per share equal to the
lowest of (i) $0.2366 per share, (ii) the lower of $1.00 per share or the fair
market value (determined based on the Fair Market Value Calculation) of the
Common Stock as of the effective date that the Company files a registration
statement on Form S-4, or such other form, with the U.S. Securities and Exchange
Commission, in connection with a merger or consolidation involving the Company,
or (iii) the fair market value (determined based on the Fair Market Value
Calculation) of the Common Stock as of the date that the warrant is exercised.
No underwriter was involved in the transaction. The above-referenced securities
were issued in reliance on the private offering exemption set forth in Section
4(2) of the Act on the basis that they were issued under circumstances not
involving a public offering.
 
     8. During the period from August 1996 to December 1996, in order to attract
and retain certain consultants, the Company granted options to purchase 30,000
shares of Common Stock to 6 persons. The options may be exercised at prices
ranging from $3.00 to $4.13 share. No underwriter was involved in the
transactions. The above-referenced securities were issued in reliance on the
private offering exemption set forth in Section 4(2) of the Act on the basis
that they were issued under circumstances not involving a public offering.
 
     9. During the period from August to October 1996, the Company issued 9,134
shares of Common Stock to 3 individuals/entities which the Company believed to
be accredited investors in connection with the exercise of options. The
aggregate proceeds paid to the Company in connection with the exercise of the
options were $9,243. No underwriter was involved in the transactions. The
above-referenced securities were issued in reliance on the private offering
exemption set forth in Section 4(2) of the Act on the basis that they were
issued under circumstances not involving a public offering.
 
                                       10
<PAGE>   13
 
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
 
     The following table sets forth selected financial data for the Company and
should be read in connection with the Consolidated Financial Statements, related
notes and other financial information appearing elsewhere in this report.
 
<TABLE>
<CAPTION>
                                                          FISCAL YEAR ENDED JUNE 30,
                                                 ---------------------------------------------
                                                   1997      1996      1995      1994    1993
                                                 --------   -------   -------   ------   -----
                                                   (IN THOUSANDS, EXCEPT PER SHARE DATA)(1)
    <S>                                          <C>        <C>       <C>       <C>      <C>
    Statement of Operations Data:
      Net revenues.............................  $  7,709   $ 7,182   $ 2,171   $  244   $  --
      Gross margin.............................     1,713     3,986       333       77      --
      Net loss.................................  $ 16,831   $23,519   $10,916   $2,773   $ 839
                                                 --------   -------   -------   ------   -----
    Per Share Data:
      Net loss.................................  $   1.61   $  5.05   $  7.76   $ 3.15   $3.04
      Weighted average shares outstanding......    11,044     4,661     1,407      881     276
                                                 --------   -------   -------   ------   -----
    Balance Sheet Data:
      Long-term obligations....................  $     51   $   189   $    --   $   --   $  --
      Mandatory Redeemable Series C Preferred
         Stock.................................  $  2,881   $    --   $    --   $   --   $  --
      Working capital (deficit)................  $ (9,133)  $   (20)  $  (277)  $  296   $(696)
      Total Assets.............................     1,752     8,529     3,771    3,852     126
      Shareholders' equity (deficit)...........  $(11,789)  $ 2,049   $   939   $3,039   $(591)
</TABLE>
 
---------------
 
(1) The Company was formed for the purpose of acquiring GZ-CA and StarPress. On
    June 28, 1996 (the "Effective Date"), the Company acquired GZ-CA and
    StarPress in reverse triangular mergers and the companies became
    wholly-owned subsidiaries of the Company (the "Reorganization"). Upon the
    consummation of the Reorganization, the stockholder interests in the Company
    of the former StarPress shareholders were larger than those of the former
    GZ-CA shareholders, and therefore, StarPress was deemed to be the acquiring
    entity for financial accounting purposes. Accordingly, the historical
    financial information presented herein, prior to the Effective Date, is the
    financial information of StarPress. The historical shares of StarPress
    presented herein have been adjusted to reflect a .14666 for 1 stock exchange
    in connection with the Reorganization.
 
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
 
CURRENT STATUS OF COMPANY
 
     Until June 1997, the principal business operations of the Company consisted
of developing, producing and marketing interactive entertainment and multimedia
products for the personal computer industry. During the third quarter of Fiscal
1997, the Company hired a new executive management team to evaluate the current
business and operations and financial condition of the Company and, if
necessary, restructure the Company (the "Restructuring"). On June 3, 1997, the
Board of Directors of the Company adopted the restructuring plan proposed by the
management team, which included terminating the Company's existing business
operations. By June 24, 1997, the Company had taken steps to cease its principal
business operations and had terminated all employees other than Mr. David
Hirschhorn, the Chairman of the Board, President, Chief Executive Officer, Chief
Financial Officer and Treasurer of the Company. On each of July 14, 1997 and
August 29, 1997, the Company received a Notice of Default and Demand for Payment
from its senior secured lender based on the Company's failure to make certain
interest payments when due. As of October 13, 1997, the Company has not paid the
past-due amounts and the senior secured lender has not foreclosed on the senior
secured loan. Since July 1997, the Company's business activities have consisted
of licensing and attempting to enter into licenses for certain of the
entertainment software products held in its library, divesting or disposing of
its businesses and products related to the personal computer industry, and
attempting to restructure its debt
 
                                       11
<PAGE>   14
 
obligations, equity structure and business operations. After October 31, 1997,
the Company intends to cease its efforts to enter into new licenses for
entertainment software products in its library.
 
RESULTS OF OPERATIONS
 
     The following table sets forth certain items in the Company's Consolidated
Statements of Operations expressed in percentage relationship to, and as
compared with, prior periods.
 
<TABLE>
<CAPTION>
                                                           FISCAL     FISCAL     FISCAL
                                                            1997       1996       1995
                                                           ------     ------     ------
        <S>                                                <C>        <C>        <C>
        Net revenues.....................................   100.0%     100.0%     100.0%
        Cost of revenues.................................    77.8       44.5       84.7
                                                           ------     ------     ------
        Gross margin.....................................    22.2       55.5       15.3
        Research and development expense.................    48.0       28.0       93.6
        Sales and marketing expense......................    52.5       41.4      115.0
        General and administrative expense...............    87.6       36.3      144.6
        Restructuring charge.............................    23.3       26.4         --
        Acquired in-process technology...................    21.1      249.7      129.4
                                                           ------     ------     ------
        Operating loss...................................  (210.3)    (326.3)    (467.3)
        Interest expense, net............................     7.7        1.1       35.4
                                                           ------     ------     ------
        Net loss.........................................  (218.3)%   (327.4)%   (502.7)%
                                                           ======     ======     ======
</TABLE>
 
  Net revenues
 
     Net revenues for Fiscal 1997 increased by $526,854 to $7,708,900 from
$7,182,046 in Fiscal 1996. The increase in net revenues of 7.3% from Fiscal 1996
to Fiscal 1997 is primarily due to the Company releasing ten new titles during
Fiscal 1997, offset by significantly lower revenues in the fourth quarter of
Fiscal 1997 as a result of the Company implementing the Restructuring. Net
revenues for Fiscal 1996 increased $5,010,742 to $7,182,046 from $2,171,334 in
Fiscal 1995. The increase in net revenues of 230.8% from Fiscal 1995 to Fiscal
1996 is primarily due to the acquisition of StarPress Multimedia, Inc. in June
1995 and the acquisition of certain products from Sony Interactive
Entertainment, Inc. in November 1995. Both acquisitions increased the Company's
catalog of products and corresponding revenues.
 
     Approximately 41% of the Company's net revenues for Fiscal 1997 were
derived from two customers. During Fiscal 1997, Tech Data Corporation and
Navarre Corporation individually accounted for 26% and 15% of net revenues,
respectively. Approximately 66% of the Company's net revenues for Fiscal 1996
were derived from three customers. During Fiscal 1996, GT Interactive, Tech Data
Corporation and Navarre Corporation individually accounted for 27%, 24% and 15%
of net revenues, respectively. Approximately 58% of the Company's net revenues
for Fiscal 1995 were derived from three customers. During Fiscal 1995, Tech Data
Corporation, Ingram Micro and Kenyon Capital Ltd. individually accounted for
36%, 12% and 10% of net revenues, respectively.
 
  Gross Margin
 
     Gross margin as a percentage of net revenues decreased to 22.2% in Fiscal
1997 from 55.5% in Fiscal 1996. The decrease in gross margin percentage is
primarily a result of the Company recording several charges to cost of revenues
in the third and fourth quarters of Fiscal 1997 related to the decrease in the
net realizable value of certain assets of the Company. These charges include
write-downs of approximately $1,516,000 for excess and obsolete inventory as
well as approximately $771,000 related to prepaid and guaranteed royalties and
acquired capitalized software development costs. Gross margin as a percentage of
net revenues increased to 55.5% in Fiscal 1996 from 15.3% in Fiscal 1995. The
increase in gross margin percentage from Fiscal 1995 to Fiscal 1996 is primarily
a result of Fiscal 1995 cost of revenues including approximately $608,000 of
amortization and write-offs of product development costs. These charges
represented a significantly larger proportional share of net revenues in Fiscal
1995 than similar charges included in Fiscal 1996 cost of revenues.
 
                                       12
<PAGE>   15
 
Additionally, during Fiscal 1996 the Company was able to decrease per unit
product costs as it gained experience in the procurement of product components.
 
  Research and Development Expenses
 
     Research and development expenses increased by $1,695,161 to $3,703,775 in
Fiscal 1997 from $2,008,614 in Fiscal 1996 and represented 48.0% and 28.0% of
net revenues in Fiscal 1997 and Fiscal 1996, respectively. The increase in
research and development expenses from Fiscal 1996 to Fiscal 1997 is primarily a
result of the Company developing ten new titles during Fiscal 1997 as well as
assuming on-going development activities in connection with its purchase of
assets from Inscape and Trimark. Research and development expenses decreased by
$23,445 to $2,008,614 in Fiscal 1996 from $2,032,059 in Fiscal 1995 and
represented 28.0% and 93.6% of net revenues in Fiscal 1996 and 1995,
respectively. The decrease in research and development expenses as a percentage
of net revenues from Fiscal 1995 to Fiscal 1996 is primarily a result of the
Company not directly incurring research and development costs and instead
shifting all research and development activities to GZ-CA in the third and
fourth quarters of Fiscal 1996 in anticipation of the Reorganization. As
previously discussed, for financial statement reporting purposes, the expenses
incurred by GZ-CA are not reflected in the Company's results of operations for
Fiscal 1996.
 
  Sales and Marketing Expenses
 
     Selling and marketing expenses during Fiscal 1997 increased to $4,049,633
from $2,973,569 in Fiscal 1996 and $2,498,488 in Fiscal 1995, representing
52.5%, 41.4% and 115.0% of net revenues during such years. The increase in sales
and marketing expenses was primarily related to increases in personnel as well
as increased participation in cooperative advertising and marketing programs to
further penetrate and promote products in traditional and alternative channels.
The increase in sales and marketing expenses, as a percentage of net revenues,
from Fiscal 1996 to Fiscal 1997 is primarily a result of significantly lower
sales in the fourth quarter of Fiscal 1997 as a result of the Company
implementing the Restructuring. The decrease in sales and marketing expenses, as
a percentage of net revenues, from Fiscal 1995 to Fiscal 1996 was primarily due
to significant increases in revenues and only moderate increases in selling and
marketing expenses.
 
  General and Administrative Expenses
 
     General and administrative expenses increased by $4,142,326 to $6,748,996
in Fiscal 1997 from $2,606,670 in Fiscal 1996. The increase in general and
administrative expenses from Fiscal 1996 to Fiscal 1997 is due in part to the
Company recording a charge in the third quarter of Fiscal 1997 of approximately
$1,253,000 related to impairment of property and equipment, intangible assets
and other long term assets and recording in the third and fourth quarters of
Fiscal 1997 approximately $1,147,000 of additional bad debt reserves. In
addition, the comparative increase is due in part to the curtailment of certain
administrative functions and personnel in the third quarter of Fiscal 1996 in
anticipation of the Reorganization. General and administrative expenses during
Fiscal 1996 decreased to $2,606,670 from $3,139,507 during Fiscal 1995. The
decrease is primarily a result of the curtailment of certain administrative
functions and decrease in personnel in anticipation of the Reorganization.
Additionally, certain recurring administrative costs including facility rents
for vacated facilities for the second half of Fiscal 1996 were reserved for and
included in the restructuring charge discussed below rather than being included
in general and administrative expenses.
 
     General and administrative expenses increased as a percentage of net
revenues to 87.6% in Fiscal 1997 from 36.3% in Fiscal 1996 but decreased from
144.6% of net revenues in Fiscal 1995. The increase as a percentage of net
revenues in Fiscal 1997 as compared to Fiscal 1996 is primarily a result of the
aforementioned charges recorded in the third and fourth quarters of Fiscal 1997
and significantly lower sales in the fourth quarter of Fiscal 1997 as a result
of the Company implementing the Restructuring. The decrease as a percentage of
net revenues in Fiscal 1996 compared to Fiscal 1995 is primarily a result of a
significant increase in revenues and a moderate decrease in general and
administrative expenses resulting from the curtailment of certain administrative
functions and personnel in the third quarter of Fiscal 1996 in anticipation of
the Reorganization.
 
                                       13
<PAGE>   16
 
  Restructuring Charges
 
     In June 1997, the Company began implementing the Restructuring. In
connection with the Restructuring, the Company recorded a charge of
approximately $2,063,000, primarily related to the write-down of property and
equipment, goodwill and intangibles related to the Inscape and Trimark asset
purchases and severance costs related to terminating all but one of the
employees of the Company.
 
     During the second quarter of Fiscal 1996, in anticipation of the
Reorganization, the Company implemented a restructuring plan to enhance overall
competitiveness, productivity and efficiency through the reduction of overhead
costs. The total estimated cost of the charge to operations during Fiscal 1996
related to such plan was $1,900,000. The charge principally reflects severance
costs resulting from a reduction of a significant portion of the Company's work
force, write-down of excess furniture and equipment and office facilities and
write-offs of assembled work force and goodwill arising from the Company's
acquisition of StarPress Multimedia, Inc. in June 1995. During Fiscal 1997, the
Company reversed approximately $267,000 of the accrued restructuring charge
recorded in Fiscal 1996, primarily related to facility and equipment leases for
its San Francisco, California facility, which leases were subsequently
sub-leased.
 
  Acquired in-process technology
 
     As a result of the Company's acquisition of certain assets from Inscape and
Trimark in February 1997, and the acquisitions of GZ-CA in June 1996 and
StarPress Multimedia, Inc. in June 1995, the Company wrote-off $1,628,000,
$17,935,000 and $2,810,000 of acquired research and development costs in Fiscal
1997, 1996 and 1995, respectively. These costs are considered non-recurring
expenses.
 
  Interest expense
 
     Interest expense increased $511,910 to $592,966 in Fiscal 1997 from $81,056
in Fiscal 1996. The increase in interest expense is primarily related to the
Company's borrowings under the Madeleine Loan Agreement (hereinafter defined).
Interest expense decreased $702,451 to $81,056 in Fiscal 1996 from $783,507 in
Fiscal 1995. The decrease in interest expense was primarily related to the
Company's payment of certain notes payable and conversion of certain debentures
and notes payable to Common Stock in the latter part of Fiscal 1995 and first
quarter of Fiscal 1996.
 
NEW ACCOUNTING STANDARDS
 
  Earnings Per Share
 
     In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per
Share." This statement is effective for both interim and annual periods ending
after December 15, 1997, and replaces the presentation of "primary" earnings per
share with "basic" earnings per share and the presentation of "fully diluted"
earnings per share with "diluted" earnings per share. Earlier application is not
permitted. When adopted, all previously reported earnings per share amounts must
be restated based on the provisions of the new standard. Application of SFAS No.
128 is not expected to have a material impact on the Company's loss per share.
 
  Reporting Comprehensive Income
 
     In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income." This statement is effective for fiscal years beginning after December
15, 1997. SFAS No. 130 establishes standards for reporting of comprehensive
income and its components in annual financial statements. Reclassification or
restatement of comparative financial statements of financial information for
earlier periods is required upon adoption of SFAS No. 130. Application of SFAS
No. 130 is not expected to have a material impact on the Company's consolidated
results of operations or loss per share data as currently reported.
 
                                       14
<PAGE>   17
 
  Disclosure about Segments of an Enterprise
 
     In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information." This statement is effective for fiscal
years beginning after December 15, 1997. SFAS No. 131 establishes standards for
reporting financial and descriptive information about an enterprise's operating
segments in its annual financial statements and selected segment information in
interim financial reports. Reclassification or restatement of comparative
financial statements or financial information for earlier periods is required
upon adoption of SFAS No. 131. Application of SFAS No. 131 is not expected to
have a material impact on the Company's consolidated results of operations or
earnings per share data as currently reported.
 
LIQUIDITY AND CAPITAL RESOURCES
 
     The Company's principal source of liquidity is cash on-hand. At June 30,
1997, the balance of cash and cash equivalents was $726,443, the net working
capital deficiency was ($9,133,497) and net stockholders' deficiency was
($11,789,259). At June 30, 1996, the balance of cash and cash equivalents was
$1,288,196, the net working capital deficiency was ($19,631) and net
shareholders' equity was $2,048,729. The decrease in the balance of cash and
cash equivalents from Fiscal 1996 to Fiscal 1997 was primarily due to the use in
Fiscal 1997 of cash and cash equivalents to fund operations and make debt
payments, as partially offset by net proceeds of $2,355,948 raised by the
Company in private placements (described below) and net proceeds of $4,710,000
received from the Amended Loan Agreement (hereinafter defined). Cash used in
operating activities during Fiscal 1997, Fiscal 1996 and Fiscal 1995 were
$6,331,949, $7,082,940 and $4,979,232, respectively.
 
     During the period from September 25, 1996 to February 7, 1997, the Company
issued 3,025 shares of Series A Convertible Preferred Stock, $.01 par value per
share and a stated liquidation value of $1,000 per share (the "Series A
Preferred"), at a price of $1,000 per share to a number of accredited investors
in a series of private placements. The cash proceeds to the Company from such
issuances, net of offering expenses, were $2,355,948. The proceeds from the
Company's private placements were used as working capital to fund the
development of products and the operations of the Company.
 
     On January 31, 1997, the Company entered into a loan agreement with
Madeleine L.L.C. ("Madeleine") in the principal amount of $3,740,000 with an
initial interest rate equal to the prime rate, as announced by Citibank, N.A.,
plus 4.25% and, commencing on July 31, 1997, increasing to a rate equal to such
prime rate plus 6.25% (the "Madeleine Loan Agreement"). The Madeleine Loan
Agreement is secured by all of the Company's assets and matures on January 30,
1998. The initial loan proceeds, net of $280,000 of fees to Madeleine, were
$3,460,000 and were used to satisfy existing trade debt and royalties and to
provide working capital to the Company. The Madeleine Loan Agreement has
numerous negative covenants which restrict the ability of the Company to effect
certain transactions without Madeleine's written consent. Among those negative
covenants is a prohibition on declaring or paying any cash dividends.
 
     On February 3, 1997, in connection with a production and development
agreement entered into with Intel Corporation ("Intel"), the Company entered
into a Convertible Promissory Note with Middlefield Ventures, Inc.
("Middlefield"), an affiliate of Intel, in the principal amount of $200,000,
bearing interest at the rate of 8% per annum. The Promissory Note matures on
February 3, 2000. Commencing on January 1, 1998 and on the first day of each
calendar quarter thereafter, the Company must pay one-eighth of the principal
amount and all accrued and unpaid interest. The Company expects to repay the
Promissory Note in the fiscal year ending June 30, 1998 and, therefore, the
Promissory Note is classified as a current liability on the Company's balance
sheet as of June 30, 1997. In connection with the Promissory Note, the Company
issued to Intel a warrant (the "Intel Warrant") to purchase 613,718 shares of
Common Stock at an exercise price of $3.46 per share. Pursuant to the terms of
the Intel Warrant, shares subject to the Intel Warrant vest as Middlefield
cancels amounts under the Promissory Note or as Intel provides certain marketing
funds to the Company.
 
     On June 5, 1997, the Company entered into an amendment to the Madeleine
Loan Agreement which provided for an additional loan in the principal amount of
$1,300,000 with the same interest rate and maturity date as the Madeleine Loan
Agreement (the "Amendment"). The loan proceeds from the Amendment, net of
 
                                       15
<PAGE>   18
 
$50,000 of fees to Madeleine, were $1,250,000 and are being used to sustain
administrative operations as the Company continues to implement the
Restructuring. Pursuant to the terms of the Amendment, Madeleine waived certain
events of default under the Madeleine Loan Agreement and certain exceptions to
the representations and warranties contained in the Madeleine Loan Agreement,
which events of default and exceptions were outstanding on June 5, 1997. The
Madeleine Loan Agreement and the Amendment are hereafter collectively referred
to as the "Amended Loan Agreement." As a condition subsequent to the Amendment,
the Company entered into a loan transaction with Mr. David Hirschhorn pursuant
to which Mr. Hirschhorn loaned $250,000 to the Company on similar terms as set
forth in the Amendment. In connection with such loan, the Company agreed to
issue to Mr. Hirschhorn a warrant to purchase shares of Common Stock on terms
and conditions to be agreed to between the Company and Mr. Hirschhorn.
 
     On July 14, 1997, the Company received a Notice of Default and Demand for
Payment from Madeleine with respect to the Amended Loan Agreement based upon the
Company's failure to make certain interest payments when due. The notice stated
that the Company was in default under the terms of the Amended Loan Agreement
and demanded that all past due amounts be paid to Madeleine by July 18, 1997.
The Company did not pay to Madeleine the past due amounts by July 18, 1997. On
August 29, 1997, the Company received a second Notice of Default and Demand for
Payment (the "August Notice") from Madeleine. The August Notice stated that in
the event that the Company failed to pay all past due amounts by September 5,
1997, Madeleine would exercise its rights to declare all obligations under the
Amended Loan Agreement immediately due and payable. The Company did not pay the
past due amounts by the September 5, 1997. As of September 29, 1997, Madeleine
has not declared the obligations under the Amended Loan Agreement immediately
due and payable. The Company currently is negotiating with Madeleine to obtain a
waiver of defaults under the Amended Loan Agreement and to amend the terms of
the Amended Loan Agreement to extend its term, reduce the interest rate thereof
and provide for later payments of amounts thereunder.
 
     The Company does not have the necessary funds to pay its secured and
unsecured debt obligations and, as noted above, is in default under the Amended
Loan Agreement as well as in default under various other credit agreements.
 
     As part of the Restructuring, the Company is in the process of negotiating
settlements with all trade creditors and debtors related to its prior business
activities pursuant to which the Company would pay to such creditors and debtors
$.30 for each $1.00 of debt. The Company is in default under agreements with
many of these creditors and debtors. The Company's obligations to such trade
creditors and debtors were approximately $6,000,000 as of June 30, 1997. In
concert with settlement negotiations, the Company is investigating various
sources of capital in an effort to raise funds for the Company to be used to
satisfy its existing obligations. In addition, the Company is exploring
opportunities to enter different businesses and industries.
 
     The Company's short-term liquidity is principally contingent on its ability
to (a) raise funds through private and/or public debt and equity placements, (b)
reach settlements with its trade creditors and debtors, and (c) obtain from
Madeleine a waiver of defaults under the Amended Loan Agreement. The Company's
immediate liquidity needs include paying existing trade debt and amounts past
due under the Amended Loan Agreement and obtaining sufficient working capital to
sustain its Restructuring efforts and service the debt payments under the
Amended Loan Agreement. Long-term liquidity needs include repayment of
borrowings under the Amended Loan Agreement which matures on January 30, 1998,
and working capital needs for continuing operations. There can be no assurances
that the Company will be able obtain the necessary capital to satisfy its
existing debt obligations and continue as a going concern. To the extent that
the Company is unable to complete any step of its Restructuring Plan, it is
likely that the Company's senior secured lender will foreclose on all of the
assets of the Company and pursue the dissolution of the Company.
 
FORWARD-LOOKING STATEMENTS
 
     Included in "Item 1. Business," herein, this "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations," and
elsewhere in this Report are certain forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended. The Company intends that
such forward-looking statements
 
                                       16
<PAGE>   19
 
shall be protected by the safe harbors provided for in such sections. Such
statements are subject to risks and uncertainties that could cause actual
results to vary materially from those projected in the forward-looking
statements. It is uncertain whether the Company will be able to effect the
Restructuring. If the Company does effect the Restructuring and pursues other
business interests, the Company may experience significant fluctuations in
future operating results due to a number of economic, competitive and other
factors. These factors and others could cause operating results to vary
significantly from those in prior periods. The Company's actual results could
differ materially from the results anticipated in these forward-looking
statements as a result of the factors set forth in "Item 1. Business -- Risk
Factors."
 
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
     Not applicable.
 
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
                       INDEX TO FINANCIAL STATEMENTS AND
                          FINANCIAL STATEMENT SCHEDULE
 
<TABLE>
<CAPTION>
                                                                                        PAGE
                                                                                        ----
<S>                                                                                     <C>
Independent Auditors' Reports.........................................................   18
Consolidated Balance Sheets as of June 30, 1997 and 1996..............................   20
Consolidated Statements of Operations for the Years Ended June 30, 1997, 1996 and
  1995................................................................................   21
Consolidated Statements of Stockholders' Equity (Deficiency) for the Years Ended June
  30, 1997, 1996 and 1995.............................................................   22
Consolidated Statements of Cash Flows for the Years Ended June 30, 1997, 1996 and
  1995................................................................................   23
Notes to Consolidated Financial Statements............................................   25
Schedule II -- Valuation and Qualifying Accounts......................................  S-1
</TABLE>
 
                                       17
<PAGE>   20
 
                          INDEPENDENT AUDITORS' REPORT
 
The Board of Directors
Graphix Zone, Inc.:
 
     We have audited the accompanying consolidated balance sheets of Graphix
Zone, Inc. and subsidiaries as of June 30, 1997 and 1996 and the related
consolidated statements of operations, stockholders' equity (deficiency) and
cash flows for the years then ended. In connection with our audits of the
consolidated financial statements, we have also audited the financial statement
schedule for the years ended June 30, 1997 and 1996 as listed in the
accompanying index. These consolidated financial statements and financial
schedule are the responsibility of the Company's management. Our responsibility
is to express an opinion on these consolidated financial statements and
financial statement schedule based on our audits.
 
     We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
 
     In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Graphix
Zone, Inc. and subsidiaries as of June 30, 1997 and 1996, and the results of its
operations and its cash flows for the years then ended in conformity with
generally accepted accounting principles. Also, in our opinion, the related
financial statement schedule for the years ended June 30, 1997 and 1996, when
considered in relation to the basic consolidated financial statements taken as a
whole, presents fairly, in all material respects, the information set forth
therein.
 
     The accompanying consolidated financial statements and financial statement
schedule have been prepared assuming that the Company will continue as a going
concern. As discussed in note 17 to the consolidated financial statements, the
Company has suffered recurring losses from operations, has a net capital
deficiency and does not have the necessary funds to pay its secured and
unsecured debt obligations. In addition, the Company has received two Notices of
Default from its senior secured lender and has taken steps to cease its
principal business operations. These factors raise substantial doubt about the
Company's ability to continue as a going concern. Management's plans in regard
to these matters are also described in note 17. The consolidated financial
statements and financial statement schedule do not include any adjustments that
might result from the outcome of this uncertainty.
 
                                          /s/ KPMG Peat Marwick LLP
 
Orange County, California
October 8, 1997
 
                                       18
<PAGE>   21
 
                         REPORT OF INDEPENDENT AUDITORS
 
The Board of Directors and Stockholders
StarPress, Inc.
 
     We have audited the accompanying consolidated statements of operations,
stockholders' equity, and cash flows of StarPress, Inc. (formerly known as Great
Bear Technology Incorporated) for the year ended June 30, 1995. Our audit also
included the financial statement schedule for the year ended June 30, 1995
listed in the Index at Item 14. These financial statements and schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and schedule based on our audit.
 
     We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
 
     In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated results of
operations, stockholders' equity and cash flows of StarPress, Inc. for the year
ended June 30, 1995, in conformity with generally accepted accounting
principles. Also, in our opinion, the related financial statement schedule for
the year ended June 30, 1995, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
 
     The accompanying consolidated financial statements have been prepared
assuming that StarPress Inc. will continue as a going concern. The Company has
incurred operating losses since its inception. This condition raises substantial
doubt about its ability to continue as a going concern. In addition, the Company
has recorded capitalized product development costs and intangible assets in its
consolidated balance sheet at June 30, 1995. The Company must generate
substantial revenue and net income in future periods to realize the carrying
value of these assets. The consolidated financial statements do not include any
adjustments to reflect the possible future effects on the recoverability and
classification of assets or the amounts and classification of liabilities that
may result from the outcome of these uncertainties.
 
                                          /s/ Ernst and Young LLP
 
Walnut Creek, California
August 18, 1995
 
                                       19
<PAGE>   22
 
                               GRAPHIX ZONE, INC.
 
                          CONSOLIDATED BALANCE SHEETS
                          AS OF JUNE 30, 1997 AND 1996
 
                                     ASSETS
 
<TABLE>
<CAPTION>
                                                                      1997             1996
                                                                  ------------     ------------
<S>                                                               <C>              <C>
Cash and cash equivalents.......................................  $    726,443     $  1,288,196
Accounts receivable, net of allowance for doubtful accounts of
  $1,397,270 in 1997 and $640,194 in 1996.......................       387,707        3,867,268
Inventories.....................................................        34,001          833,700
Deferred loan fees..............................................       238,333               --
Prepaid expenses and other current assets.......................        88,630          281,883
                                                                  ------------     ------------
          Total current assets..................................     1,475,114        6,271,047
Property and equipment, net.....................................       250,000          653,833
Intangible assets, net..........................................            --          850,186
Other assets, net...............................................        26,570          753,619
                                                                  ------------     ------------
                                                                  $  1,751,684     $  8,528,685
                                                                  ============     ============
 
                       LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY)
Notes payable...................................................  $  4,561,895     $    750,000
Accounts payable................................................     2,852,819        2,542,806
Accrued royalties...............................................     1,609,730          977,764
Accrued liabilities.............................................     1,509,167        1,159,946
Accrued restructuring charge....................................        75,000          573,461
Deferred revenue................................................            --          286,701
                                                                  ------------     ------------
          Total current liabilities.............................    10,608,611        6,290,678
Other liabilities...............................................        51,147          189,278
                                                                  ------------     ------------
          Total liabilities.....................................    10,659,758        6,479,956
Mandatory Redeemable Series C Convertible Preferred Stock,
  1,300,000 shares authorized, 1,185,185 issued and outstanding
  at June 30, 1997 (Liquidation preference $4,000,000)..........     2,881,185               --
Stockholders' equity (deficiency)
  Preferred stock, $.01 par value, 25,000,000 shares
     authorized -- all classes:
     Series B Convertible Preferred Stock, $.01 par value, 3,500
       shares authorized, 2,255 issued and outstanding at June
       30, 1997.................................................     1,585,948               --
  Common stock, $.01 par value, 100,000,000 shares authorized,
     12,745,503 and 10,608,748 issued and outstanding at June
     30, 1997 and 1996, respectively............................       127,455          106,087
  Additional paid-in capital....................................    41,469,405       40,083,684
  Accumulated deficit...........................................   (54,972,067)     (38,141,042)
                                                                  ------------     ------------
          Net stockholders' equity (deficiency).................   (11,789,259)       2,048,729
                                                                  ------------     ------------
Commitments and contingencies...................................
Going concern...................................................
Subsequent events...............................................
                                                                  $  1,751,684     $  8,528,685
                                                                  ============     ============
</TABLE>
 
          See accompanying Notes to Consolidated Financial Statements
 
                                       20
<PAGE>   23
 
                               GRAPHIX ZONE, INC.
 
                     CONSOLIDATED STATEMENTS OF OPERATIONS
                    YEARS ENDED JUNE 30, 1997, 1996 AND 1995
 
<TABLE>
<CAPTION>
                                                       1997             1996             1995
                                                   ------------     ------------     ------------
<S>                                                <C>              <C>              <C>
Net revenues.....................................  $  7,708,900     $  7,182,046     $  2,171,334
Cost of revenues.................................     5,995,565        3,195,934        1,838,699
                                                   ------------     ------------     ------------
Gross margin.....................................     1,713,335        3,986,112          332,635
                                                   ------------     ------------     ------------
Operating expenses:
  Research and development.......................     3,703,775        2,008,614        2,032,059
  Sales and marketing............................     4,049,633        2,973,569        2,498,488
  General and administrative.....................     6,748,996        2,606,670        3,139,507
  Restructuring charge...........................     1,795,638        1,900,000               --
  Acquired in-process technology.................     1,628,000       17,934,863        2,810,000
                                                   ------------     ------------     ------------
          Total operating expenses...............    17,926,042       27,423,716       10,480,054
                                                   ------------     ------------     ------------
Operating loss...................................   (16,212,707)     (23,437,604)     (10,147,419)
Interest expense, net............................      (592,966)         (81,056)        (783,507)
Other income (expense), net......................       (25,352)              --           14,529
                                                   ------------     ------------     ------------
Net loss.........................................  $(16,831,025)    $(23,518,660)    $(10,916,397)
                                                   ============     ============     ============
Loss per share of common stock...................  $      (1.61)    $      (5.05)    $      (7.76)
                                                   ============     ============     ============
Weighted average common shares...................    11,043,679        4,661,401        1,406,688
                                                   ============     ============     ============
</TABLE>
 
          See accompanying Notes to Consolidated Financial Statements
 
                                       21
<PAGE>   24
 
                               GRAPHIX ZONE, INC.
 
          CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIENCY)
                    YEARS ENDED JUNE 30, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
                                                                                                      PREFERRED STOCK
                                                                                                ---------------------------
                                                                                                                      SERIES
                                                                           COMMON STOCK              SERIES A         B
                                                                     ------------------------   -------------------   -----
                                                                       SHARES       AMOUNT      SHARES     AMOUNT     SHARES
                                                                     ----------   -----------   ------   ----------   -----
<S>                                                                  <C>          <C>           <C>      <C>          <C>
Balance, June 30, 1994.............................................   1,340,942   $ 6,744,939       --   $       --      --
Common Stock issued for acquisition of StarPress Multimedia,
  Inc..............................................................   1,935,539     1,649,682       --           --      --
Common Stock issued in private placement, net......................     381,316     3,081,451       --           --      --
Detachable warrants issued in connection with convertible
  debentures and notes payable.....................................          --     1,059,796       --           --      --
Common Stock issued upon conversion of debentures..................     319,132     2,200,278       --           --      --
Common stock issued upon exercise of warrants......................     301,753        20,575       --           --      --
Common Stock issued for services...................................      43,118       158,500       --           --      --
Stock option compensation..........................................          --       720,351       --           --      --
Notes receivable for purchase of common stock......................          --       (73,782)      --           --      --
Net loss...........................................................          --            --       --           --      --
                                                                     ----------    ----------   ------    ---------   -----
Balance, June 30, 1995.............................................   4,321,800    15,561,790       --           --      --
Common stock issued upon conversion of debentures..................      24,932       195,180       --           --      --
Common stock issued upon exercise of warrants......................      52,995         3,613       --           --      --
Common stock issued upon exercise of options.......................     300,260       134,879       --           --      --
Common stock issued for acquisition of assets......................     172,059       292,852       --           --      --
Stock option compensation..........................................          --       195,682       --           --      --
Common stock issued in satisfaction of obligations.................      85,159        80,000       --           --      --
Common stock issued for services...................................     125,000       618,750       --           --      --
Common stock issued for acquisition of GZ-CA.......................   5,526,543    23,107,025       --           --      --
Issuance of GZ-DE Common Stock                                               --   (40,083,684)      --           --      --
Net loss...........................................................          --            --       --           --      --
                                                                     ----------    ----------   ------    ---------   -----
Balance, June 30, 1996.............................................  10,608,748       106,087       --           --      --
Common stock issued upon exercise of options.......................      52,850           529       --           --      --
Common stock issued for services...................................      67,890           679       --           --      --
Issuance of Series A convertible preferred stock...................          --            --    3,025    2,355,948      --
Exchange of Series A for Series B convertible preferred stock......          --            --   (3,025)  (2,355,948)  3,025
Conversion of Series B preferred stock to common stock.............   2,023,515        20,235       --           --    (770)
Accretion of discount on Series C Convertible Preferred Stock......          --            --       --           --      --
Redemption of common stock from merger dissenters..................      (7,500)          (75)      --           --      --
Common stock warrants issued in connection with notes payable......          --            --       --           --      --
Convertible preferred stock dividends..............................          --            --       --           --      --
Discount on issuance of Series A preferred stock...................          --            --       --     (603,792)     --
Amortization of discount on Series A Convertible Preferred Stock...          --            --       --      603,792      --
Net loss...........................................................          --            --       --           --      --
                                                                     ----------    ----------   ------    ---------   -----
Balance, June 30, 1997.............................................  12,745,503   $   127,455       --   $       --   2,255
                                                                     ==========    ==========   ======    =========   =====
 
<CAPTION>
 
                                                                                                                   NET
 
                                                                                   ADDITIONAL                  STOCKHOLDERS'
 
                                                                                    PAID IN      ACCUMULATED      EQUITY
 
                                                                       AMOUNT       CAPITAL        DEFICIT     (DEFICIENCY)
 
                                                                     ----------   ------------   -----------   ------------
 
<S>                                                                  <C>          <C>            <C>           <C>
Balance, June 30, 1994.............................................  $       --   $         --   $(3,705,985)  $  3,038,954
 
Common Stock issued for acquisition of StarPress Multimedia,
  Inc..............................................................          --             --           --       1,649,682
 
Common Stock issued in private placement, net......................          --             --           --       3,081,451
 
Detachable warrants issued in connection with convertible
  debentures and notes payable.....................................          --             --           --       1,059,796
 
Common Stock issued upon conversion of debentures..................          --             --           --       2,200,278
 
Common stock issued upon exercise of warrants......................          --             --           --          20,575
 
Common Stock issued for services...................................          --             --           --         158,500
 
Stock option compensation..........................................          --             --           --         720,351
 
Notes receivable for purchase of common stock......................          --             --           --         (73,782)
 
Net loss...........................................................          --             --   (10,916,397)   (10,916,397)
 
                                                                      ---------    -----------   -----------    -----------
 
Balance, June 30, 1995.............................................          --             --   (14,622,382)       939,408
 
Common stock issued upon conversion of debentures..................          --             --           --         195,180
 
Common stock issued upon exercise of warrants......................          --             --           --           3,613
 
Common stock issued upon exercise of options.......................          --             --           --         134,879
 
Common stock issued for acquisition of assets......................          --             --           --         292,852
 
Stock option compensation..........................................          --             --           --         195,682
 
Common stock issued in satisfaction of obligations.................          --             --           --          80,000
 
Common stock issued for services...................................          --             --           --         618,750
 
Common stock issued for acquisition of GZ-CA.......................          --             --           --      23,107,025
 
Issuance of GZ-DE Common Stock                                               --     40,083,684           --              --
 
Net loss...........................................................          --             --   (23,518,660)   (23,518,660)
 
                                                                      ---------    -----------   -----------    -----------
 
Balance, June 30, 1996.............................................          --     40,083,684   (38,141,042)     2,048,729
 
Common stock issued upon exercise of options.......................          --         13,403           --          13,932
 
Common stock issued for services...................................          --        199,946           --         200,625
 
Issuance of Series A convertible preferred stock...................          --             --           --       2,355,948
 
Exchange of Series A for Series B convertible preferred stock......   2,355,948             --           --              --
 
Conversion of Series B preferred stock to common stock.............    (770,000)       749,765           --              --
 
Accretion of discount on Series C Convertible Preferred Stock......          --       (139,852)          --        (139,852)
 
Redemption of common stock from merger dissenters..................          --        (74,987)          --         (75,062)
 
Common stock warrants issued in connection with notes payable......          --        809,805           --         809,805
 
Convertible preferred stock dividends..............................          --       (172,359)          --        (172,359)
 
Discount on issuance of Series A preferred stock...................          --        603,792           --              --
 
Amortization of discount on Series A Convertible Preferred Stock...          --       (603,792)          --              --
 
Net loss...........................................................          --             --   (16,831,025)   (16,831,025)
 
                                                                      ---------    -----------   -----------    -----------
 
Balance, June 30, 1997.............................................  $1,585,948   $ 41,469,405   (54,972,067)  $(11,789,259)
 
                                                                      =========    ===========   ===========    ===========
 
</TABLE>
 
          See accompanying Notes to Consolidated Financial Statements
 
                                       22
<PAGE>   25
 
                               GRAPHIX ZONE, INC.
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                    YEARS ENDED JUNE 30, 1997, 1996 AND 1995
 
<TABLE>
<CAPTION>
                                                                 1997             1996             1995
                                                             ------------     ------------     ------------
<S>                                                          <C>              <C>              <C>
Cash flows from operating activities:
  Net loss.................................................  $(16,831,025)    $(23,518,660)    $(10,916,397)
  Net Adjustments to reconcile net loss to net cash used in
    operating activities:
    Depreciation and amortization..........................     1,064,342          349,769           95,067
    Impairment of intangibles and other long-term assets...     1,101,000               --        1,680,046
    Acquired in-process technology.........................     1,628,000       17,934,863        2,810,000
    Provision for sales returns and doubtful accounts......     1,727,000          221,000          398,000
    Provision for inventory reserve........................     1,537,603           90,000               --
    Write-down of excess furniture and equipment...........       252,000               --               --
    Amortization of discount on convertible debentures.....            --               --          579,122
    Stock option and warrant compensation expense..........            --          195,682          853,851
    Restructuring charge...................................     1,795,638        1,900,000               --
    Changes in operating assets and liabilities:
      Decrease (increase) in accounts receivable...........     1,752,561       (3,926,851)        (619,476)
      Decrease (increase) in inventories...................      (737,904)         251,246           (4,447)
      Decrease in prepaid expenses and other current
         assets............................................       208,747          424,507           71,981
      Decrease (increase) in other assets..................       143,149          (59,679)          54,691
      Increase (decrease) in accounts payable..............       310,013         (162,490)        (593,782)
      Increase in accrued royalties........................       631,966          360,857               --
      Increase (decrease) in accrued liabilities...........       199,633         (612,483)         594,842
      Decrease in accrued restructuring....................      (827,961)        (484,031)              --
      Increase (decrease) in deferred revenue..............      (286,701)         (46,670)          17,270
                                                             ------------     ------------     ------------
         Net cash used in operating activities.............    (6,331,949)      (7,082,940)      (4,979,232)
Cash flows from investing activities:
  Purchase of property and equipment.......................      (684,622)         (42,000)        (226,727)
  Proceeds from sale of property and equipment.............            --           97,360               --
  Acquisition of StarPress Multimedia, Inc.................            --               --         (337,000)
  Acquisition of DMT assets................................            --          (20,890)              --
  Net cash acquired from purchase of GZ-CA.................            --        6,854,357               --
                                                             ------------     ------------     ------------
         Net cash provided by (used in) investing
           activities......................................      (684,622)       6,888,827         (563,727)
Cash flows from financing activities:
  Release of restricted cash from escrow...................            --               --          592,700
  Proceeds from convertible notes payable..................            --               --        2,766,537
  Proceeds from notes payable to related parties...........            --               --          300,000
  Payments for redemption of common stock..................       (75,062)              --               --
  Payments on notes payable to related parties.............            --               --         (222,000)
  Proceeds from notes payable..............................     4,910,000               --          265,000
  Payments on notes payable................................      (750,000)        (575,285)        (243,000)
  Proceeds from exercise of stock options..................        13,932          134,879               --
  Proceeds from exercise of warrants.......................            --            3,613           20,575
  Proceeds from convertible preferred stock issuances,
    net....................................................     2,355,948               --               --
  Proceeds from common stock issuances, net................            --               --        3,081,451
                                                             ------------     ------------     ------------
         Net cash provided by (used in) financing
           activities......................................     6,454,818         (436,793)       6,561,263
Net increase (decrease) in cash and cash equivalents.......      (561,753)        (630,906)       1,018,304
Cash and cash equivalents at the beginning of year.........     1,288,196        1,919,102          900,798
                                                             ------------     ------------     ------------
Cash and cash equivalents at end of year...................  $    726,443     $  1,288,196     $  1,919,102
                                                             ============     ============     ============
</TABLE>
 
                                                                     (continued)
 
                                       23
<PAGE>   26
 
                               GRAPHIX ZONE, INC.
 
               CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
                    YEARS ENDED JUNE 30, 1997, 1996 AND 1995
 
<TABLE>
<CAPTION>
                                                                 1997             1996             1995
                                                             ------------     ------------     ------------
<S>                                                          <C>              <C>              <C>
Supplemental disclosure of cash flow information:
Cash paid during the year for interest.....................  $    257,664     $     86,635     $    140,251
                                                             ============     ============     ============
Supplemental disclosure of noncash investing and financing
  activities:
  Mandatory redeemable Series C convertible preferred stock
    issued in connection with acquisitions.................  $  2,741,333               --               --
                                                             ============     ============     ============
  Common stock issued in connection with acquisitions and
    services...............................................  $    200,625     $ 24,018,627     $  1,674,682
                                                             ============     ============     ============
  Conversion of convertible debentures and notes payable to
    common stock...........................................  $         --     $    195,180     $  2,200,278
                                                             ============     ============     ============
  Common stock issued in satisfaction of obligations.......  $         --     $     80,000     $         --
                                                             ============     ============     ============
  Preferred stock dividends accrued and not paid...........  $    172,359     $         --     $         --
                                                             ============     ============     ============
  Discount on issuance of preferred stock..................  $    603,792     $         --     $         --
                                                             ============     ============     ============
  Loan fees added to notes payable.........................  $    330,000     $         --     $         --
                                                             ============     ============     ============
  Common stock warrants issued in connection with notes
    payable................................................  $    809,805     $         --     $         --
                                                             ============     ============     ============
</TABLE>
 
          See accompanying Notes to Consolidated Financial Statements
 
                                       24
<PAGE>   27
 
                               GRAPHIX ZONE, INC.
 
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                          JUNE 30, 1997, 1996 AND 1995
 
(1) GENERAL INFORMATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
  ORGANIZATION
 
     Graphix Zone, Inc., a Delaware corporation (the "Company" or "GZ-DE"), was
incorporated on January 17, 1996 for the purpose of acquiring GZ Multimedia,
Inc. (formerly Graphix Zone, Inc.), a California corporation ("GZ-CA"), and
StarPress, Inc., a Colorado corporation ("StarPress"). Both GZ-CA and StarPress
were publishers of entertainment-oriented interactive multimedia software. On
June 28, 1996, the Company acquired GZ-CA and StarPress in reverse triangular
mergers and the companies became wholly-owned subsidiaries of the Company (the
"Reorganization"). Following the consummation of the Reorganization, the
Company's principal business was developing, producing and marketing CD-ROM and
on-line products for the personal computer industry. In addition, the Company
operated certain other businesses, including developing and operating WILMA, an
Internet site for live music venues and developing and marketing certain
Internet access and exploration products.
 
  HISTORICAL FINANCIAL STATEMENTS
 
     Upon the consummation of the Reorganization, the stockholder interests in
the Company of the former StarPress shareholders were larger than those of the
former GZ-CA shareholders, and therefore, StarPress was deemed to be the
acquiring entity for financial accounting purposes. Accordingly, the historical
financial statements presented herein, prior to the effective date of the
Reorganization, are the financial statements of StarPress. The historical shares
of StarPress presented therein have been adjusted to reflect a .14666 for 1
stock exchange in connection with the Reorganization. All references to the
"Company" prior to June 28, 1996 relate to StarPress.
 
  CURRENT STATUS OF COMPANY
 
     In March 1997, the Company hired a new executive management team for the
purpose of evaluating the current business and operations and financial
condition of the Company and, if necessary, restructuring the Company (the
"Restructuring"). The management team performed an in-depth review of the
Company's past history of operating losses, current financial condition, current
strategic position within the entertainment software industry, competitors in
such industry and capital requirements for new product development. In June
1997, based on the results of its review, the management team proposed to the
Board of Directors of the Company a restructuring plan (as described below, the
"Restructuring Plan") for the Company, which included terminating the Company's
existing business operations. On June 3, 1997, the Board of Directors of the
Company adopted the Restructuring Plan proposed by the management team.
 
     The Restructuring Plan adopted by the Board of Directors of the Company
consists of the following elements: Business -- Divest or dispose of the
Company's existing businesses related to the personal computer industry and
explore opportunities to enter into new businesses and industries; Senior
Secured Debt -- Renegotiate the terms of the Company's senior secured loan and
the related collateral agreements to extend the term of the loan, reduce the
interest rate thereof and provide for later payments of amounts due thereunder
and to reduce the senior lender's warrant position in the Company; Outstanding
Unsecured Debt -- Pay to unsecured creditors $0.30 for each $1.00 of debt
outstanding; Outstanding Convertible Preferred Stock -- Exchange outstanding
shares of the Company's Series B and Series C Convertible Preferred Stock, each
$.01 par value per share (collectively, the "Preferred Stock"), for shares of
the Company's common stock, $.01 par value per share ("Common Stock"), at an
exchange price of approximately $0.75 per share; and Additional
Capital -- Evaluate alternatives for raising additional funds for the Company.
 
                                       25
<PAGE>   28
 
                               GRAPHIX ZONE, INC.
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                          JUNE 30, 1997, 1996 AND 1995
 
     By June 24, 1997, the Company had taken steps to cease its principal
business operations and had terminated all employees other than Mr. David
Hirschhorn, the Chairman of the Board, President, Chief Executive Officer, Chief
Financial Officer and Treasurer of the Company.
 
     Since July 1997, the Company's business activities have consisted of
licensing and attempting to enter into licenses for certain of the entertainment
software products held in its library, divesting or disposing of its businesses
and products related to the personal computer industry, and attempting to
restructure its debt obligations, equity structure and business operations.
 
  PRINCIPLES OF CONSOLIDATION
 
     The accompanying consolidated financial statements include the accounts of
the Company and its wholly-owned subsidiaries GZ-CA and StarPress. All material
inter-company balances and transactions have been eliminated in consolidation.
 
  REVENUE RECOGNITION
 
     Revenue was recognized from CD-ROM sales upon shipment. The Company granted
certain distributors limited rights to exchange merchandise and price protection
on unsold merchandise. The Company established a reserve for price adjustments
and estimated returns at the time the related revenue was recognized.
 
  CASH AND CASH EQUIVALENTS
 
     Cash equivalents are highly liquid investments purchased with an original
maturity of three months or less. Cash equivalents include bank demand deposits
and money market funds.
 
  INVENTORIES
 
     Inventories are comprised primarily of CD-ROM products and packaging
materials and are stated at the lower of cost (first-in, first-out) or market
(net realizable value). See Note 8 for a discussion regarding the write-down of
inventory.
 
  PROPERTY AND EQUIPMENT
 
     Property and equipment are stated at cost. Depreciation of property and
equipment is computed on a straight-line basis over estimated useful lives of
two to seven years. Equipment held under capital leases and leasehold
improvements are amortized on a straight-line basis over the shorter of the
lease term or the estimated useful life of the related asset. See Note 8 for
discussions regarding write-downs of property and equipment.
 
  SOFTWARE DEVELOPMENT COSTS
 
     The Company capitalized costs related to the development of certain
software products. In accordance with Statement of Financial Accounting
Standards No. 86, "Accounting for the Costs of Computer Software,"
capitalization of costs began when technological feasibility was established and
ended when the product was available for general release to customers.
Capitalized software development costs as of June 30, 1996 included amounts
capitalized pursuant to the acquisitions described in Note 7.
 
     Amortization was computed on an individual product basis and was recognized
over the greater of the remaining economic lives of each product or the ratio
that current gross revenues for a product bore to the total of current and
anticipated revenues for that product, commencing when the products became
available
 
                                       26
<PAGE>   29
 
                               GRAPHIX ZONE, INC.
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                          JUNE 30, 1997, 1996 AND 1995
 
for general release to customers. Software development costs generally were
being amortized over a three-year period. The Company continually assesses the
recoverability of software development costs by comparing the carrying value of
individual products to their net realizable value.
 
     The Company incurred amortization expense for software development costs of
$85,720, $214,731 and $720,340 in Fiscal 1997, 1996 and 1995, respectively. The
Company wrote-down software development costs of approximately $21,000 in Fiscal
1997 in connection with the Restructuring. See Note 8 for discussions regarding
write-downs of software development costs.
 
  INTANGIBLE ASSETS
 
     The Company accounted for goodwill and other intangible assets at the lower
of amortized cost or fair value. Goodwill represented the excess of purchase
price over fair value of net assets acquired. Goodwill and other intangibles are
amortized on a straight-line basis over the expected periods to be benefited
(generally two to five years). The Company assesses the recoverability of
intangible assets by determining whether the amortization of the intangible
asset balance over its remaining life could be recovered through projected non-
discounted cash flows. The amount of goodwill impairment, if any, is measured
based on projected discounted cash flows using a discount rate reflecting the
Company's average cost of funds. See Note 8 for discussions of write-downs of
goodwill and intangible assets.
 
  ROYALTY EXPENSE
 
     Royalty expense was recognized based upon actual net product sales in
accordance with the terms of the related royalty agreement. Royalty advances
were capitalized and expensed when earned. The Company periodically reviewed the
realizability of capitalized royalty advances and wrote-off those advances which
it determined might not be realized from future sales. Royalty expenses are
included in cost of revenues in the accompanying consolidated statements of
operations. See Note 8 for a discussion of write-downs of royalty advances.
 
  FAIR VALUE OF FINANCIAL INSTRUMENTS
 
     In December 1991, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 107, "Disclosure about
Fair Value of Financial Instruments." SFAS No. 107 requires all entities to
disclose the fair value of financial instruments, both assets and liabilities
recognized and not recognized on the balance sheet, for which it is practicable
to estimate fair value. SFAS No. 107 defines fair value of a financial
instrument as the amount at which the instrument could be exchanged in a current
transaction between willing parties.
 
     As of June 30, 1997 and 1996, the carrying value of cash and cash
equivalents, accounts receivable, accounts payable and accrued liabilities and
accrued royalties approximates fair value due to the short term nature of such
instruments. The carrying value of all debt approximates fair value as the
related interest rates approximates rates currently available to the Company.
 
  LONG-LIVED ASSETS
 
     During Fiscal 1996, the Company adopted SFAS No. 121, "Accounting for
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of,"
which establishes accounting standards for the recognition and measurement of
impairment of long-lived assets, certain identifiable intangibles and goodwill
either to be held or disposed of. See Note 8 for a discussion of charges
recorded by the Company during Fiscal 1997 in accordance with SFAS No. 121.
 
                                       27
<PAGE>   30
 
                               GRAPHIX ZONE, INC.
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                          JUNE 30, 1997, 1996 AND 1995
 
  USE OF ESTIMATES
 
     The financial statements have been prepared in conformity with generally
accepted accounted principles. In preparing the financial statements, management
is required to make estimates and assumptions that affect the reported amounts
of assets and liabilities as of the dates of the balance sheets and revenues and
expenses for the periods. Actual results could differ significantly from those
estimates.
 
  INCOME TAXES
 
     The Company accounts for income taxes under the provisions of SFAS No. 109,
"Accounting for Income Taxes." SFAS No. 109 generally provides that deferred tax
assets and liabilities be recognized for temporary differences between the
financial reporting basis and the tax basis of the Company's assets and
liabilities and expected benefits of utilizing net operating loss
carry-forwards. A valuation allowance is required to reduce the potential
deferred tax asset when it is more likely than not that all or some portion of
the potential deferred tax asset will not be realized due to the lack of
expected future taxable income. The impact on deferred taxes of changes in tax
rates and laws, if any, are applied to the years during which temporary
differences are expected to be settled, and are reflected in the financial
statements in the period of enactment.
 
  STOCK-BASED COMPENSATION
 
     Effective June 30, 1996, the Company adopted SFAS No. 123, "Accounting for
Stock-Based Compensation." SFAS No. 123 establishes the financial accounting and
reporting standards for stock-based compensation plans. The Company elected to
continue accounting for stock-based employee compensation plans in accordance
with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" and related interpretations ("APB Opinion No. 25"), as SFAS No. 123
permits, and to follow the pro forma net income, pro forma earnings per share,
and stock-based compensation plan disclosure requirements set forth in SFAS No.
123 (See Note 9).
 
  NET LOSS PER SHARE OF COMMON STOCK
 
     In February 1997, the FASB issued SFAS No. 128, "Earnings Per Share." This
statement is effective for both interim and annual periods ending after December
15, 1997, and replaces the presentation of "primary" earnings per share with
"basic" earnings per share and the presentation of "fully diluted" earnings per
share with "diluted" earnings per share. Earlier application is not permitted.
When adopted, all previously reported earnings per share amounts must be
restated based on the provisions of the new standard. Application of SFAS No.
128 is not expected to have a material impact on the Company's loss per share.
 
     Net loss per share of Common Stock is computed using the weighted average
number of shares of Common Stock outstanding for the year. Dividends declared
and discounts on issuances of Preferred Stock increase the net loss for
determining net loss per share of Common Stock.
 
  COMPREHENSIVE INCOME
 
     In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income." This statement is effective for fiscal years beginning after December
15, 1997. SFAS No. 130 establishes standards for reporting comprehensive income
and its components in annual financial statements. Reclassification or
restatement of comparative financial statements of financial information for
earlier periods is required upon adoption of SFAS No. 130. Application of the
SFAS No. 130 is not expected to have a material impact on the Company's
consolidated results of operations or loss per share data as currently reported.
 
                                       28
<PAGE>   31
 
                               GRAPHIX ZONE, INC.
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                          JUNE 30, 1997, 1996 AND 1995
 
  DISCLOSURES ABOUT SEGMENTS
 
     In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information." This statement is effective for fiscal
years beginning after December 15, 1997. SFAS No. 131 establishes standards for
reporting financial and descriptive information about an enterprise's operating
segments in its annual financial statements and selected segment information in
interim financial reports. Reclassification or restatement of comparative
financial statements or financial information for earlier periods is required
upon adoption of SFAS No. 131. Application of SFAS No. 131 is not expected to
have a material impact on the Company's consolidated results of operations or
earnings per share data as currently reported.
 
  RECLASSIFICATION
 
     Certain prior year amounts have been reclassified to conform to the
presentation for Fiscal 1997.
 
(2) INVENTORIES
 
     Inventories consisted of the following:
 
<TABLE>
<CAPTION>
                                                                      JUNE 30,
                                                              ------------------------
                                                                1997           1996
                                                              ---------     ----------
        <S>                                                   <C>           <C>
        Finished goods....................................    $  34,001     $  479,747
        Components........................................           --        353,953
                                                                -------       --------
                                                              $  34,001     $  833,700
                                                                =======       ========
</TABLE>
 
     See Note 8 for discussions regarding write-downs of inventory.
 
(3) PROPERTY AND EQUIPMENT
 
     Property and equipment consisted of the following:
 
<TABLE>
<CAPTION>
                                                                      JUNE 30,
                                                              ------------------------
                                                                1997           1996
                                                              ---------     ----------
        <S>                                                   <C>           <C>
        Computer and office equipment.....................    $ 333,000     $  824,474
        Furniture and fixtures............................       15,000        174,760
        Computer software.................................       27,000        101,287
        Equipment held under capital lease obligations....           --        100,575
                                                              ---------      ---------
                                                                375,000      1,201,096
        Accumulated depreciation and amortization.........     (125,000)      (547,263)
                                                              ---------      ---------
                                                              $ 250,000     $  653,833
                                                              =========      =========
</TABLE>
 
     See Note 8 for discussions regarding write-downs of property and equipment.
 
                                       29
<PAGE>   32
 
                               GRAPHIX ZONE, INC.
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                          JUNE 30, 1997, 1996 AND 1995
 
(4) INTANGIBLE ASSETS
 
     Intangible assets consist of the following:
 
<TABLE>
<CAPTION>
                                                                        JUNE 30,
                                                                  --------------------
                                                                   1997         1996
                                                                  -------     --------
        <S>                                                       <C>         <C>
        Assembled work force..................................    $    --     $185,000
        Goodwill..............................................         --      560,186
        Other.................................................         --      105,000
                                                                    -----     --------
                                                                       --      850,186
        Accumulated amortization..............................         --           --
                                                                    -----     --------
                                                                  $    --     $850,186
                                                                    =====     ========
</TABLE>
 
     See Note 8 for discussions regarding write-downs of goodwill and intangible
assets.
 
(5) OTHER ASSETS
 
     Other assets consist of the following:
 
<TABLE>
<CAPTION>
                                                                        JUNE 30,
                                                                  --------------------
                                                                   1997         1996
                                                                  -------     --------
        <S>                                                       <C>         <C>
        Capitalized software development costs................    $    --     $238,342
        Capitalized warrant valuation (see Note 12)...........         --      312,000
        Other.................................................     26,570      221,477
                                                                  -------     --------
                                                                   26,570      771,819
        Accumulated amortization..............................         --      (18,200)
                                                                  -------     --------
                                                                  $26,570     $753,619
                                                                  =======     ========
</TABLE>
 
     See Note 8 for discussions regarding write-downs of other assets.
 
(6) NOTES PAYABLE
 
     On October 27, 1995, the Company borrowed $750,000 under a loan agreement
with Silicon Valley Bank. The note bore interest at the bank's prime rate plus
1.5%, was secured by all of the Company's assets, excluding the assets purchased
from Sony Interactive Entertainment (see Note 7), and had a maturity date of
February 24, 1996. In connection with the loan agreement, the Company issued to
Silicon Valley Bank a warrant to purchase 6,160 shares of Common Stock at an
exercise price of $8.52 per share. The warrant expires on October 27, 2000. On
June 28, 1996, the Company repaid the outstanding principal balance of, and all
accrued and unpaid interest under, its existing loan with Silicon Valley Bank
and simultaneously entered into a new loan agreement with Silicon Valley Bank
for a $750,000 loan bearing interest at the bank's prime rate plus 3%. In
connection with the new loan agreement, the Company issued to Silicon Valley
Bank a warrant to purchase 20,000 shares of Common Stock at an exercise price of
$5.625 per share. The warrant expires on June 26, 2001. In December 1996, in
connection with a Forbearance Agreement pursuant to which Silicon Valley Bank
agreed to forbear until December 31, 1996 from taking any legal actions to
foreclose on the assets of the Company in connection with the Company's defaults
under the loan agreement with Silicon Valley Bank, the Company issued to Silicon
Valley Bank a warrant to purchase 100,000 shares of Common Stock at an exercise
price equal to the lowest price at which the Company sells securities in the two
equity placements immediately prior to the time of exercise of the warrant. The
warrant expires on December 12, 2001. The fair value of the warrant was deemed
immaterial as of the date of issuance. In February 1997, the
 
                                       30
<PAGE>   33
 
                               GRAPHIX ZONE, INC.
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                          JUNE 30, 1997, 1996 AND 1995
 
Company repaid the outstanding principal balance of, and all accrued and unpaid
interest under, such loan using proceeds from the private equity placements
described in Note 9 below.
 
     On January 31, 1997, the Company entered into a loan agreement with
Madeleine L.L.C., a New York limited liability company ("Madeleine"), in the
original principal amount of $3,740,000 with an initial interest rate equal to
the prime rate, as announced by Citibank, N.A., plus 4.25% and, commencing on
July 31, 1997, increasing to a rate equal to such prime rate plus 6.25% (the
"Madeleine Loan Agreement"). The Madeleine Loan Agreement is secured by all of
the Company's assets and matures on January 30, 1998. The loan proceeds, net of
$280,000 of fees paid to Madeleine, were $3,460,000. The Madeleine Loan
Agreement has numerous negative covenants which restrict the ability of the
Company to effect certain transactions without Madeleine's written consent.
Among these negative covenants is a prohibition on declaring or paying any cash
dividends. In connection with the Madeleine Loan Agreement, the Company issued
to Madeleine a warrant (the "Madeleine Warrant") to purchase 300,000 shares of
Common Stock at an exercise price equal to the lower of $2.68 per share or the
fair market value of the Common Stock which shall be determined based on the
average of the last sales prices for Common Stock over the 7 trading days
immediately preceding the date of exercise (the "Fair Market Value
Calculation"). The Madeleine Warrant expires on January 31, 2000. The Company
recorded an original issue discount with respect to the Madeleine loan of
$93,709 which represents the fair value of the Madeleine Warrant at the time of
issuance. The fair value of the Madeleine Warrant is reflected as a reduction to
the principal amount of the Madeleine loan and is being amortized over the life
of the loan.
 
     On February 3, 1997, in connection with a production and development
agreement entered into with Intel Corporation ("Intel"), the Company entered
into a Convertible Promissory Note with Middlefield Ventures, Inc.
("Middlefield"), an affiliate of Intel in the principal amount of $200,000,
bearing interest at the rate of 8% per annum. The Promissory Note matures on
February 3, 2000. Commencing on January 1, 1998 and on the first day of each
calendar quarter thereafter, the Company must pay one-eighth of the principal
amount and all accrued and unpaid interest. The Company expects to repay the
Promissory Note in the fiscal year ending June 30, 1998 and, therefore, the
Promissory Note is classified as a current liability on the Company's balance
sheet as of June 30, 1997. In connection with the Promissory Note, the Company
issued to Intel a warrant (the "Intel Warrant") to purchase 613,718 shares of
Common Stock of the Company at an exercise price of $3.46 per share. Pursuant to
the terms of the Intel Warrant, shares subject to the Intel Warrant vest as
Middlefield cancels amounts under the Promissory Note or as Intel provides
certain marketing funds to the Company. The Company recorded an original issue
discount with respect to the Intel Promissory Note of $226,226 which represents
the fair value of the Intel Warrant at the time of issuance. The fair value of
the Intel Warrant is reflected as a reduction to the principal amount of the
Intel Promissory Note and is being amortized over the life of the loan.
 
     On June 5, 1997, the Company and Madeleine entered into an amendment (the
"Amendment") to the Madeleine Loan Agreement which provided for an additional
loan in the principal amount of $1,300,000 under the terms of the Madeleine Loan
Agreement. The loan proceeds from the Amendment, net of $50,000 of fees paid to
Madeleine, were $1,250,000. Pursuant to the terms of the Amendment, Madeleine
waived certain events of default under the Madeleine Loan Agreement and certain
exceptions to the representatives and warranties contained in the Madeleine Loan
Agreement, which events of default and exceptions were outstanding on June 5,
1997. The Madeleine Loan Agreement and the Amendment are hereafter collectively
referred to as the "Amended Loan Agreement." In connection with the Amendment,
the Company issued to Madeleine a warrant (the "Second Madeleine Warrant") to
purchase 25% of the Common Stock of the Company, determined on a fully diluted
basis as of June 5, 1997, at an exercise price equal to the lowest of (a)
$0.2366 per share, (b) the lower of $1.00 per share or the fair market value
(determined based on the Fair Market Value Calculation) of the Common Stock of
the Company as of the effective date that the Company files a registration
statement on Form S-4, or such other form, with the U.S. Securities and Exchange
 
                                       31
<PAGE>   34
 
                               GRAPHIX ZONE, INC.
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                          JUNE 30, 1997, 1996 AND 1995
 
Commission, in connection with a merger or consolidation involving the Company,
or (c) the fair market value (determined based on the Fair Market Value
Calculation) of the Common Stock of the Company as of the date the Second
Madeleine Warrant is exercised. The Second Madeleine Warrant expires on June 5,
2000. The Company recorded an original issue discount with respect to the loan
made in connection with the Amendment of $489,870 which represents the fair
value of the Second Madeleine Warrant at the time of issuance. The fair value of
the Second Madeleine Warrant is reflected as a reduction to the principal amount
of the Madeleine loan and is being amortized over the life of the loan.
 
     As a condition subsequent to the Amendment, the Company entered into a loan
transaction with Mr. David J. Hirschhorn, Chairman of the Board, President,
Chief Executive Officer, Chief Financial Officer, Treasurer and a director of
the Company, pursuant to which at October 1997 Mr. Hirschhorn loaned $250,000 to
the Company on similar terms as set forth in the Amendment. In connection with
such loan, the Company agreed to issue to Mr. Hirschhorn a warrant to purchase
shares of Common Stock on terms and conditions to be agreed to between the
Company and Mr. Hirschhorn. The Company and Mr. Hirschhorn have not reached an
agreement regarding the terms of the warrant.
 
     On July 14, 1997, the Company received a Notice of Default and Demand for
Payment from Madeleine with respect to the Madeleine Loan Agreement based upon
the Company's failure to make certain interest payments when due. The notice
stated that the Company was in default under the terms of the Madeleine Loan
Agreement and demanded that all past due amounts be paid to Madeleine by July
18, 1997. The Company did not pay to Madeleine the past due amounts by the July
18, 1997 deadline. On August 29, 1997, the Company received a second Notice of
Default and Demand for Payment (the "August Notice") from Madeleine. The August
Notice stated that in the event that the Company failed to pay all past due
amounts by September 5, 1997, Madeleine would exercise its rights to declare all
obligations under the Amended Loan Agreement immediately due and payable. The
Company did not pay the past due amounts by the September 5, 1997. As of October
8, 1997, Madeleine has not declared all obligations under the Amended Loan
Agreement immediately due and payable. The Company currently is negotiating with
Madeleine to obtain a waiver of defaults under the Amended Loan Agreement and to
amend the terms of the Madeleine Loan Agreement to extend its term, reduce the
interest rate thereof and provide for later payments of amounts thereunder.
 
(7) ACQUISITIONS AND TRANSACTIONS
 
STARPRESS MULTIMEDIA, INC.
 
     In June 1995, the Company acquired all of the outstanding capital stock of
StarPress Multimedia, Inc., a developer and publisher of interactive software
titles, in exchange for 1,935,539 shares of the Company's Common Stock (which
were valued using the per share price determined by an independent appraisal).
StarPress Multimedia, Inc. had acquired iTravel International Ltd. ("iTravel"),
a developer located in Seattle, Washington, on March 31, 1995 for 180,000 shares
of common stock of StarPress Multimedia, Inc. StarPress assumed StarPress
Multimedia, Inc.'s obligations to issue additional shares of common stock to
former iTravel shareholders. In April and May 1996, 71,258 additional shares of
the Company's Common Stock were issued to meet this commitment. In addition, the
Company issued options to purchase 34,318 shares of Common Stock at a price of
$8.52 per share (vested immediately and exercisable for three years) for outside
financing expenses directly related to the acquisition and assumed all
outstanding options and warrants of StarPress Multimedia, Inc. to purchase
shares of the Company's Common Stock. The acquisition was accounted for by the
purchase method of accounting.
 
                                       32
<PAGE>   35
 
                               GRAPHIX ZONE, INC.
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                          JUNE 30, 1997, 1996 AND 1995
 
     The total purchase price for StarPress Multimedia, Inc. was $2,011,682
based upon an independent appraisal (including acquisition costs of $362,000).
An allocation of the purchase price is as follows:
 
<TABLE>
<CAPTION>
                                                            ALLOCATION OF      AMORTIZATION
                           DESCRIPTION                      PURCHASE PRICE     (USEFUL LIFE)
        --------------------------------------------------  --------------     -------------
        <S>                                                 <C>                <C>
        In-process technology charged to operations.......   $  2,810,000         N/A
        Product development costs.........................        110,000       3 years
        Assembled work force..............................        240,000       3 years
        Goodwill..........................................         31,686       3 years
        Net liabilities assumed...........................     (1,180,004)
                                                              -----------
          Purchase price..................................   $  2,011,682
                                                              ===========
</TABLE>
 
  SONY INTERACTIVE ENTERTAINMENT, INC.
 
     On November 1, 1995, the Company purchased from Sony Interactive
Entertainment, Inc. ("Sony") certain products and other assets which consisted
of 14 products currently in distribution or production and related finished
goods inventory, prepaid royalties, certain accounts receivable and furniture
and equipment. The purchase price for these assets consisted of 136,059 shares
of Common Stock valued at $115,965 (which were valued by independent appraisal)
and a promissory note with a principal amount of $561,781 which bore interest at
the prime rate as quoted by Chemical Bank and which was secured by the assets
acquired. The promissory note was paid in full on February 2, 1996. The
acquisition was accounted for by the purchase method of accounting.
 
     The allocation of the purchase price for the Sony assets is as follows:
 
<TABLE>
<CAPTION>
                                                            ALLOCATION OF      AMORTIZATION
                           DESCRIPTION                      PURCHASE PRICE     (USEFUL LIFE)
        --------------------------------------------------  --------------     -------------
        <S>                                                 <C>                <C>
        Prepaid royalties.................................     $311,000           N/A
        Finished goods inventory..........................      132,457         3 years
        Product development costs.........................      125,417         3 years
        Furniture and equipment...........................      100,000         3 years
        Accounts receivable...............................     $  8,872           N/A
                                                               --------
          Purchase price..................................     $677,746
                                                               ========
</TABLE>
 
  DIGITAL MEDIA THEORY, INC.
 
     On April 22, 1996, the Company entered into an Asset Purchase Agreement
with Digital Media Theory, Inc. ("DMT"). The Company purchased from DMT certain
assets which consisted of an Internet computer database, equipment contracts and
supplies, and rights, title and interest to certain intellectual property. The
purchase price for these assets consisted of 36,000 shares of the Company's
Common Stock valued at $176,887 and a promissory note for $23,099. Acquisition
costs were $20,890. The acquisition was accounted for by the purchase method of
accounting.
 
                                       33
<PAGE>   36
 
                               GRAPHIX ZONE, INC.
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                          JUNE 30, 1997, 1996 AND 1995
 
     The allocation of the purchase price for the assets of DMT is as follows:
 
<TABLE>
<CAPTION>
                                                            ALLOCATION OF      AMORTIZATION
                           DESCRIPTION                      PURCHASE PRICE     (USEFUL LIFE)
        --------------------------------------------------  --------------     -------------
        <S>                                                 <C>                <C>
        Goodwill..........................................   $    100,876          5 years
        Computer database.................................         75,000          5 years
        Trademarks and covenant not to compete............         30,000        2-5 years
        Furniture and equipment...........................         15,000        3-5 years
                                                                 --------
          Purchase price..................................   $    220,876
                                                                 ========
</TABLE>
 
  GZ-CA
 
     On June 28, 1996, the Company acquired all of the outstanding shares of
capital stock of GZ-CA in exchange for the issuance of 5,526,543 shares of
Common Stock to the shareholders of GZ-CA. In connection with the acquisition,
the Company also issued 125,000 shares of Common Stock to its investment banker
in exchange for services rendered in connection with the acquisition. In
addition, the Company assumed all outstanding options and warrants of GZ-CA and
such options and warrants became exercisable to purchase shares of Common Stock.
The acquisition was accounted for by the purchase method of accounting.
 
     The total purchase price for the shares of the capital stock of GZ-CA was
$23,930,957 (which was determined based upon the fair market value of GZ-CA
common stock), including acquisition costs of $823,932. The allocation of the
purchase price for the shares of the capital stock of GZ-CA is as follows:
 
<TABLE>
<CAPTION>
                                                            ALLOCATION OF      AMORTIZATION
                           DESCRIPTION                      PURCHASE PRICE     (USEFUL LIFE)
        --------------------------------------------------  --------------     -------------
        <S>                                                 <C>                <C>
        In-process technology charged to operations.......   $ 17,934,863         N/A
        Product development costs.........................         89,390       3 years
        Assembled work force..............................        185,000       3 years
        Goodwill..........................................        459,310       3 years
        Net assets assumed................................      5,262,394         N/A
                                                              -----------
          Purchase price..................................   $ 23,930,957
                                                              ===========
</TABLE>
 
  INSCAPE
 
     On February 24, 1997, the Company entered into an agreement with Inscape, a
Delaware general partnership among Home Box Office and corporations owned by
Warner Music Group, Inc. ("WMG") and Nash New Media, Inc., and WMG
(collectively, "Inscape"), to purchase certain assets from and assume certain
liabilities of Inscape. The purchased assets consisted of all rights, title and
interest in twelve existing pc-game products and seven pc-game products under
development, all rights, title and interest in the Inscape name, furniture and
equipment and certain leases and other agreements. The liabilities assumed
consisted of accrued compensation costs associated with those Inscape employees
offered employment with the Company.
 
     The purchase price for the Inscape assets consisted of 948,148 shares of
the Company's Series C Convertible Preferred Stock, $.01 par value per share,
and a stated liquidation value of $3.375 per share (the "Series C Preferred").
The Series C Preferred is convertible into Common Stock, at the option of the
holder, at a conversion price of $3.375 per share and must be redeemed by the
Company on February 28, 2000 at $3.375 per share. The holder of the Series C
Preferred is entitled to receive dividends of $0.10125 per share per annum which
are fully cumulative from date of issuance. Although the stated liquidation
value of the shares of the Series C Preferred issued is $3,200,000, the Company
determined the fair market value of such
 
                                       34
<PAGE>   37
 
                               GRAPHIX ZONE, INC.
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                          JUNE 30, 1997, 1996 AND 1995
 
shares of Series C Preferred to be $2,193,066 based upon the fair market value
of the Common Stock on the date of the transaction, discounted to take into
account the restricted nature of the securities.
 
     The allocation of the purchase price for the Inscape assets is as follows:
 
<TABLE>
<CAPTION>
                                                          ALLOCATION OF      AMORTIZATION
                          DESCRIPTION                     PURCHASE PRICE     (USEFUL LIFE)
        ------------------------------------------------  --------------     -------------
        <S>                                               <C>                <C>
        In-process technology charged to operations.....    $1,153,000           N/A
        Assembled work force............................       476,000         5 years
        Goodwill........................................       129,723         5 years
        Furniture and equipment.........................       474,066       2 - 5 years
        Assumed liabilities.............................       (39,723)          N/A
                                                            ----------
                  Purchase price........................    $2,193,066
                                                            ==========
</TABLE>
 
     Certain assets acquired from Inscape were written-off in the fourth quarter
of Fiscal 1997 in connection with the Restructuring (See Note 8).
 
  TRIMARK
 
     On February 26, 1997, the Company entered into an agreement with Trimark
Holdings, Inc. and its subsidiary, Trimark Interactive, Inc. ("Trimark"), to
purchase certain assets from and assume certain liabilities of Trimark. The
purchased assets consisted of all rights, title and interest in seven existing
pc-game products and three pc-game products under development, inventories and
certain other agreements. The liabilities assumed consisted primarily of
liabilities related to pc-game products under development.
 
     The purchase price for the Trimark assets consisted of 237,037 shares of
the Series C Preferred. The Series C Preferred is convertible into Common Stock,
at the option of the holder, at a conversion price of $3.375 per share and must
be redeemed by the Company on February 28, 2000 at $3.375 per share. The holder
of the Series C Preferred is entitled to receive dividends of $0.10125 per share
per annum which are fully cumulative from date of issuance. Although the stated
liquidation value of the shares of Series C Preferred issued is $800,000, the
Company determined the fair market value of the shares of Series C Preferred to
be $548,267 based upon the fair market value of the Common Stock on the date of
the transaction, discounted to take into account the restricted nature of the
securities.
 
     The allocation of the purchase price for the Trimark assets is as follows:
 
<TABLE>
<CAPTION>
                                                            ALLOCATION OF      AMORTIZATION
                           DESCRIPTION                      PURCHASE PRICE     (USEFUL LIFE)
        --------------------------------------------------  --------------     -------------
        <S>                                                 <C>                <C>
        In-process technology charged to operations.......     $475,000               N/A
        Assembled work force..............................       36,000           5 years
        Goodwill..........................................       37,267           5 years
                                                             ----------
                  Purchase price..........................     $548,267           5 years
                                                             ==========
</TABLE>
 
     Certain assets acquired from Trimark were written off in the fourth quarter
of Fiscal 1997 in connection with the Restructuring (See Note 8).
 
(8) RESTRUCTURING CHARGES
 
     During the second quarter of Fiscal 1996, the Company adopted a
restructuring plan to enhance overall competitiveness, productivity and
efficiency through the reduction of overhead costs (the "1996 Restructuring
Plan"). The 1996 Restructuring Plan included the elimination of the Company's
in-house software research and development activities. In connection with the
1996 Restructuring Plan, the Company recorded
 
                                       35
<PAGE>   38
 
                               GRAPHIX ZONE, INC.
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                          JUNE 30, 1997, 1996 AND 1995
 
restructuring charges of $1,950,000, $50,000 of which were reversed in the
fourth quarter of Fiscal 1996 due to changes in the underlying estimates. The
charges principally reflected severance costs of $777,492 resulting from a
reduction of a significant portion of the Company's work force, write-down and
disposal of excess furniture and equipment and office facilities of $946,103,
and write-offs of assembled work force and goodwill of $226,405 arising from the
Company's acquisition of StarPress Multimedia, Inc. in June 1995. At June 30,
1997, none of the accrued restructuring costs related to the 1996 Restructuring
Plan remained outstanding. During the first quarter of Fiscal 1997, the Company
reversed approximately $267,000 of the accrued restructuring charge recorded in
Fiscal 1996, primarily related to facility and equipment leased for its San
Francisco, California facility, which leases were subsequently sub-leased.
 
     In March 1997, the Company hired a new executive management team for the
purpose of evaluating the current business and operations and financial
condition of the Company and, if necessary, restructuring the Company (the
"Restructuring"). The management team performed an in-depth review of the
Company's past history of operating losses, current financial condition, current
strategic position within the entertainment software industry, competitors in
such industry and capital requirements for new product development. In
connection with the Company's evaluation of its business and operations and
financial condition and in accordance with SFAS 121, in March 1997 the Company
evaluated all assets and liabilities to determine impairment, if any. As a
result, the Company recorded a charge of approximately $1,221,000 to general and
administrative expenses related to property and equipment, intangible assets and
other long term assets being impaired during the third quarter of Fiscal 1997.
In addition, the Company recorded charges to cost of revenues of approximately
$1,000,000 related to the net realizable value of inventory, approximately
$321,000 related to the net realizable value of prepaid royalties and acquired
capitalized software development costs being impaired and approximately $203,000
of bad debt reserves during the third quarter of Fiscal 1997.
 
     In June 1997, based on the results of its review, the management team
proposed to the Board of Directors of the Company a Restructuring plan for the
Company, which included terminating the Company's existing business operations.
On June 3, 1997, the Board of Directors adopted the Restructuring plan. By June
24, 1997, the Company had taken steps to cease its principal business operations
and had terminated all employees other than Mr. David Hirschhorn, the Chairman
of the Board, President, Chief Executive Officer, Chief Financial Officer and
Treasurer of the Company.
 
     In June 1997, in connection with the Restructuring, the Company recorded a
charge of approximately $2,063,000 primarily related to the write-down of
property and equipment, goodwill and intangibles related to the Inscape and
Trimark asset purchases and severance costs related to terminating all but one
of the employees of the Company. As of June 30, 1997, the remaining balance in
the restructuring accrual is $75,000 and is expected to be paid by December 31,
1997.
 
     Additionally, as part of the Company's continuing evaluation of its
business and operations and financial condition the Company recorded charges to
cost of revenues and general and administrative expenses of approximately
$966,000 and $976,000, respectively, in the fourth quarter of Fiscal 1997.
Charges to cost of revenues primarily relates to the net realizable value of
inventory and to the accrual for certain future guaranteed royalties. Charges to
general and administrative expenses primarily relate to reserves established for
uncollectable accounts receivable.
 
(9) STOCKHOLDERS' EQUITY
 
  PREFERRED STOCK
 
     During the period from September 25, 1996 to February 7, 1997, the Company
issued 3,025 shares of Series A Convertible Preferred Stock, $.01 par value per
share and a stated liquidation value of $1,000 per share (the "Series A
Preferred"), at a price of $1,000 per share to a number of accredited investors
in a series
 
                                       36
<PAGE>   39
 
                               GRAPHIX ZONE, INC.
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                          JUNE 30, 1997, 1996 AND 1995
 
of private placements. The cash proceeds to the Company from such issuances, net
of offering expenses, was $2,355,948. The Series A Preferred was convertible, at
the option of the holders, into shares of Common Stock at a conversion price per
share equal to the lower of (a) $3.375 or (b) 80% of the average closing bid
price of the Common Stock for the five days immediately prior to the applicable
conversion date. In connection with the issuance of the Series A Preferred, the
Company recorded a discount of $603,792 to reflect the initial conversion
discount feature. The discount was amortized over the 60-day holding period and
is reflected in the accompanying Consolidated Statement of Stockholders' equity
(deficiency) in Fiscal 1997. The holders of the Series A Preferred were entitled
to receive dividends of $80 per share per annum which were fully cumulative from
the date of issuance. In addition, the Company issued to such investors warrants
to purchase 221,204 shares of Common Stock at an exercise prices of between
$4.69 and $5.00 per share (the "Series A Warrants"). The Company determined the
value of the Series A Warrants to be immaterial.
 
     On February 24, 1997, the Company issued 3,025 shares of Series B
Convertible Preferred Stock, $.01 par value per share and with a stated
liquidation value of $1,000 per share (the "Series B Preferred"), and warrants
to purchase 221,204 shares of Common Stock at an exercise price of $5.00 per
share (the "Series B Warrants") in exchange for all of the outstanding shares of
Series A Preferred and Series A Warrants. The Series B Preferred is convertible,
at the option of the holders, into shares of Common Stock at conversion price
per share equal to the lower of (a) $3.375 or (b) 80% of the average closing bid
price of the Common Stock for the five days immediately prior to the conversion
date. The holders of the Series B Preferred are entitled to receive dividends of
$80 per share per annum which are fully cumulative from the date of issuance.
The Series B Warrants expire on January 31, 2000. During the fourth quarter of
Fiscal 1997, certain holders of 770 shares of Series B Preferred converted such
shares into 2,023,515 shares of Common Stock. During the period from July 1,
1997 to October 8, 1997, 579 shares of Series B Preferred were converted into
3,433,501 shares of Common Stock.
 
     In April 1997, the Company solicited the votes of the six holders of its
Series B Preferred to amend the Certificate of Designations of the Series B
Preferred to establish a $1.00 conversion price floor. For the proposed
amendment to become effective, a vote of the holders of the Series B Preferred,
voting as a class, and (b) the Common Stock and Series C Preferred Stock, voting
together as one class, must be obtained. In light of the Restructuring, the
Company has not pursued obtaining this vote.
 
     On March 5, 1997, the Company issued 1,185,185 shares of Series C Preferred
to two accredited investors in connection with two separate acquisitions of
certain assets from such investors (see Note 7). The total stated liquidation
value of such shares of Series C Preferred was $4,000,000, however, the Company
determined that the fair market value of such shares at the time of issuance was
$2,741,333 based upon the fair market value of the Common Stock at the time of
such issuance of Preferred Stock, discounted to take into account the restricted
nature of the Series C Preferred. The shares of Series C Preferred are
convertible into shares of Common Stock at the option of the holders, at a
conversion price of $3.375 per share and are subject to mandatory redemption by
the Company on February 28, 2000 at $3.375 per share. The holders of the Series
C Preferred are entitled to receive dividends of $0.10125 per share per annum
which are fully cumulative from the date of issuance. In connection with the
issuance of the Series C Preferred, the Company recorded a discount of
$1,258,667 which is being amortized on a straight line basis through February
28, 2000.
 
     The Company is negotiating exchange agreements with the holders of shares
of Series B Preferred and Series C Preferred pursuant to which all outstanding
shares would be converted into shares of Common Stock of the Company at an
exchange price of approximately $0.75 per share. The Company has entered into
exchange agreements with several, but not all, of the holders of Series B
Preferred and has not entered into exchange agreements with the holders of
Series C Preferred.
 
                                       37
<PAGE>   40
 
                               GRAPHIX ZONE, INC.
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                          JUNE 30, 1997, 1996 AND 1995
 
  COMMON STOCK
 
     In December 1996, the Company issued (i) 34,375 shares of Common Stock,
with a fair market value of $103,125 on the date of issuance, to Cruttenden Roth
Incorporated ("Cruttenden"), the Company's investment banker, and (ii) 9,167
shares of Common Stock, with a fair market value of $27,500 on the date of
issuance, to David J. Hirschhorn, a managing director of Cruttenden at the time
of such issuance and the current Chairman of the Board, President, Chief
Executive Officer, Chief Financial Officer, Treasurer and a director of the
Company, in connection with investment banking services performed by such
parties for the Company related to the Reorganization. In December 1996, the
Company issued 24,348 shares of Common Stock with a fair market value of $70,000
on the date of issuance to Ronald S. Posner, the Company's Chairman of the Board
and Chief Executive Officer at the time of issuance, as payment for accrued
compensation.
 
  CONVERTIBLE SUBORDINATED DEBENTURES AND BRIDGE LOANS
 
     During March 1995, the Company raised net proceeds of $2,766,537 (net of
offering costs of $165,963) through the issuance of convertible subordinated
debentures (the "Debentures") with detachable common stock warrants. The net
proceeds of the offering were allocated between the Debentures and the warrants
($1,806,741 and $959,796, respectively) based on their relative fair values. The
Debentures bore interest at a rate of 9% per annum and were convertible at a
price of $8.52 per share under certain circumstances. As of June 30, 1995,
Debentures with a carrying balance of $2,200,278 had been converted into 319,132
shares of Common Stock. On July 31, 1995, the remaining $185,585 of Debentures
were converted into 24,932 shares of Common Stock.
 
     During Fiscal 1995, the Company borrowed $300,000 from certain officers and
shareholders of the Company and $265,000 from outside investors. In
consideration for such loans, the Company paid interest at a rate of 9% per
annum and issued warrants to purchase 25,134 shares of Common Stock with the
same terms and conditions as the warrants issued in the Debentures offering. All
of the above-described loans were repaid with proceeds from the Debentures
offering.
 
  STOCK WARRANTS
 
     In September 1994, the Company issued warrants to purchase up to 82,130
shares of Common Stock to two financial consultants ("Financial Consultants'
Warrants") in connection with services provided to the Company. The exercise
price of the Financial Consultants' Warrants is $10.23 per share and they may be
exercised until thirty (30) days after the registration of the shares underlying
the Financial Consultants' Warrants.
 
     In connection with the issuance of the Debentures, discussed above, each
Debenture holder was issued a warrant to purchase shares of the Company's Common
Stock at a purchase price of $.48 per share. Warrants to purchase a total of
329,614 shares were issued in connection with the Debentures.
 
     In October 1995, the Company issued a warrant to purchase up to 6,160
shares of Common Stock to a lender ("Lender's Warrant") in connection with a
business loan. The exercise price of the Lender's Warrant is $8.52 per share and
the Lender's Warrant may be exercised at any time prior to October 27, 2000.
 
                                       38
<PAGE>   41
 
                               GRAPHIX ZONE, INC.
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                          JUNE 30, 1997, 1996 AND 1995
 
     In connection with the Reorganization, the Company assumed all outstanding
warrants of GZ-CA. The following table summarizes the number of shares of Common
Stock issuable upon exercise of such warrants, the exercise price per share of
Common Stock and the applicable expiration date:
 
<TABLE>
<CAPTION>
          SHARES OF         PER SHARE            WARRANT
         COMMON STOCK     EXERCISE PRICE     EXPIRATION DATE
         ------------     --------------     ---------------
<S>      <C>              <C>                <C>
             116,667          $ 2.50             5/31/99
             120,000          $ 3.90             6/30/99
              15,000          $ 3.63             6/05/00
             483,135          $4.125             2/02/99
             720,000          $5.125             2/28/01
              20,000          $5.625             6/26/01
           ---------
Total:     1,474,802
           =========
</TABLE>
 
  STOCK OPTIONS
 
     1996 Stock Option Plan
 
     The Company's 1996 Stock Option Plan (the "Plan") is administered by a
committee of the Board of Directors of the Company (the "Committee") which
determines the recipients and terms of options granted under the Plan. All stock
option plans of the Company's wholly-owned subsidiaries, GZ-CA and StarPress,
have been assumed under the Plan. The Plan provides for the grant of incentive
stock options ("ISOs") and non-qualified stock options ("NQOs") for up to
2,500,000 shares of Common Stock. The terms of the Plan require that ISOs
granted must have an exercise price of not less than 100% of the fair market
value of the Common Stock on the date of grant and must be exercised within ten
years of the date of grant. The terms of the Plan require that NQOs granted
under the Plan must have an exercise price of not less than 85% of the fair
market value of the Common Stock on the date of grant and must be exercised
within five years of the date of grant. The Plan also provides for automatic
annual grants of NQOs to each member of the Committee for the purchase of 25,000
shares of Common Stock at an exercise price equal to 100% of the fair market
value on the date of grant. NQOs granted to members of the Committee vest as
follows: 50% of the shares subject to the NQO vest six months after the date of
grant and the remaining 50% of the shares vest twelve months after the date of
grant. At June 30, 1997, 934,446 options granted under the Plan were exercisable
with a weighted average exercise price of $3.09. At June 30, 1997, there were
394,818 additional shares available for grant under the Plan.
 
                                       39
<PAGE>   42
 
                               GRAPHIX ZONE, INC.
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                          JUNE 30, 1997, 1996 AND 1995
 
     The following is a summary of stock option activity under the Plan:
 
<TABLE>
<CAPTION>
                                                            NUMBER OF     WEIGHTED-AVERAGE
                                                             SHARES        EXERCISE PRICE
                                                            ---------     ----------------
        <S>                                                 <C>           <C>
        Outstanding at June 30, 1994......................     66,437           7.37
        Options granted...................................     46,613           2.40
        Options exercised.................................     (1,467)          1.70
        Options canceled..................................    (16,238)          7.24
        Assumed from StarPress Multimedia, Inc. ..........    279,414           0.56
                                                            ---------
        Outstanding at June 30, 1995......................    374,759           1.75
        Options granted...................................    517,710           6.38
        Options exercised.................................   (300,260)          1.37
        Options canceled..................................   (396,647)          4.94
        Assumed from GZ-CA................................    314,050           4.33
                                                            ---------
        Outstanding as of June 30, 1996...................    509,612           5.12
        Options granted...................................  1,270,450           2.88
        Options exercised.................................    (43,716)          0.11
        Options canceled..................................   (262,855)          3.27
                                                            ---------           ----
        Outstanding at June 30, 1997......................  1,473,491           3.01
                                                            =========           ====
</TABLE>
 
     Subsequent to June 30, 1997, as a result of the termination of all but one
employee (see Note 8), all options under the Plan have been cancelled.
 
     During Fiscal 1996, the Company accelerated the vesting period of certain
stock options granted to an officer of the Company resulting in a new
measurement date of such options. The exercise price of the options was below
the fair market value on the date of acceleration. Accordingly, earned
compensation of $195,682 was recorded for the difference between the option
exercise price and fair market value on the date of acceleration.
 
  NON-PLAN STOCK OPTIONS
 
     On March 17, 1997, the Company granted David J. Hirschhorn, the Chairman of
the Board, President, Chief Executive Officer, Chief Financial Officer,
Treasurer and a director of the Company, a non-Plan NQO to purchase 2,500,000
shares of Common Stock at an exercise price of $2.00 per share (the fair market
value of the Common Stock on the date of grant). The option vests over a period
of four years. The option may be exercised as to the vested portions at any time
after the date of vesting until the date that is five years from the individual
vesting dates.
 
     During Fiscal 1997, the Company granted various non-Plan NQOs to purchase
an aggregate of 30,000 shares of Common Stock at exercise prices ranging from
$3.00 to $4.13 per share (the fair market value of the Common Stock on the
respective date of grant). The options were granted to several consultants and
individuals providing assistance to the Company. The options vest at various
times and upon certain triggering events, and expire in five years from the date
of grant. The Company determined the fair value of the options granted to be
immaterial.
 
     During Fiscal 1995, the Company granted various non-Plan NQOs to purchase
an aggregate of 106,679 shares of Common Stock at exercise prices ranging from
$3.43 to $4.25 per share (the fair market value of the
 
                                       40
<PAGE>   43
 
                               GRAPHIX ZONE, INC.
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                          JUNE 30, 1997, 1996 AND 1995
 
Common Stock on the respective date of grant). Options for 56,679 shares were
granted to certain related parties. The remainder were granted to consultants
and other individuals providing assistance to the Company. The options vest at
various times until their expiration ten years from the date of grant, subject
to acceleration upon the occurrence of certain events.
 
     Certain directors, officers and consultants of the Company were granted
non-Plan NQOs to purchase 121,581 shares of Common Stock during Fiscal 1995.
These options vested immediately upon grant at exercise prices ranging form
$.007 to $8.52 per share. Compensation expense of $720,351 related to the
issuance of these stock options was recorded for the year ended June 30, 1995.
 
     A summary of the stock option activity for all non-Plan NQOs is as follows:
 
<TABLE>
<CAPTION>
                                                           NUMBER OF     WEIGHTED AVERAGE
                                                            SHARES        EXERCISE PRICE
                                                           ---------     ----------------
        <S>                                                <C>           <C>
        Outstanding at June 30, 1994.....................    182,988           5.57
        Options granted..................................    121,581           3.25
                                                           ---------           ----
 
        Outstanding at June 30, 1995.....................    304,569           4.66
        Assumed from GZ-CA...............................    119,179           3.43
                                                           ---------           ----
 
        Outstanding at June 30, 1996.....................    423,748           4.34
        Options granted..................................  2,530,000           2.02
        Options exercised................................     (9,134)          0.88
        Options canceled.................................     (4,441)          5.06
                                                           ---------           ----
 
        Outstanding at June 30, 1997.....................  2,940,173           2.34
                                                           =========           ====
</TABLE>
 
     As of June 30, 1997, there were approximately 1,269,490 non-Plan NQOs
exercisable with a weighted average exercise price of $2.95.
 
     The per share weighted-average fair value of options granted during Fiscal
1997 and 1996 was $2.88 and $6.38, respectively, on the date of grant using the
Black-Scholes option-pricing model with the following weighted-average
assumptions: Fiscal 1997 -- risk-free interest rate of 6.50%, volatility of 25%
and an expected life of 4 years; Fiscal 1996 -- risk-free interest rate of
6.50%, volatility of 25% and an expected life of 4 years.
 
     The Company applies APB Opinion No. 25, "Accounting for Stock Issued to
Employees," in accounting for its Plan and, accordingly, no compensation cost
has been recognized for its stock options in the financial statements. Had the
Company determined compensation cost based on the fair value at the grant date
for its stock options under SFAS No. 123, the Company's net loss and net loss
per share would have been reduced to the pro forma amounts indicated below:
 
<TABLE>
<CAPTION>
                                                               YEAR ENDED JUNE 30
                                                          -----------------------------
                                                              1997             1996
                                                          ------------     ------------
        <S>                                               <C>              <C>
        Net loss:
          As reported.................................    $(16,831,025)    $(23,518,660)
          Pro forma...................................    $(17,569,606)    $(23,591,052)
        Net loss per share:
          As reported.................................    $      (1.61)    $      (5.05)
          Pro forma...................................    $      (1.68)    $      (5.06)
</TABLE>
 
                                       41
<PAGE>   44
 
                               GRAPHIX ZONE, INC.
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                          JUNE 30, 1997, 1996 AND 1995
 
     Pro forma net loss and pro forma net loss per share reflect only options
granted in Fiscal 1997 and 1996. The full impact of calculating compensation
cost for stock options under SFAS 123 is not reflected in the pro forma net loss
amounts presented above because compensation cost is reflected over the options'
vesting period of four years and compensation cost for options granted prior to
July 1, 1995 is not considered.
 
(10) INCOME TAXES
 
     Deferred income taxes reflect the net effect of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax assets and liabilities, are as follows:
 
<TABLE>
<CAPTION>
                                                                     JUNE 30,
                                                           ----------------------------
                                                               1997            1996
                                                           ------------     -----------
        <S>                                                <C>              <C>
        Deferred tax assets:
          Net operating loss carryforwards.............    $ 13,418,000     $ 6,867,000
          Reserves not currently deductible............       3,117,000         698,000
          Less valuation allowance.....................     (16,535,000)     (7,565,000)
                                                           ------------     ------------
             Total deferred tax assets.................              --              --
                                                           ============     ============
        Deferred tax liability:
          Identified intangible assets.................              --              --
                                                           ============     ============
</TABLE>
 
     The valuation allowance for deferred tax assets as of June 30, 1997 was
$16,535,000. The net change in the total valuation allowance for the year ended
June 30, 1997 was an increase of $8,970,000.
 
     Reconciliation of the Federal statutory rate to the Company's effective tax
rate is as follows:
 
<TABLE>
<CAPTION>
                                                                       1997      1996
                                                                       -----     -----
        <S>                                                            <C>       <C>
        Federal statutory rate.....................................    (34.0)%   (34.0)%
        State income taxes, net....................................     (3.7)     (6.1)
        Write-off of acquired in-process technology for which no
          tax benefit is recognized................................      9.7      30.6
        Net operating loss carryforward with no tax benefit
          recognized...............................................     28.0       9.5
                                                                        ----      ----
                                                                          --        --
                                                                        ====      ====
</TABLE>
 
     As of June 30, 1997, the Company had net operating loss carryforwards for
Federal and state income tax purposes of approximately $36,484,000 and
$16,664,000, respectively, which are available to offset future taxable income.
The net operating loss carryforwards, if not utilized, will expire over the
period from 2005 through 2012. Pursuant to the Reorganization and the conversion
of certain shares of Preferred Stock into shares of Common Stock and other
equity related transactions, the utilization of the net operating loss
carryforwards may be limited due to restrictions imposed under applicable
Federal and state tax law due to a change in ownership.
 
                                       42
<PAGE>   45
 
                               GRAPHIX ZONE, INC.
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                          JUNE 30, 1997, 1996 AND 1995
 
(11) COMMITMENTS AND CONTINGENCIES
 
  LEASES
 
     The Company leases certain equipment under non-cancelable operating lease
agreements which provide for the following minimum annual lease payments:
 
<TABLE>
<CAPTION>
                                   YEAR ENDING                           OPERATING
                                    JUNE 30,                             LEASES
            ---------------------------------------------------------    -------
            <S>                                                          <C>
              1998...................................................    $24,315
              1999...................................................     11,133
              2000...................................................      1,856
                                                                         -------
            Total minimum lease payments.............................    $37,304
                                                                         =======
</TABLE>
 
     On June 27, 1997, the Company entered into a month-to-month lease for its
corporate office and warehouse space with an affiliated party. The monthly lease
payment under the lease is $2,550, which management believes is below the market
rate for comparable space.
 
     The Company subleases approximately 12,100 square feet of office space in
San Francisco, California, which location formerly was used as the principal
executive offices of StarPress. The Company has assigned its sublease to a third
party, but remains liable as a guarantor of the sublease, in the event of
default by the assignee, until December 1997.
 
     Total rental expense, including month-to-month rentals, approximated
$447,906, $248,000 and $230,000 in Fiscal 1997, 1996 and 1995, respectively.
 
  ROYALTIES
 
     The Company entered into agreements with major music production and
entertainment companies to produce interactive music, educational and
entertainment CD-ROM titles. These agreements obligate the Company to pay
royalties, as specified in the agreements, based on the sales of the CD-ROMs and
based on certain guarantees. As of June 30, 1997, the Company has accrued all
earned royalties and future guarantees.
 
  LEGAL MATTERS
 
     The Company is involved with certain legal proceedings and other claims
arising in the normal course of business. In the opinion of the Company's
management, the liability, if any, resulting from such litigation would not have
a material adverse affect on the Company's consolidated financial position or
results of operations. Set forth below is a summary of certain material legal
proceedings to which the Company and/or any of its subsidiaries is a party.
 
     The Company and Tunes Network, Inc. (formerly Surf Communications, Inc.)
("Tunes") currently are involved in an arbitration pending in the San Francisco,
California office of the American Arbitration Association. The arbitration was
instituted in April 1997. The arbitration relates to claims made by Tunes
against the Company in the amount of $322,000, plus unspecified additional
royalties, interest and attorneys' fees, allegedly owed under an agreement
entered into between the Company and Tunes as of November 5, 1996 (the "November
5th Agreement"). The November 5th Agreement relates to services to be performed
by Tunes in connection with creating and maintaining an Internet website for the
Company. The Company intends to vigorously contest liability for the amounts
claimed. Although the Company cannot predict the likely outcome of this
arbitration at this time, management intends to vigorously defend this
arbitration and believes that the final outcome will not have a material adverse
effect on the Company's consolidated financial condition, results of operations
or liquidity.
 
                                       43
<PAGE>   46
 
                               GRAPHIX ZONE, INC.
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                          JUNE 30, 1997, 1996 AND 1995
 
(12) DISTRIBUTION AGREEMENT
 
     On March 13, 1996, the Company entered into a distribution agreement (the
"GT Agreement") with GT Interactive Software Corp. ("GT"). In connection with
the GT Agreement, the Company issued a warrant to GT to purchase up to 800,000
shares of Common Stock at a per share exercise price of $5.125. The Warrant
expires on February 28, 2001. As of June 30, 1996, GT had acquired 80,000 shares
through partial exercise of such warrant. The Company has agreed that upon
receiving a request from GT the Company will register the Common Stock
underlying the warrant. At the time of issuance, management estimated that the
fair market value of the warrant was $312,000. Such amount was being amortized
over the five year life of the GT Agreement. During the third quarter of Fiscal
1997, the Company determined that the GT Agreement would not yield any material
future economic benefit to the Company and recorded a charge of $247,000 for the
unamortized value of the warrant which amount is included in general and
administrative expenses in the accompanying consolidated statements of
operations. On July 2, 1997, the Company and GT amended and restated the GT
Agreement in connection with settling certain disputes related to payments under
the terms of the original agreement.
 
(13) SIGNIFICANT CUSTOMERS AND EXPORT SALES
 
     The Company had sales to two major customers: Tech Data Corporation and
Navarre Corporation, which represented approximately 26% and 15%, respectively,
of Fiscal 1997 revenues. The Company had sales to three major customers: GT
Interactive, Tech Data Corporation and Navarre Corporation, which represented
approximately 27%, 24% and 15%, respectively, of Fiscal 1996 revenues and 36%,
12% and 10%, respectively, of Fiscal 1995 revenues. At June 30, 1997 and 1996,
accounts receivable included approximately $313,000 and $3,134,000,
respectively, due from these major customers.
 
(14) RELATED PARTY TRANSACTIONS
 
     Certain former officers and major shareholders of the Company were
affiliated with companies which provided various shipping, warehousing,
consulting, legal and accounting services to the Company. The cost of these
services were $47,975 for the year ended June 30, 1995.
 
     On March 21, 1996, GZ-CA advanced an aggregate of $110,162 to two executive
officers and one senior staff member of the Company in order to assist such
persons with the exercise of certain vested stock options under the Plan. These
advances were secured by promissory notes which bore interest at a rate of 6%
per annum and became due on or before termination of employment with the
Company. As of June 30, 1996, $94,062 remained outstanding under these
promissory notes. During Fiscal 1997, two of the promissory notes were paid off
in full. On May 21, 1997, the Company cancelled the third promissory note in
connection with a Separation and Settlement Agreement entered into with Ronald
S. Posner with respect to the termination of Mr. Posner's employment as the
Co-Chairman of the Board and Chief Executive Officer of the Company. At the time
that the Company cancelled Mr. Posner's promissory note, the balance of unpaid
principal and accrued and unpaid interest thereunder was approximately $44,000.
 
     Pursuant to the 1996 Restructuring Plan, on April 2, 1996, the Company
entered into an agreement pursuant to which PolarCap, LLC, owned and operated by
Douglas D. Cole, a former director and chief executive officer of the Company,
acquired 100% equity ownership of Logatronix, Ltd. ("Great Bear -- Bulgaria"), a
wholly-owned subsidiary of the Company based in Sofia, Bulgaria, and certain
other assets of the Company. The purchase price consisted of a $40,000
promissory note, a contingent payment in the event of the sale or other transfer
of any of the Great Bear - Bulgaria stock by PolarCap, LLC, a contingent payment
in the event of the collection of certain receivables transferred to PolarCap,
LLC in the acquisition, and the assumption by PolarCap, LLC of certain Great
Bear -- Bulgaria liabilities.
 
                                       44
<PAGE>   47
 
                               GRAPHIX ZONE, INC.
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                          JUNE 30, 1997, 1996 AND 1995
 
(15) PROFIT SHARING PLAN
 
     The Company and its wholly-owned subsidiaries maintain a pretax savings and
profit sharing plan under Section 401(k) of the Internal Revenue Code. Under the
plan, eligible employees are able to contribute from 1% to 15% of their
compensation. The Company makes a matching contribution of certain amounts
contributed by the employee and may, at its discretion, make additional
contributions to the plan, up to a maximum of 15% of the employee's
compensation. During Fiscal 1997, the Company made matching contributions in the
aggregate amount of $13,137.
 
(16) JOINT VENTURE
 
     Under a joint venture agreement with Olivetti Telemedia, the Company is
obligated to invest $450,000 in cash and contribute intellectual property valued
by the joint venture at $1,000,000. The cash is to be contributed based upon the
financial needs of the joint venture, as determined by the joint venture's
governing board. On February 26, 1996, the Company received a letter from
Olivetti Telemedia requesting that the Company become current on its cash
contribution obligations to the joint venture. The parties are currently in
negotiations regarding this request. During Fiscal 1996, the Company had accrued
and expensed $100,000 of the required contribution of $450,000. The Company does
not expect it will be required to contribute material amounts to the joint
venture beyond the $100,000 accrued as of June 30, 1997.
 
(17) GOING CONCERN
 
     The Company incurred significant losses from operations during Fiscal 1997
and Fiscal 1996, and, as of June 30, 1997, the Company's net working capital
deficiency was ($9,133,497). By July 24, 1997, the Company had taken steps to
cease its principal business operations. The Company does not have the necessary
funds to pay its secured and unsecured debt obligations. The Company is in
default under the terms of its senior secured loan and agreements with other
creditors and has received two Notices of Default from its senior secured
lender. In connection with the Restructuring, the Company is attempting to
renegotiate the terms of its senior secured loan, negotiate the payment of $.30
for each $1.00 of unsecured debt, convert outstanding shares of Preferred Stock
into shares of Common Stock, and raise operating funds for the Company. However,
there can be no assurances that the Company will be able to successfully
complete the Restructuring and continue as a going concern. If the Company is
unsuccessful in completing the Restructuring, it is likely that Madeleine will
foreclose upon all of the assets of the Company and pursue the dissolution of
the Company.
 
                                       45
<PAGE>   48
 
ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
         FINANCIAL DISCLOSURE
 
     None.
 
                                    PART III
 
ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
 
     The information set forth under the captions "ELECTION OF DIRECTORS" and
"TRANSACTIONS WITH MANAGEMENT AND OTHERS -- Section 16(a) Beneficial Ownership
Reporting Compliance" in the Company's definitive proxy statement (the "Proxy
Statement") for the Annual Meeting of Stockholders scheduled to be held on
December 16, 1997, is incorporated herein by reference. The Proxy Statement will
be filed with the U.S. Securities and Exchange Commission not later than 120
days after the close of Fiscal 1997.
 
ITEM 11.  EXECUTIVE COMPENSATION
 
     The information set forth under the captions "COMPENSATION OF EXECUTIVE
OFFICERS" and "INFORMATION ABOUT THE BOARD OF DIRECTORS AND COMMITTEES OF THE
BOARD -- Compensation of Directors" in the Proxy Statement is incorporated
herein by reference, provided however, that the Report of the Compensation
Committee on Executive Compensation and the Performance Graph set forth under
the caption "COMPENSATION OF EXECUTIVE OFFICERS" shall not be deemed
incorporated by reference in this Report and shall not otherwise be deemed
"filed" as part of this Report.
 
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
 
     The information set forth under the caption "SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT" in the Proxy Statement is incorporated herein
by reference.
 
ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
     The information set forth under the caption "TRANSACTIONS WITH MANAGEMENT
AND OTHERS" in the Proxy Statement is incorporated herein by reference.
 
                                    PART IV
 
ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
 
<TABLE>
<CAPTION>
                                                                                        PAGE
                                                                                        ----
<S>                                                                                     <C>
(A)(1) FINANCIAL STATEMENTS
             Index to Financial Statements and Financial Statements...................   17
(A)(2) FINANCIAL STATEMENT SCHEDULES
             Schedule II -- Valuation and Qualifying Accounts.........................  S-1
</TABLE>
 
     All other schedules are omitted because they are not required, are not
applicable or the information required to be set forth therein is included in
the financial statements or in the notes thereto.
 
                                       46
<PAGE>   49
 
(A)(3) EXHIBITS. The Exhibits listed below are filed with this Annual Report on
       Form 10-K.
 
<TABLE>
<CAPTION>
EXHIBIT
NUMBER                                       DESCRIPTION
-------    --------------------------------------------------------------------------------
<C>        <S>
  2.1      Agreement and Plan of Reorganization dated January 3, 1996 between GZ
           Multimedia, Inc. (formerly Graphix Zone, Inc.), a California corporation
           ("GZ-CA"), and StarPress, Inc., a Colorado corporation ("StarPress"), previously
           filed with the U.S. Securities and Exchange Commission (the "Commission") as
           Exhibit 2.1 to the Company's Registration Statement on Form S-4 dated March 25,
           1996 (Registration No. 333-2642) (the "Registration Statement"), which is
           incorporated herein by reference.
  2.2      Restructuring Plan adopted by the Board of Directors of the Company on June 3,
           1997.
  3.1      Certificate of Incorporation of the Company, previously filed with the
           Commission as Exhibit 3.1 to the Registration Statement, which is incorporated
           herein by reference.
  3.2      Amended and Restated Certificate of Designations of Series A Convertible
           Preferred Stock of the Company, previously filed with the Commission as Exhibit
           3.3 to the Company's Quarterly Report on Form 10-Q for the quarterly period
           ended September 30, 1996 (File No. 0-28676) (the "September 1996 Quarterly
           Report"), which is incorporated herein by reference.
  3.3      Certificate of Amendment of Amended and Restated Certificate of Designations of
           Series A Convertible Preferred Stock of the Company, previously filed with the
           Commission as Exhibit 3.4 to the Company's September 1996 Quarterly Report,
           which is incorporated herein by reference.
  3.4      Certificate of Amendment of Certificate of Designations of Series A Convertible
           Preferred Stock of the Company.
  3.5      Certificate of Designations of Series B Convertible Preferred Stock of the
           Company, previously filed with the Commission as Exhibit 3.1 to the Company's
           Current Report on Form 8-K dated February 18, 1997, and filed with the
           Commission on March 5, 1997 (File No. 0-28676) (the "March 5th Current Report"),
           which is incorporated herein by reference.
  3.6      Certificate of Designations of Series C Convertible Preferred Stock of the
           Company, previously filed as Exhibit 10.34 to the Company's Current Report on
           Form 8-K dated March 5, 1997, and filed with the Commission on March 20, 1997
           (File No. 0-28676) (the "March 20th Current Report"), which is incorporated
           herein by reference.
  3.7      Bylaws of the Company, previously filed with the Commission as Exhibit 3.2 to
           the Registration Statement, which is incorporated herein by reference.
  4.1      Registration Rights Agreements dated January 31, 1994 and February 28, 1994
           among GZ-CA, Frank Cutler, James Cutler, Jr. and Gregory A. Brown, previously
           filed with the Commission as an exhibit to GZ-CA's Registration Statement on
           Form SB-2 dated March 15, 1994 or amendment thereto dated May 15, 1994
           (Registration No. 33-76552-LA) (the "1994 Registration Statement"), which is
           incorporated herein by reference.
  4.2      Form of Registration Rights Agreement dated February 2, 1996 among GZ-CA and
           each of the investors in the GZ-CA 1996 private placement offering (the "1996
           Private Placement"), previously filed with the Commission as Exhibit 10.16 to
           the Registration Statement, which is incorporated herein by reference.
  4.3      Registration Rights Agreement dated March 13, 1996 between GZ-CA and GT
           Interactive Software Corp., a Delaware corporation ("GTIS"), previously filed
           with the Commission as Exhibit 10.7 to the Registration Statement, which is
           incorporated herein by reference.

Management Contracts and Compensatory Plans or Arrangements

 10.1      Warrant Agreements dated January 31, 1994 and February 28, 1994 between GZ-CA
           and Frank Cutler, previously filed with the Commission as an exhibit to the 1994
           Registration Statement, which is incorporated herein by reference.
</TABLE>
 
                                       47
<PAGE>   50
 
<TABLE>
<CAPTION>
EXHIBIT
NUMBER                                       DESCRIPTION
-------    --------------------------------------------------------------------------------
<C>        <S>
 10.2      Non-Qualified Stock Option Agreement dated July 1, 1994 between GZ-CA and Frank
           Cutler, previously filed with the Commission as Exhibit 10.4 to GZ-CA's
           Registration Statement on Form S-8 dated December 6, 1994, and filed with the
           Commission on December 9, 1994, which is incorporated herein by reference.
 10.3      Non-Qualified Stock Option Agreement dated January 26, 1995 between GZ-CA and
           John and Anne Aber, previously filed with the Commission as Exhibit 10.20 to
           GZ-CA's Annual Report on Form 10-KSB for the fiscal year ended June 30, 1995,
           and filed with the Commission on October 5, 1995 (File No. 0-24166) (the "GZ-CA
           1995 Annual Report"), which is incorporated herein by reference.
 10.4      Non-Qualified Stock Option Agreement dated January 26, 1995 between GZ-CA and
           John Aber, previously filed with the Commission as Exhibit 10.21 to the GZ-CA
           1995 Annual Report, which is incorporated herein by reference.
 10.5      Non-Qualified Stock Option Agreement dated January 26, 1995 between GZ-CA and
           Anne Aber, previously filed with the Commission as Exhibit 10.22 to the GZ-CA
           1995 Annual Report, which is incorporated herein by reference.
 10.6      Non-Qualified Stock Option Agreement dated January 26, 1995 between GZ-CA and
           Thomas and Honor Vandeveer, previously filed with the Commission as Exhibit
           10.23 to the GZ-CA 1995 Annual Report, which is incorporated herein by
           reference.
 10.7      1996 Stock Option Plan of the Company (the "1996 Plan"), previously filed with
           the Commission as Exhibit 10.1 to the Registration Statement, which is
           incorporated herein by reference.
 10.8      Form of Non-Qualified Stock Option Agreement pertaining to the 1996 Plan,
           previously filed with the Commission as Exhibit 10.2 to the Registration
           Statement, which is incorporated herein by reference.
 10.9      Form of Incentive Stock Option Agreement pertaining to the 1996 Plan, previously
           filed with the Commission as Exhibit 10.3 to the Registration Statement, which
           is incorporated herein by reference.
 10.10     Employment letter dated January 15, 1996 between GZ-CA and Norman H. Block.
 10.11     Separation and Settlement Agreement dated April 18, 1997 between the Company and
           Norman H. Block.
 10.12     Employment Agreement dated June 23, 1995 between StarPress and Ronald S. Posner,
           previously filed with the Commission as an exhibit to StarPress' Annual Report
           on Form 10-KSB for the fiscal year ended June 30, 1995, and filed with the
           Commission on September 27, 1995 (the "StarPress 1995 Annual Report"), which is
           incorporated herein by reference.
 10.13     Promissory Note dated March 21, 1996 in the original principal amount of $41,250
           by Ronald S. Posner in favor of the Company.
 10.14     Separation and Settlement Agreement dated May 21, 1997 among the Company, GZ-CA,
           StarPress and Ronald S. Posner.
 10.15     Employment letter dated March 25, 1996 between the Company and Melissa Orr.
 10.16     Amended and Restated Employment Agreement dated October 28, 1996 between the
           Company and Charles R. Cortright, Jr.
 10.17     Employment letter dated February 26, 1997 between the Company and Robert D.
           Shishino, previously filed with the Commission as Exhibit 10.6 to the Company's
           Quarterly Report on Form 10-Q for the quarterly period ended March 31, 1997, and
           filed with the Commission on May 20, 1997 (File No. 0-28676) (the "March 1997
           Quarterly Report"), which is incorporated herein by reference.
</TABLE>
 
                                       48
<PAGE>   51
 
<TABLE>
<CAPTION>
EXHIBIT
NUMBER                                       DESCRIPTION
-------    --------------------------------------------------------------------------------
<C>        <S>
 10.18     Terms of Employment Agreement between the Company and David J. Hirschhorn.
 10.19     Terms of Stock Option granted by the Company to David J. Hirschhorn.
 10.20     Confidential Settlement Agreement and Mutual General Release dated October 13,
           1997 and effective as of May 30, 1997 among the Company, Charles Cortright and
           Angela Cortright.
 
                                                               Other Material Contracts
 10.21     Office Building Lease dated October 10, 1990 between GZ-CA and Masaaki & Fumiko
           Nakaoka, as amended, previously filed with the Commission as an exhibit to the
           1994 Registration Statement, which is incorporated herein by reference.
 10.22     Office Building Lease dated September 13, 1994 between GZ-CA and Pan Pacific
           Investments, as amended by First, Second and Third Amendments, previously filed
           with the Commission as an exhibit to the GZ-CA 1995 Annual Report, which is
           incorporated herein by reference.
 10.23     Joint Venture Agreement dated March 31, 1995 among StarPress Multimedia, Inc., a
           Delaware corporation ("StarPress Multimedia"), Olivetti Systems and Network
           Holdings N.V., previously filed with the Commission as an exhibit to the
           StarPress 1995 Annual Report, which is incorporated herein by reference.
 10.24     Sublease Agreement dated August 13, 1995 between StarPress and International
           Business Machines Corporation, previously filed with the Commission as an
           exhibit to the StarPress 1995 Annual Report, which is incorporated herein by
           reference.
 10.25     Business Loan Agreement dated October 27, 1995 between Silicon Valley Bank and
           StarPress, previously filed with the Commission as an exhibit to StarPress'
           Quarterly Report on Form 10-QSB for the quarterly period ended September 30,
           1995 (the "StarPress September 1995 Quarterly Report"), which is incorporated
           herein by reference.
 10.26     Business Loan Agreement dated June 26, 1996 between GZ-CA and Silicon Valley
           Bank, previously filed with the Commission as Exhibit 10.28 to the Company's
           Annual Report on Form 10-K for the fiscal year ended June 30, 1996 (File No.
           0-28676), which is incorporated herein by reference.
 10.27     Warrant to Purchase Stock dated December 12, 1996 between the Company and
           Silicon Valley Bank.
 10.28     Asset Purchase Agreement dated November 1, 1995 between StarPress and Sony
           Interactive Entertainment, Inc., previously filed with the Commission as an
           exhibit to the StarPress September 1995 Quarterly Report, which is incorporated
           herein by reference.
 10.29     Form of Warrant Agreement entered into between GZ-CA and each of the investors
           in the 1996 Private Placement, previously filed with the Commission as Exhibit
           10.17 to the Registration Statement, which is incorporated herein by reference.
 10.30     Distribution Agreement dated March 13, 1996 among GZ-CA, StarPress and GTIS,
           previously filed with the Commission as Exhibit 10.4 to the Registration
           Statement, which is incorporated herein by reference.
 10.31     Keep-Well Agreement dated March 13, 1996 among the Company, GZ-CA and GTIS,
           previously filed with the Commission as Exhibit 10.5 to the Registration
           Statement, which is incorporated herein by reference.
 10.32     Common Stock Purchase Warrant dated March 13, 1996 between GZ-CA and GTIS,
           previously filed with the Commission as Exhibit 10.6 to the Registration
           Statement, which is incorporated herein by reference.
</TABLE>
 
                                       49
<PAGE>   52
 
<TABLE>
<CAPTION>
EXHIBIT
NUMBER                                       DESCRIPTION
-------    --------------------------------------------------------------------------------
<C>        <S>
 10.33     Loan and Security Agreement dated January 31, 1997 between the Company and
           Madeleine L.L.C., a New York limited liability company ("Madeleine"), previously
           filed with the Commission as Exhibit 10.1 to the March 1997 Quarterly Report,
           which is incorporated herein by reference.
 10.34     Amendment No. 1 to Loan and Security Agreement dated March 5, 1997 between the
           Company and Madeleine, previously filed with the Commission as Exhibit 10.3 to
           the March 1997 Quarterly Report, which is incorporated herein by reference.
 10.35     Consent and Amendment Number Two to Loan and Security Agreement dated June 5,
           1997 between the Company and Madeleine.
 10.36     Warrant to Purchase 300,000 Shares of Common Stock dated January 31, 1997
           between the Company and Madeleine, previously filed with the Commission as
           Exhibit 10.2 to the March 1997 Quarterly Report, which is incorporated herein by
           reference.
 10.37     Warrant to Purchase Shares of Common Stock dated June 5, 1997 between the
           Company and Madeleine.
 10.38     Asset Purchase Agreement dated February 24, 1997 among the Company, Inscape and
           Warner Music Group, Inc., previously filed with the Commission as Exhibit 10.32
           to the March 20th Current Report, which is incorporated herein by reference.
 10.39     Asset Purchase Agreement dated February 26, 1997 among the Company, Trimark
           Holdings, Inc. and its subsidiary, Trimark Interactive, previously filed with
           the Commission as Exhibit 10.33 to the March 20th Current Report, which is
           incorporated herein by reference.
 10.40     Form of StarPress 9% Convertible Subordinated Debentures with Warrant
           Agreements, previously filed with the Commission as an exhibit to StarPress'
           Current Report on Form 8-K dated March 31, 1995, which is incorporated herein by
           reference.
 10.41     Sub-Lease Agreement dated June 23, 1997 between the Company and Daimler Commerce
           Partners, L.P.
 10.42     Promissory Note dated February 3, 1997 in the original principal amount of
           $200,000 by the Company in favor of Middlefield Ventures, Inc.
 10.43     Warrant to Purchase 613,718 Shares of Common Stock of Graphix Zone, Inc. dated
           February 3, 1997 between the Company and Intel Corporation.
 11        Statement Regarding Computation of Per Share Earnings (Loss).
 21        Subsidiaries of the Registrant.
 23.1      Consent of Ernst & Young LLP, independent auditors.
 23.2      Consent of KPMG Peat Marwick LLP, independent auditors.
 27        Financial Data Schedule.
</TABLE>
 
(B) REPORTS ON FORM 8-K
 
     No reports on Form 8-K were filed during the fourth quarter of Fiscal 1997.
 
                                       50
<PAGE>   53
 
                                   SIGNATURES
 
     Pursuant to the requirements of Section 13 or 15(d) 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.
 
                                          GRAPHIX ZONE, INC.
 
Date: October 13, 1997                    By:    /s/ DAVID J. HIRSCHHORN
                                            ------------------------------------
                                            David J. Hirschhorn
                                            Chairman of the Board,
                                            President, Chief Executive Officer,
                                            Chief Financial Officer and
                                              Treasurer
 
     Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
 
<TABLE>
<CAPTION>
                    NAME                                    TITLE                    DATE
---------------------------------------------   -----------------------------  -----------------
<C>                                             <S>                            <C>
 
           /s/ DAVID J. HIRSCHHORN              Director, Chairman of the       October 13, 1997
---------------------------------------------   Board, President, Chief
             David J. Hirschhorn                Executive Officer, Chief
                                                Financial Officer and
                                                Treasurer (Principal
                                                Executive Officer, Principal
                                                Financial Officer and
                                                Principal Accounting Officer)
             /s/ KEVIN P. GENDA                 Director                        October 13, 1997
---------------------------------------------
               Kevin P. Genda
 
                                                Director
---------------------------------------------
              Ronald S. Posner
</TABLE>
 
                                       51
<PAGE>   54
 
                                  SCHEDULE II
 
                      GRAPHIX ZONE, INC. AND SUBSIDIARIES
                       VALUATION AND QUALIFYING ACCOUNTS
                             (AMOUNTS IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                                        YEAR ENDED JUNE 30,
                                                                     -------------------------
                                                                      1997      1996      1995
                                                                     ------     -----     ----
<S>                                                                  <C>        <C>       <C>
ALLOWANCE FOR DOUBTFUL ACCOUNTS
Balance, beginning of year.........................................  $  640     $ 177     $ --
Additions charged to expense.......................................   1,524       384      154
Additions from acquisitions........................................      --        79       23
Deductions, accounts written-off...................................    (767)       --       --
                                                                     ------     -----     ----
Balance, end of year...............................................  $1,397     $ 640     $177
                                                                     ======     =====     ====
ALLOWANCE FOR SALES RETURNS AND DISCOUNTS
Balance, beginning of year.........................................  $  849     $ 501     $ --
Net additions (reductions) charged (credited) to sales.............     203      (163)     244
Additions from acquisitions........................................      --       511      257
                                                                     ------     -----     ----
Balance, end of year...............................................  $1,052     $ 849     $501
                                                                     ======     =====     ====
ALLOWANCE FOR COOPERATIVE ADVERTISING FUNDS
Balance, beginning of year.........................................  $  191     $ 165     $ --
Net additions (reductions) charged (credited) to sales and
  marketing expense................................................     114        26      165
                                                                     ------     -----     ----
Balance, end of year...............................................  $  305     $ 191     $165
                                                                     ======     =====     ====
</TABLE>
 
                                       S-1
<PAGE>   55
 
                                 EXHIBIT INDEX
 
<TABLE>
<CAPTION>
EXHIBIT
NUMBER                                       DESCRIPTION
-------    --------------------------------------------------------------------------------
<C>        <S>
  2.1      Agreement and Plan of Reorganization dated January 3, 1996 between GZ
           Multimedia, Inc. (formerly Graphix Zone, Inc.), a California corporation
           ("GZ-CA"), and StarPress, Inc., a Colorado corporation ("StarPress"), previously
           filed with the U.S. Securities and Exchange Commission (the "Commission") as
           Exhibit 2.1 to the Company's Registration Statement on Form S-4 dated March 25,
           1996 (Registration No. 333-2642) (the "Registration Statement"), which is
           incorporated herein by reference.
  2.2      Restructuring Plan adopted by the Board of Directors of the Company on June 3,
           1997.
  3.1      Certificate of Incorporation of the Company, previously filed with the
           Commission as Exhibit 3.1 to the Registration Statement, which is incorporated
           herein by reference.
  3.2      Amended and Restated Certificate of Designations of Series A Convertible
           Preferred Stock of the Company, previously filed with the Commission as Exhibit
           3.3 to the Company's Quarterly Report on Form 10-Q for the quarterly period
           ended September 30, 1996 (File No. 0-28676) (the "September 1996 Quarterly
           Report"), which is incorporated herein by reference.
  3.3      Certificate of Amendment of Amended and Restated Certificate of Designations of
           Series A Convertible Preferred Stock of the Company, previously filed with the
           Commission as Exhibit 3.4 to the Company's September 1996 Quarterly Report,
           which is incorporated herein by reference.
  3.4      Certificate of Amendment of Certificate of Designations of Series A Convertible
           Preferred Stock of the Company.
  3.5      Certificate of Designations of Series B Convertible Preferred Stock of the
           Company, previously filed with the Commission as Exhibit 3.1 to the Company's
           Current Report on Form 8-K dated February 18, 1997, and filed with the
           Commission on March 5, 1997 (File No. 0-28676) (the "March 5th Current Report"),
           which is incorporated herein by reference.
  3.6      Certificate of Designations of Series C Convertible Preferred Stock of the
           Company, previously filed as Exhibit 10.34 to the Company's Current Report on
           Form 8-K dated March 5, 1997, and filed with the Commission on March 20, 1997
           (File No. 0-28676) (the "March 20th Current Report"), which is incorporated
           herein by reference.
  3.7      Bylaws of the Company, previously filed with the Commission as Exhibit 3.2 to
           the Registration Statement, which is incorporated herein by reference.
  4.1      Registration Rights Agreements dated January 31, 1994 and February 28, 1994
           among GZ-CA, Frank Cutler, James Cutler, Jr. and Gregory A. Brown, previously
           filed with the Commission as an exhibit to GZ-CA's Registration Statement on
           Form SB-2 dated March 15, 1994 or amendment thereto dated May 15, 1994
           (Registration No. 33-76552-LA) (the "1994 Registration Statement"), which is
           incorporated herein by reference.
  4.2      Form of Registration Rights Agreement dated February 2, 1996 among GZ-CA and
           each of the investors in the GZ-CA 1996 private placement offering (the "1996
           Private Placement"), previously filed with the Commission as Exhibit 10.16 to
           the Registration Statement, which is incorporated herein by reference.
  4.3      Registration Rights Agreement dated March 13, 1996 between GZ-CA and GT
           Interactive Software Corp., a Delaware corporation ("GTIS"), previously filed
           with the Commission as Exhibit 10.7 to the Registration Statement, which is
           incorporated herein by reference.

Management Contracts and Compensatory Plans or Arrangements

 10.1      Warrant Agreements dated January 31, 1994 and February 28, 1994 between GZ-CA
           and Frank Cutler, previously filed with the Commission as an exhibit to the 1994
           Registration Statement, which is incorporated herein by reference.
</TABLE>
<PAGE>   56
 
<TABLE>
<CAPTION>
EXHIBIT
NUMBER                                       DESCRIPTION
-------    --------------------------------------------------------------------------------
<C>        <S>
 10.2      Non-Qualified Stock Option Agreement dated July 1, 1994 between GZ-CA and Frank
           Cutler, previously filed with the Commission as Exhibit 10.4 to GZ-CA's
           Registration Statement on Form S-8 dated December 6, 1994, and filed with the
           Commission on December 9, 1994, which is incorporated herein by reference.
 10.3      Non-Qualified Stock Option Agreement dated January 26, 1995 between GZ-CA and
           John and Anne Aber, previously filed with the Commission as Exhibit 10.20 to
           GZ-CA's Annual Report on Form 10-KSB for the fiscal year ended June 30, 1995,
           and filed with the Commission on October 5, 1995 (File No. 0-24166) (the "GZ-CA
           1995 Annual Report"), which is incorporated herein by reference.
 10.4      Non-Qualified Stock Option Agreement dated January 26, 1995 between GZ-CA and
           John Aber, previously filed with the Commission as Exhibit 10.21 to the GZ-CA
           1995 Annual Report, which is incorporated herein by reference.
 10.5      Non-Qualified Stock Option Agreement dated January 26, 1995 between GZ-CA and
           Anne Aber, previously filed with the Commission as Exhibit 10.22 to the GZ-CA
           1995 Annual Report, which is incorporated herein by reference.
 10.6      Non-Qualified Stock Option Agreement dated January 26, 1995 between GZ-CA and
           Thomas and Honor Vandeveer, previously filed with the Commission as Exhibit
           10.23 to the GZ-CA 1995 Annual Report, which is incorporated herein by
           reference.
 10.7      1996 Stock Option Plan of the Company (the "1996 Plan"), previously filed with
           the Commission as Exhibit 10.1 to the Registration Statement, which is
           incorporated herein by reference.
 10.8      Form of Non-Qualified Stock Option Agreement pertaining to the 1996 Plan,
           previously filed with the Commission as Exhibit 10.2 to the Registration
           Statement, which is incorporated herein by reference.
 10.9      Form of Incentive Stock Option Agreement pertaining to the 1996 Plan, previously
           filed with the Commission as Exhibit 10.3 to the Registration Statement, which
           is incorporated herein by reference.
 10.10     Employment letter dated January 15, 1996 between GZ-CA and Norman H. Block.
 10.11     Separation and Settlement Agreement dated April 18, 1997 between the Company and
           Norman H. Block.
 10.12     Employment Agreement dated June 23, 1995 between StarPress and Ronald S. Posner,
           previously filed with the Commission as an exhibit to StarPress' Annual Report
           on Form 10-KSB for the fiscal year ended June 30, 1995, and filed with the
           Commission on September 27, 1995 (the "StarPress 1995 Annual Report"), which is
           incorporated herein by reference.
 10.13     Promissory Note dated March 21, 1996 in the original principal amount of $41,250
           by Ronald S. Posner in favor of the Company.
 10.14     Separation and Settlement Agreement dated May 21, 1997 among the Company, GZ-CA,
           StarPress and Ronald S. Posner.
 10.15     Employment letter dated March 25, 1996 between the Company and Melissa Orr.
 10.16     Amended and Restated Employment Agreement dated October 28, 1996 between the
           Company and Charles R. Cortright, Jr.
 10.17     Employment letter dated February 26, 1997 between the Company and Robert D.
           Shishino, previously filed with the Commission as Exhibit 10.6 to the Company's
           Quarterly Report on Form 10-Q for the quarterly period ended March 31, 1997, and
           filed with the Commission on May 20, 1997 (File No. 0-28676) (the "March 1997
           Quarterly Report"), which is incorporated herein by reference.
 10.18     Terms of Employment Agreement between the Company and David J. Hirschhorn.
</TABLE>
<PAGE>   57
 
<TABLE>
<CAPTION>
EXHIBIT
NUMBER                                       DESCRIPTION
-------    --------------------------------------------------------------------------------
<C>        <S>
 10.19     Terms of Stock Option granted by the Company to David J. Hirschhorn
 10.20     Confidential Settlement Agreement and Mutual General Release dated October 13,
           1997 and effective as of May 30, 1997 among the Company, Charles Cortright and
           Angela Cortright.
                                                               Other Material Contracts
 10.21     Office Building Lease dated October 10, 1990 between GZ-CA and Masaaki & Fumiko
           Nakaoka, as amended, previously filed with the Commission as an exhibit to the
           1994 Registration Statement, which is incorporated herein by reference.
 10.22     Office Building Lease dated September 13, 1994 between GZ-CA and Pan Pacific
           Investments, as amended by First, Second and Third Amendments, previously filed
           with the Commission as an exhibit to the GZ-CA 1995 Annual Report, which is
           incorporated herein by reference.
 10.23     Joint Venture Agreement dated March 31, 1995 among StarPress Multimedia, Inc., a
           Delaware corporation ("StarPress Multimedia"), Olivetti Systems and Network
           Holdings N.V., previously filed with the Commission as an exhibit to the
           StarPress 1995 Annual Report, which is incorporated herein by reference.
 10.24     Sublease Agreement dated August 13, 1995 between StarPress and International
           Business Machines Corporation, previously filed with the Commission as an
           exhibit to the StarPress 1995 Annual Report, which is incorporated herein by
           reference.
 10.25     Business Loan Agreement dated October 27, 1995 between Silicon Valley Bank and
           StarPress, previously filed with the Commission as an exhibit to StarPress'
           Quarterly Report on Form 10-QSB for the quarterly period ended September 30,
           1995 (the "StarPress September 1995 Quarterly Report"), which is incorporated
           herein by reference.
 10.26     Business Loan Agreement dated June 26, 1996 between GZ-CA and Silicon Valley
           Bank, previously filed with the Commission as Exhibit 10.28 to the Company's
           Annual Report on Form 10-K for the fiscal year ended June 30, 1996 (File No.
           0-28676), which is incorporated herein by reference.
 10.27     Warrant to Purchase Stock dated December 12, 1996 between the Company and
           Silicon Valley Bank.
 10.28     Asset Purchase Agreement dated November 1, 1995 between StarPress and Sony
           Interactive Entertainment, Inc., previously filed with the Commission as an
           exhibit to the StarPress September 1995 Quarterly Report, which is incorporated
           herein by reference.
 10.29     Form of Warrant Agreement entered into between GZ-CA and each of the investors
           in the 1996 Private Placement, previously filed with the Commission as Exhibit
           10.17 to the Registration Statement, which is incorporated herein by reference.
 10.30     Distribution Agreement dated March 13, 1996 among GZ-CA, StarPress and GTIS,
           previously filed with the Commission as Exhibit 10.4 to the Registration
           Statement, which is incorporated herein by reference.
 10.31     Keep-Well Agreement dated March 13, 1996 among the Company, GZ-CA and GTIS,
           previously filed with the Commission as Exhibit 10.5 to the Registration
           Statement, which is incorporated herein by reference.
 10.32     Common Stock Purchase Warrant dated March 13, 1996 between GZ-CA and GTIS,
           previously filed with the Commission as Exhibit 10.6 to the Registration
           Statement, which is incorporated herein by reference.
 10.33     Loan and Security Agreement dated January 31, 1997 between the Company and
           Madeleine L.L.C., a New York limited liability company ("Madeleine"), previously
           filed with the Commission as Exhibit 10.1 to the March 1997 Quarterly Report,
           which is incorporated herein by reference.
</TABLE>
<PAGE>   58
 
<TABLE>
<CAPTION>
EXHIBIT
NUMBER                                       DESCRIPTION
-------    --------------------------------------------------------------------------------
<C>        <S>
 10.34     Amendment No. 1 to Loan and Security Agreement dated March 5, 1997 between the
           Company and Madeleine, previously filed with the Commission as Exhibit 10.3 to
           the March 1997 Quarterly Report, which is incorporated herein by reference.
 10.35     Consent and Amendment Number Two to Loan and Security Agreement dated June 5,
           1997 between the Company and Madeleine.
 10.36     Warrant to Purchase 300,000 Shares of Common Stock dated January 31, 1997
           between the Company and Madeleine, previously filed with the Commission as
           Exhibit 10.2 to the March 1997 Quarterly Report, which is incorporated herein by
           reference.
 10.37     Warrant to Purchase Shares of Common Stock dated June 5, 1997 between the
           Company and Madeleine.
 10.38     Asset Purchase Agreement dated February 24, 1997 among the Company, Inscape and
           Warner Music Group, Inc., previously filed with the Commission as Exhibit 10.32
           to the March 20th Current Report, which is incorporated herein by reference.
 10.39     Asset Purchase Agreement dated February 26, 1997 among the Company, Trimark
           Holdings, Inc. and its subsidiary, Trimark Interactive, previously filed with
           the Commission as Exhibit 10.33 to the March 20th Current Report, which is
           incorporated herein by reference.
 10.40     Form of StarPress 9% Convertible Subordinated Debentures with Warrant
           Agreements, previously filed with the Commission as an exhibit to StarPress'
           Current Report on Form 8-K dated March 31, 1995, which is incorporated herein by
           reference.
 10.41     Sub-Lease Agreement dated June 23, 1997 between the Company and Daimler Commerce
           Partners, L.P. .
 10.42     Promissory Note dated February 3, 1997 in the original principal amount of
           $200,000 by the Company in favor of Middlefield Ventures, Inc.
 10.43     Warrant to Purchase 613,718 Shares of Common Stock of Graphix Zone, Inc. dated
           February 3, 1997 between the Company and Intel Corporation.
 11        Statement Regarding Computation of Per Share Earnings (Loss).
 21        Subsidiaries of the Registrant.
 23.1      Consent of Ernst & Young LLP, independent auditors.
 23.2      Consent of KPMG Peat Marwick LLP, independent auditors.
 27        Financial Data Schedule.
</TABLE>