<PAGE> 1
Filed pursuant to Rule 424(b)(1)
Reg. No. 333-18605
PROSPECTUS 1,600,000 UNITS
[PIRANHA LOGO]
[PIRANHA LOGO]
PIRANHA INTERACTIVE PUBLISHING, INC.(R)
All of the Units being offered hereby (the "Offering") are being sold by
Piranha Interactive Publishing, Inc., a Nevada corporation (together with its
predecessor, the "Company"). Each unit ("Unit") offered by the Company consists
of one share of Common Stock, $.001 par value ("Common Stock"), and one
redeemable Class A Warrant ("Class A Warrant"). The Class A Warrants included in
the Units offered hereby are collectively referred to in this Prospectus as the
"Class A Warrants" or "Warrants." The components of the Units will be separately
transferable immediately upon issuance. Each Class A Warrant entitles the holder
to purchase for $6.50 one share of Common Stock, subject to adjustment, at any
time through the fifth anniversary of the date of this Prospectus. Commencing
one year from the date hereof, the Class A Warrants are subject to redemption by
the Company at a redemption price of $.05 per Warrant on 30 days' written
notice, provided the average closing bid price of the Common Stock for any 30
consecutive trading days ending within 15 days of the notice of redemption
exceeds $9.10 per share (subject to adjustment). See "Description of
Securities".
Prior to this Offering, there has been no public market for the Units,
Common Stock or the Warrants and there can be no assurance that such a market
will develop. The Common Stock, Units and Class A Warrants have each been
approved for quotation on the Nasdaq SmallCap Market ("Nasdaq") under the
symbols "PRAN", "PRANU" and "PRANW", respectively. See "Underwriting" for a
discussion of factors considered in determining the initial public offering
price. FOR INFORMATION CONCERNING A SECURITIES AND EXCHANGE COMMISSION
INVESTIGATION RELATING TO THE REPRESENTATIVE OF THE SEVERAL UNDERWRITERS, SEE
"RISK FACTORS" AND "UNDERWRITING".
Upon completion of this Offering (assuming no exercise of the Underwriters'
over-allotment option), the Officers and Directors of the Company as a group
will hold approximately 50% of the Company's outstanding voting stock, all of
which voting stock is controlled by Timothy M. Brannan, President and Chairman
of the Company, as Voting Trustee under a Voting Trust Agreement and as proxy
pursuant to an Irrevocable Proxy Agreement. See "Principal Stockholders".
------------------
THE SECURITIES OFFERED HEREBY INVOLVE A HIGH DEGREE OF RISK AND IMMEDIATE
SUBSTANTIAL DILUTION. SEE "RISK FACTORS" AND "DILUTION" BEGINNING ON PAGE 7 OF
THIS PROSPECTUS. THESE SECURITIES SHOULD NOT BE PURCHASED BY INVESTORS WHO
CANNOT AFFORD THE LOSS OF THEIR ENTIRE INVESTMENT
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES AGENCY NOR HAS THE COMMISSION OR ANY
SUCH AGENCY PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
==============================================================================================================
PROCEEDS TO
PRICE TO PUBLIC UNDERWRITING COMPANY(2)
DISCOUNTS AND
COMMISSIONS(1)
<S> <C> <C> <C>
- --------------------------------------------------------------------------------------------------------------
Per Unit....................................... $5.00 $.475 $4.525
- --------------------------------------------------------------------------------------------------------------
Total(3)....................................... $8,000,000 $760,000 $7,240,000
==============================================================================================================
</TABLE>
(1) Does not include additional compensation to be received by D.H. Blair
Investment Banking Corp., as representative ("Representative") of the
several underwriters (the "Underwriters"), in the form of (a) a
non-accountable expense allowance payable by the Company to the
Representative equal to 3% ($240,000) of the aggregate initial public
offering price of the Units ($276,000 if the overallotment option is
exercised in full) and (b) an option to the Representative (the "Unit
Purchase Option") to purchase up to 160,000 Units for $6.50 per Unit (130%
of the initial public offering price) during the three-year period
commencing two years after the date of this Prospectus . The Company has
agreed to indemnify the Underwriters against certain liabilities, including
liabilities under the Securities Act of 1933, as amended. See
"Underwriting".
(2) Before deducting expenses of the Offering payable by the Company estimated
at $880,000 ($916,000 if the over-allotment option is exercised in full),
including the Representative's non-accountable expense allowance.
(3) The Company has granted the Underwriters a 30-day option to purchase up to
240,000 additional Units on the same terms and conditions as set forth above
solely to cover over-allotments, if any, subject to the right of the
Representative to elect, in its sole discretion, to exercise such option
individually, and not as representative of the several Underwriters. If the
over-allotment option is exercised in full, the total Price to Public,
Underwriting Discounts and Commissions and Proceeds to Company will be
$9,200,000, $874,000 and $8,326,000, respectively. See "Underwriting".
------------------
The Units are offered by the Underwriters on a "firm commitment" basis,
subject to prior sale, when, as and if delivered to and accepted by the
Underwriters, and subject to the right of the Underwriters to withdraw, cancel
or modify such offer without notice and to reject orders in whole or in part and
to certain other conditions. It is expected that delivery of the certificates
representing the Units will be made at the offices of D.H. Blair Investment
Banking Corp., 44 Wall Street, New York, New York 10005, on or about September
23, 1997.
D.H. BLAIR INVESTMENT BANKING CORP.
The date of this Prospectus is September 18, 1997.
<PAGE> 2
[COMPANY'S LOGO]
Piranha publishes interactive multimedia software providing education,
entertainment, reference and personal productivity titles for the home personal
computer market.
[Photos of six products offered by the Company, clockwise from upper left:
Majestic(TM); Syn-Factor(TM); Travel CD Piranha Pack(TM); Alice's Adventures in
Wonderland; Piranha Pack -- Something for Everyone(TM); and The Academic
Edge(TM)Piranha Pack(TM).]
The Company intends to distribute to its shareholders annual reports
containing financial statements audited by its independent public accountants
and will make available copies of quarterly reports for the first three quarters
of each fiscal year containing unaudited financial information.
CERTAIN PERSONS PARTICIPATING IN THE OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE UNITS. SUCH
TRANSACTIONS MAY INCLUDE THE PURCHASE OF UNITS, THE COMMON STOCK AND WARRANTS,
FOLLOWING THE PRICING OF THE OFFERING TO COVER A SYNDICATE SHORT POSITION IN THE
UNITS, THE COMMON STOCK AND WARRANTS, OR FOR THE PURPOSE OF MAINTAINING THE
PRICE OF THE UNITS AND THE IMPOSITION OF PENALTY BIDS. FOR A DESCRIPTION OF
THESE ACTIVITIES, SEE "UNDERWRITING."
Piranha Interactive Publishing(R), Majestic(TM), Alien Encounter(TM),
Syn-Factor(TM), Treasured Tales(TM), Travel CD Piranha Pack(TM), The Academic
Edge(TM), Piranha Pack -- Something For Everyone(TM), Piranha Pack(TM),
Preschool Mother Goose(TM) and the Piranha logo are trademarks of the Company.
This Prospectus also includes trademarks and trade names of entities other than
the Company.
<PAGE> 3
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information and financial statements (including the notes thereto) appearing
elsewhere in this Prospectus. Unless otherwise indicated, the information in
this Prospectus does not give effect to the exercise of: (i) the Underwriters'
over-allotment option; (ii) the Warrants; or (iii) the Unit Purchase Option.
Except as specifically otherwise set forth elsewhere in this Prospectus, all
share information contained herein gives retroactive effect to (A) the
reincorporation of the Company in the State of Nevada (previously organized and
existing as an Arizona corporation) and a recapitalization effected in November
1996 (the "Recapitalization") consisting of (i) an increase in the Company's
authorized shares of Common Stock to 20,000,000 shares; (ii) the provision for
5,000,000 shares of Preferred Stock, with the designations, powers and
preferences to be determined by the Board of Directors from time to time; and
(iii) the conversion upon such reincorporation and Recapitalization of all of
the issued and outstanding shares of Common Stock, no par value, of the Arizona
corporation into 1,200,000 shares of the Nevada corporation's Common Stock,
$.001 par value, on an approximately 242-for-one basis and (B) an approximately
0.33 share of Common Stock dividend declared by the Company as of August 11,
1997 and issued as to each share of the Company's then outstanding Common Stock.
When used in this Prospectus, unless otherwise specified, the term "Common
Stock" shall refer to the $.001 par value Common Stock of the surviving Nevada
corporation. See "Capitalization" and "Description of Securities".
THE COMPANY
Piranha Interactive Publishing, Inc. (the "Company") publishes interactive
multimedia software products providing education and entertainment as well as
reference and personal productivity titles for the home personal computer ("PC")
market. The Company generally licenses software programs being developed by
independent third party developers. The Company then directs and assists the
developers in finishing the programs according to its specifications, imprints
and duplicates the programs in a media format, packages them in a proprietary
manner, and markets and distributes the finished products under the Piranha name
as well as proprietary titles whenever possible. Since the release of its first
title in August 1995, the Company has licensed and marketed seven titles under
its own label including (i) three "Piranha Packs," each of which offers 10 or 11
individual subject titles relating to a central theme and (ii) four standalone,
individually packaged titles. In addition, the Company has marketed 13 titles
under affiliate relationships with two third party publishers pursuant to
revenue-sharing agreements. To date, the Company has published all of its titles
in computer compact disc read-only memory ("CD-ROM") format. In the future, the
Company may distribute its products in other media, such as digital versatile
disc ("DVD"), on-line information services, television-based formats, telephone
and cable networks and direct broadcast satellite, if market acceptance of such
formats becomes widespread.
The Company intends to focus its product offerings on "edutainment" titles,
which combine entertainment and educational content, games, reference and
personal productivity titles, and other content titles which it determines to
have market potential. The Company has published and plans to publish titles in
various categories, including entertainment (e.g. Majestic: Alien Encounter, a
deep space adventure game), early childhood education (e.g. Treasured Tales
Presents Alice's Adventures in Wonderland, a children's interactive storybook),
reference (e.g. Academic Edge, a 10 CD educational theme pack), and personal
productivity (e.g. Travel CD Piranha Pack, an 11 CD travel and recreational
theme pack). When practicable, the Company publishes titles which are episodic
in design, thereby facilitating the production of sequential products and the
generation of increased customer loyalty. For example, Syn-Factor, the sequel to
the Company's game, Majestic: Alien Encounter, was released in February of 1997.
The Company is also scheduled to release Dead Reckoning, a 3-D action game, and
Cracking the Conspiracy [working title], a 3-D adventure game, during the fourth
quarter of 1997 and the first quarter of 1998, respectively.
The Company's strategy is generally to license its software programs from
independent, third party software developers. The Company believes this strategy
enables it to avoid expending significant financial resources over a lengthy
period of time towards the research and development of a product that may never
achieve significant market acceptance, a substantial burden facing in-house
software development companies.
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As competition for products from independent developers intensifies, however,
the Company may be required to commit significant financial resources to third
party developers in order to obtain desirable programs. By drawing upon
independent developers, the Company is able to capitalize upon the variety of
creative products currently being developed by a growing number of independent
software developers, an increase made possible in part by the availability of
industry standard authoring tools which assist software programmers with the
technical development of the titles. Pursuant to license agreements with these
developers, the Company pays a royalty based upon sales of the product and in
most instances an up-front advance and/or guaranteed minimum royalty payment.
The Company has also designed one title, Preschool Mother Goose, with the
assistance of consultants which it then subcontracted to independent software
programmers for development. The Company may follow the same procedure with
additional future titles.
The Company's growth strategy consists of (i) targeting the growing
home-based, consumer PC market, (ii) building the brand recognition of "Piranha"
title offerings, (iii) expanding and enhancing its portfolio of interactive
multimedia software products by generally licensing software programs from third
party developers who are in the process of developing such products, (iv)
expanding the placement of Piranha products with retailers and distributors, and
(v) seeking out appropriate strategic relationships, including the acquisition
of other software publishers.
The Company presently sells its products to retailers and distributors
through its own direct sales and marketing efforts. The Company's marketing
activities include channel marketing in partnership with its retailers and
distributors; direct advertising in PC periodicals; Internet website demos and
advertising; trade shows; and pre-release marketing. Since its inception in
November 1994, the Company has entered into distribution agreements with several
large national software distributors, as well as a number of other smaller and
specialty distributors. The Company currently places its products with a number
of the largest software retailers (in terms of software sales volume) in the
United States.
The Company's management team has worked closely together for the past
three to six years and all have prior software publishing experience. The
Company was incorporated in Arizona on November 14, 1994 and reincorporated in
Nevada on November 22, 1996. Its corporate headquarters are located at 1839 West
Drake, Suite B, Tempe, Arizona 85283, and its telephone number is (602)
491-0500. The Company's website address is http://www.piranhainteractive.com.
------------------------
This Prospectus contains "forward-looking statements," including statements
regarding, among other items, the Company's growth strategy, future products,
sales, ability to license future software programs and market products and
anticipated trends in the Company's business. Actual results could differ
materially from these forward-looking statements as a result of a number of
factors, including, but not limited to, the Company's early stage of
development, the need for additional financing, intense competition in various
aspects of its business, the seasonal nature of its business, its dependence on
third party authors and key personnel, and other factors described under "Risk
Factors" and elsewhere herein.
4
<PAGE> 5
THE OFFERING
Securities Offered by the
Company..................
1,600,000 Units, each Unit consisting of one share of
Common Stock and one Class A Warrant. Each Class A
Warrant is exercisable at any time through the fifth
anniversary of the date of this Prospectus to
purchase one share of Common Stock for $6.50,
subject to adjustment. The Class A Warrants are
subject to redemption by the Company at $.05 per
Warrant upon 30 days prior written notice at any
time commencing one year from the date of this
Prospectus in certain circumstances. The Common
Stock and Class A Warrants will be separately
tradeable immediately upon issuance. See
"Description of Securities".
Common Stock Outstanding
Before Offering(1).......
1,600,000 shares(2)(3)
Common Stock Outstanding
After Offering(1)........
3,200,000 shares(2)(3)(4)
Use of Proceeds............
The Company intends to use the proceeds for repayment
of an aggregate of $1,620,000 principal amount of
notes issued pursuant to the Bridge Financing (the
"Bridge Notes"), including accrued interest;
repayment of an aggregate of $625,000 principal
amount of notes issued to the Representative and a
corporation controlled by a family member of the
sole stockholder of the Representative
(collectively, the "Representative Notes"),
including accrued interest; acquisition of software
programs; sales and marketing costs, including
salaries for additional personnel; and working
capital. See "Use of Proceeds" and "Underwriting".
Risk Factors...............
The securities offered hereby involve a high degree of
risk and will result in immediate substantial
dilution to public investors. An investment in the
Units offered hereby should be made only after a
careful consideration of the various risks which may
affect the Company and its operations. See "Risk
Factors" and "Dilution".
Nasdaq Symbols.............
Common Stock -- PRAN
Units -- PRANU
Class A
Warrants -- PRANW
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(1) For a description of the voting and other rights of the Common Stock, see
"Description of Securities -- Common Stock".
(2) Does not include 66,500 shares of Common Stock which are issuable upon
exercise of options to be outstanding at the closing of the Offering at an
exercise price of $5.00 and 233,500 shares of Common Stock reserved for
issuance upon future grants of options to be issued under the Company's 1996
Stock Option Plan. See "Management -- 1996 Stock Option Plan".
(3) Includes 1,225,000 shares of Common Stock (the "Escrow Shares") which have
been deposited into escrow by the holders thereof on a pro rata basis. The
Escrow Shares are subject to cancellation and will be contributed to the
capital of the Company if the Company does not attain certain earnings
levels or the market price of the Company's Common Stock does not achieve
certain levels during the next five years. If such earnings or market price
levels are met, the Company will record a substantial non-cash charge to
earnings, for financial reporting purposes, as compensation expense relating
to the value of the Escrow Shares released to Company officers, directors,
employees and consultants. See "Risk Factors -- Charges and Potential
Charges to Earnings", "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Potential Charges to Income", and
"Principal Stockholders".
(4) Does not include shares of Common Stock issuable upon exercise of (i) the
Unit Purchase Option and the Class A Warrants underlying the Unit Purchase
Option; (ii) the Class A Warrants forming part of the Units offered hereby;
(iii) the Units included in the Underwriters' over-allotment option; and
(iv) the 750,000 Class A Warrants to be issued to holders of the Bridge
Warrants. See "Capitalization -- Bridge Financing", "Description of
Securities", "Shares Eligible for Future Sale", and "Underwriting".
5
<PAGE> 6
SUMMARY FINANCIAL INFORMATION
STATEMENT OF OPERATIONS DATA:
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
YEAR ENDED YEAR ENDED (UNAUDITED)
DECEMBER 31, DECEMBER 31, ----------------------
1995 1996 1996 1997
----------------- ------------ --------- ----------
<S> <C> <C> <C> <C>
Net Sales................................... $ 1,342,034 $ 424,810 $ 353,144 $ 67,656
Costs and Expenses.......................... 1,153,891 1,337,148 695,607 1,019,502
Net income (loss)........................... 188,143 (912,338) (342,463) (951,846)
Net loss per common share(1)................ $ (2.54)
Shares used in computing net loss per common
share(1).................................. 375,000
Pro forma net income (loss)(2).............. 109,123 (834,874) (312,385)
Pro forma net income (loss) per common
share(1):................................. $ 0.26 $ (2.11) $ (0.75)
Shares used in computing pro forma net
income (loss) per common share(1):........ 417,334 395,565 416,244
</TABLE>
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(1) The Escrow Shares are excluded from the computation of net loss per common
share. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Potential Charges to Income" and Note 13 of Notes
to Financial Statements.
(2) From inception, until November 15, 1996, the Company elected to be treated
as a Subchapter S corporation for federal income tax purposes. As such, all
tax liability flowed through to the individual shareholders. The pro forma
financial data presented herein is as if the Company had been a C
corporation for federal income tax purposes from inception at an assumed tax
rate of 42%.
BALANCE SHEET DATA:
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30, 1997
---------------------- -------------------------------
1995 1996 ACTUAL AS ADJUSTED(1)
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<S> <C> <C> <C> <C>
Current assets........................... $491,086 $ 493,506 $ 304,197 $ 4,837,916
Working capital (deficit)................ 173,926 (1,214,783) (2,266,370) 4,563,350
Total assets............................. 521,166 1,053,870 964,841 4,913,201
Total liabilities........................ 353,704 1,755,892 2,618,709 322,708
Stockholders' equity (deficit)........... 167,462 (702,022) (1,653,868) 4,590,493
</TABLE>
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(1) Adjusted to give effect to the sale of the 1,600,000 Units offered hereby at
an initial public offering price of $5.00 per Unit less underwriter
discounts, commissions and estimated expenses of the Offering and the
repayment of the Bridge Notes and the Representative Notes. See "Use of
Proceeds" and "Management's Discussion and Analysis of Financial Condition
and Results of Operations".
6
<PAGE> 7
RISK FACTORS
An investment in the securities offered hereby involves a high degree of
risk and should only be made by investors who can afford the loss of their
entire investment. Prospective investors, prior to making an investment
decision, should give careful consideration, in addition to the other
information contained in this Prospectus, to the following risk factors. This
Prospectus contains "forward-looking statements," including statements
regarding, among other items, the Company's growth strategy, future products,
sales, ability to license future software programs and market products and
anticipated trends in the Company's business. Actual results could differ
materially from these forward-looking statements as a result of a number of
factors, including, but not limited to, the Company's early stage of
development, the need for additional financing, intense competition in various
aspects of its business, the seasonal nature of its business, its dependence on
third party authors and key personnel, and other factors described in the Risk
Factors sections set forth below and elsewhere herein.
EARLY STAGE COMPANY; LIMITED OPERATING HISTORY. The Company commenced
operations in November 1994 and began shipping its products in August 1995. The
Company's financial statements for the period ended December 31, 1996, reflect
deficits for working capital as well as a total stockholders' deficit of
$(702,022) and an accumulated deficit of $(212,519). The Company's financial
statements for the six month period ended June 30, 1997, reflect deficits for
working capital as well as a total stockholders' deficit of $(1,653,868) and an
accumulated deficit of $(1,164,365). Although the Company was profitable during
the fourth quarter of 1995, since that time it has incurred losses. The
Company's profitability in 1995 was enhanced due to the fact that the Company
had not then incurred expenses to develop necessary infrastructure nor incurred
any significant overhead. The Company's founders did not begin drawing salaries
until October 1995. In addition, the Company's working capital deficiency during
the last three quarters of 1996 and the first half of 1997 materially hampered
its ability to launch new products or sell sufficient quantities of existing
products in accordance with its business strategy. Accordingly, past results are
not indicative of future performance. The Company's ability to expand its
operations is dependent upon a number of factors such as the availability of
appropriate programs to the Company, the Company's marketing efforts, trends in
personal computer sales and usage, changes in available technology, changes in
the competitive environment of personal computer software and general economic
conditions. Many of these factors are outside the Company's control and changes
in these factors or the emergence of new competitive or other factors cannot be
accurately predicted. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
ACCUMULATED DEFICIT; WORKING CAPITAL AND CAPITAL DEFICITS. To become
profitable, the Company will need to substantially expand its product offerings.
In the past, the Company's revenues have been concentrated in only a few
products, with three products resulting in 90% of annual net sales for 1995, two
products resulting in 78% of annual net sales for 1996 and three products
resulting in 80% of net sales for the six month period ended June 30, 1997.
However, the Company believes this concentration to be largely a result of the
limited number of products offered to date, and the Company intends to market a
broader variety and number of titles in the future consistent with its business
strategy. In the past, the Company's ability to release new products as well as
its ability to ship existing products in a timely manner and in sufficient
quantities to meet customer demand have been hampered by its inability to
generate sufficient cash flows from operations and its inability to raise
capital from external sources. The Company's financial statements for the year
ended December 31, 1996 and the six month period ended June 30, 1997 reflect
deficits for total capital and working capital as well as an accumulated deficit
in retained earnings. Furthermore, the Company does not have experience
marketing a significant number of products, and there can be no assurance that
it will be able to do so successfully. There can be no assurance that revenues
will increase significantly in the future or that the Company will achieve
ongoing profitable operations. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and "Business".
THE COMPANY'S ABILITY TO CONTINUE AS A GOING CONCERN. The Company has
received a report from its independent auditors that includes an explanatory
paragraph regarding uncertainty as to the ability of the Company to continue as
a going concern. Among the factors raising substantial doubt as to the Company's
ability to continue as a going concern is the Company's difficulty in generating
sufficient cash flows from operations, and its subsequent working capital
deficiency. The Company has incurred operating losses and may
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<PAGE> 8
continue to do so in the future. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations," and "Financial
Statements -- Report of Independent Auditors."
NEED FOR ADDITIONAL FINANCING. The Company has significant cash
requirements in connection with its business. In addition to its working capital
requirements, the Company must fund the production and marketing of its products
prior to the time the products are available for sale. Additionally, the Company
in most cases pays upfront advances and/or guaranteed royalties to third party
authors, which expenditures are expected to significantly increase as the
Company expands its product lines. See "Risk Factors -- Dependence on Third
Party Authors." The Company's potential receipt of revenues from product sales
are subject to substantial contingencies, and there can be no assurances
concerning the timing and amount of future revenues from product sales.
Additionally, the Company generally does not receive payment from its retail and
distribution customers until a period after products are sold to end-users.
Historically, the Company has received such payments from between 90 to 120 days
after shipment of its products. This slow revenue receipt cycle which has
occurred in the past, and is expected to continue in the future, has resulted in
the Company having inadequate working capital to maintain its distribution
pipelines, fund publication of new products or otherwise fund its ongoing
operations. Further, the Company's sales are seasonal and, accordingly, during a
significant portion of its fiscal year the Company's revenues have been, and may
in the future be, insufficient to fund its operating expenses. The Company will
attempt to obtain credit, such as a revolving loan facility, to alleviate the
effects of its cash flow cycles, but there can be no assurance that the Company
will obtain such credit on satisfactory terms or at all.
The Company expects that the net proceeds of this Offering will enable it
to meet its liquidity and capital requirements for approximately 12 months
following completion of the Offering, although the Company's capital
requirements are subject to numerous contingencies associated with early-stage
companies. The Company may be required to seek additional financing in the event
of delays, cost overruns or unanticipated expenses associated with a company in
an early stage of development, or in the event the Company does not realize
anticipated revenues. In addition, the Company may require additional financing
in the future to further expand its product offerings or to make strategic
acquisitions. There can be no assurance that such additional financing will be
available, or that, if available, such financing will be obtainable on terms
favorable to the Company or its stockholders. The Company has no commitment for
any such financing and in the event such necessary financing is not obtained,
the Company's operations will be materially adversely affected and the Company
will have to cease or substantially reduce operations. Any additional equity
financings may be dilutive to stockholders, and debt financings, if available,
may involve restrictive covenants. See "Use of Proceeds" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations".
SEASONALITY; FLUCTUATIONS IN QUARTERLY RESULTS. A significant portion of
the Company's operating expenses are relatively fixed, and planned expenditures
are based in part on sales forecasts. If net sales do not meet the Company's
expectations, the Company's business, operating results and financial condition
could be materially adversely affected. Further, the edutainment and games
software business is highly seasonal. Net revenues are typically significantly
higher during the fourth calendar quarter, due primarily to the increased demand
for such software during the year-end holiday buying season. As the Company's
profitability significantly depends on sales made in the fourth quarter, the
Company's operations could be materially adversely affected by an economic
downturn in any fourth quarter. Additionally, if product introductions planned
for the peak holiday season are delayed, the Company's operating results could
be materially adversely affected. Net revenues in other quarters are generally
lower and vary significantly as a result of new product introductions and other
factors. There can be no assurance that the Company will achieve consistent
profitability on a quarterly or annual basis. As a result of its working capital
deficiency during the last three quarters of 1996 and the six month period ended
June 30, 1997, the Company's net sales were materially hampered by its inability
to launch new products and, during the second and third quarters of 1996, to
ship quantities of products sufficient to satisfy customer demand.
The Company has experienced, and expects to continue to experience,
significant fluctuations in quarterly operating results due to a variety of
factors, including the size and rate of growth of the consumer multimedia
software market, market acceptance of the Company's products and those of its
competitors, development and promotional expenses relating to the introduction
of new products or new versions of existing products,
8
<PAGE> 9
projected and actual changes in computing platforms, the timing and success of
product introductions, product returns, changes in pricing policies by the
Company and its competitors, the accuracy of retailers' forecasts of consumer
demand, the timing of orders from major customers, order cancellations and
delays in shipment. In response to competitive pressures, the Company may take
certain pricing or marketing actions that could materially adversely affect the
Company's business, operating results and financial condition. Products are
generally shipped as orders are received, and accordingly the Company operates
with little backlog. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
DEPENDENCE ON THIRD PARTY AUTHORS; DEPENDENCE ON LICENSES. The Company
does not generally develop or own the source code to its products, but licenses
software programs from third party developers. Although the Company believes
that the lack of in-house program developers generally represents a cost
advantage, currently the Company is entirely dependent on third party authors
for the development of new software products. Additionally, as competition for
products of third party authors increases, the Company may be required to pay
significant sums to its third party developers in order to acquire desirable
products. Such expenditures may, for some products, offset any cost advantage
the Company may have over competitors who rely upon in-house developers. The
Company typically receives many new programs each month for evaluation from
independent software developers; however, there can be no assurance that the
Company will continue to obtain a supply of quality software programs from
independent authors. In order to generate a profit, the Company will need a
substantial number of new products, and competition among software publishers
for licenses with independent authors is intensifying. In the future, the
Company may be required to provide significantly higher advance payments,
guaranteed minimum royalties and/or greater royalty percentages to independent
authors in order to compete for licenses of their products. If the Company is
unable to license or acquire new products which are responsive to consumer
preferences in a timely manner in order to offset decreasing revenue from
products reaching the end of their life cycle, the Company's results of
operations will be adversely affected. See "Business -- Products."
INTENSE COMPETITION. The consumer software industry is intensely
competitive and subject to rapid change. The Company believes that the principal
competitive factors affecting the markets for its titles include content,
quality, brand recognition, the Company's reputation, price, marketing,
distribution, access to retail shelf space and critical reviews. These factors
could be affected by the Company's ability to license products developed by
third party authors which gain market acceptance and enhance the Company's
reputation with distributors, retailers and consumers. In addition, consumer
demand for particular software products may be adversely affected by the
increasing number of competitive products from which to choose, making it
difficult to predict the Company's future success in publishing packaged
software products for the retail market. Rapid changes in technology, product
obsolescence and advances in computer hardware require the Company to develop or
acquire new products and to enhance its existing products on a timely basis. The
Company's marketplace has recently experienced a higher emphasis on on-line and
Internet related services and content tailored for these new media. To the
extent that demand increases for on-line products and content, the demand for
the Company's existing products and future performance may change.
The consumer multimedia software market is highly fragmented with products
offered by many vendors. The Company's products compete directly with those of
large and established software companies, such as GT Interactive, Broderbund,
and The Learning Company, as well as a large number of small independent
publishers similar to the Company. Most of these competitors have greater
financial, technical, marketing, sales and customer support resources, as well
as greater name recognition and access to customers than the Company. Due to the
low technical and economic barriers to entry into the multimedia software
market, the Company anticipates facing additional competition from an increasing
number of small, privately-held competitors. The Company will compete with such
companies not only for retail shelf space and sales, but also for obtaining
licenses for software programs being developed by third parties. In addition,
many large companies with sophisticated product marketing and technical
abilities and financial resources that do not presently compete with the Company
may enter the multimedia software market. For example, entertainment companies
have begun to produce and directly market their own titles, featuring their
proprietary characters, to the consumer software market. To the extent that
competitors, as a result of their purchasing capacity, have greater access to
financial and other resources or achieve a performance, price or distribution
advantage, the
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Company's business and results of operations could be adversely affected.
Furthermore, the Company anticipates that there will be consolidation of the
consumer multimedia market around a smaller number of vendors who may be better
positioned and have greater resources with which to compete than the Company.
The Company will also face increased competition as it seeks to deliver
multimedia content through other new media, such as the World Wide Web, the
Internet and on-line proprietary services. There is no assurance that the
Company will have the resources required to respond to market or technological
changes or to compete successfully in the future. See "Business -- Competition."
The Company's success will be dependent upon, among other factors, its
ability to publish products that will achieve significant market penetration and
yield profitable margins. To the extent the Company's products do not gain
market acceptance, its operating results will be adversely affected. In
addition, such product failures could adversely impact the Company's reputation
in the industry and impact its ability to secure access to retail shelf space
and distribution channels and to attract new developers.
COMPETITION FOR RETAIL SHELF SPACE AND PROMOTIONAL SUPPORT. The
competition for shelf space in retail stores is intense. To the extent that the
number of consumer software products and computer platforms increases, this
competition for shelf space may further intensify. At present, the Company's
products constitute a small percentage of a retailer's sales volume, and there
can be no assurance that retailers will provide the Company's products with
adequate levels of shelf space and promotional support. Increased competition
could result in loss of shelf space for, and reduction in sell-through of, the
Company's products at retail stores, as well as significant price competition,
any of which could adversely affect the Company's business, operating results
and financial condition.
The retail multimedia software market has experienced rapid change in
recent years, including consolidations and financial difficulties. These changes
have resulted in a greater degree of unpredictability as to retailer customer
accounts as well as increased competition for retail shelf space. To the extent
any retailers upon which the Company is dependent were to suffer financial
difficulties, the Company's operations could be materially adversely affected.
Due to increased competition for limited retail shelf space and promotional
resources, retailers and distributors are increasingly in a better position to
negotiate favorable terms of sale, including price discounts and product return
policies, as well as cooperative market development funds. Retailers often
require software publishers to pay fees in exchange for preferred shelf space.
The amounts paid to retailers by software publishers and distributors for
preferred shelf space are generally determined on a case by case basis and there
is, as of yet, no industry standard for determining such fees, although larger
publishers and distributors will likely have a competitive advantage in this
regard to the extent they have greater financial resources and negotiating
leverage. See "Business -- Competition."
COMPETITION FOR DISTRIBUTION CHANNELS; DISTRIBUTION RISKS. Sales to a
limited number of distributors have and will continue to constitute a
substantial portion of the Company's revenues. The Company's agreements with its
distributors generally are terminable by either party, with or without cause and
contain no minimum purchase obligations. During the year ended December 31,
1996, sales to three distributors accounted for approximately 21%, 18% and 11%,
respectively, of the Company's net sales. During the six month period ended June
30, 1997, sales to three distributors accounted for approximately 35%, 12% and
10%, respectively, of the Company's net sales during such period. If the Company
were to lose all or a significant portion of the revenue attributable to its
principal distributors, or its principal distributors were to lose sales of the
Company's products to their principal accounts, the loss could have a material
adverse effect on the Company's operating results. In addition, the retail sales
of the Company's products have in the past and may in the future be heavily
concentrated among a few retailers. During the year ended December 31, 1996,
sales to two retailers accounted for approximately 20% and 7% respectively, of
the Company's net sales. During the six month period ended June 30, 1997, no
single retailer accounted for more than 2%, of the Company's net sales during
such period. However, management believes that its sales during such six month
period are not necessarily indicative of the results that may be expected for
future periods as its working capital deficiency experienced during such period
prevented the Company from launching new titles. Competition for access to
distributors, as well as for retail shelf space, is intense. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
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The type and number of distribution channels is increasing to include
non-traditional software retailers such as book, music, video, magazine, toy,
gift, convenience, drug and grocery store chains. Additionally, as technology
changes, the type and number of distribution channels will further change and
new types of competitors, such as cable or telephone companies, and new
distribution channels are likely to emerge. These new methods may include
delivery of software using on-line services or the Internet, which will
necessitate certain changes in the Company's business and operations, including
without limitation, addressing operational challenges such as improving download
time for pictures, images and programs, ensuring proper regulation of content
quality and developing sophisticated security for transmitting payments. Rapid
growth in the use of and interest in the Internet and the World Wide Web is a
recent phenomenon. The Company cannot accurately predict the impact on-line
media will have on the retail computer software industry. Should on-line
distribution channels increase, the Company will be required to modify its
existing technology bases in order for its products to be compatible and thereby
remain competitive. It is critical to the success of the Company that, as these
changes occur, it maintain access to such channels of software distribution in
its market segments. See "Business -- Sales and Marketing".
Even within traditional channels of distribution for consumer software
products there has been rapid change among distributors, including
consolidations and financial difficulties. These factors affecting distribution
channels could negatively affect the Company's business and results of
operations. With increasing concentration in the traditional channels of
distribution, the Company's customers have increased leverage in negotiating
favorable terms of sale, including price discounts and product return policies.
In addition, a number of the Company's larger competitors have attempted, with
some success, to enter into exclusive software distribution arrangements with
certain retail outlets. If the occurrence of these exclusive arrangements
increases and the Company is not able to offer a competing product line or
arrangement, the Company's operating results may be negatively impacted. See
"Business -- Competition."
The Company's management believes that the establishment and maintenance of
good relations with its retailers and distributors is directly related to its
ability to gain access to limited shelf space and promotional resources. In
connection with the Company's initial organization and start-up, members of its
management and other employees expended significant resources towards the
establishment of relationships with retailers, distributors and their respective
buyers in anticipation of marketing its products to such distribution channels.
As a result of the Company's inability to secure a revolving line of credit or
other source of financing, the Company experienced a severe working capital
deficiency during the last three quarters of 1996 and the first half of 1997.
This deficiency hampered the Company's ability to capitalize upon new
distributor relationships by shipping sufficient quantities of existing products
to satisfy consumer demand and/or launch new products. While the Company
believes that such limitations have not adversely affected its credibility with
such distributors and retailers, there can be no assurances in this regard.
LICENSING ARRANGEMENTS. The Company's rights to license most of its
software products included in the multiple CD-ROM Piranha Packs are
non-exclusive and, generally, of short duration. When licensing standalone,
individually packaged titles, the Company attempts to obtain exclusive licenses
for a longer term (to date, ranging from three years to six years). The
Company's exclusive license arrangements, however, may become non-exclusive or
terminate if the Company does not satisfy certain performance criteria, such as
selling a minimum amount of units or paying a minimum amount of royalties. There
is no assurance the Company will be able to continue to obtain new products from
developers or to maintain or expand its market share in the event that a
competitor offers the same or similar software products. In circumstances where
the Company has non-exclusive rights, the Company's competitive advantage, if
any, will be limited to its ability to obtain and market in a timely manner
software which is responsive to consumer preferences.
The Company has prepaid in the past, and anticipates that it will prepay in
the future, royalties to third party developers. In addition, the Company
anticipates that the amounts of prepaid royalties which it will pay in the
future are likely to significantly exceed amounts previously paid. There can be
no assurance that the sales of products associated with such royalties will be
sufficient to cover the amount of such prepayment or any guaranteed minimum
royalties. Companies with greater financial resources than the Company may be
able to make higher offers or guarantees to developers of commercially desirable
multimedia software products than the Company is able to make. As competition
for products of independent developers
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intensifies, the Company may not be able to obtain the products that it desires,
or may be required to reduce its profit margins and pay significantly greater
royalties, signing bonuses and/or advances against royalties in order to license
desired software programs. See "Business -- Intellectual Property Licenses and
Distribution Agreements."
POTENTIAL ADVERSE EFFECT OF REDEMPTION OF WARRANTS. Commencing one year
from the date hereof, the Class A Warrants may be redeemed by the Company at a
redemption price of $.05 per Warrant upon 30 days' notice provided the average
closing bid price (as defined therein) of the Common Stock for any 30
consecutive trading days ending within 15 days of the notice of redemption
exceeds $9.10 (subject to adjustment). Notice by the Company of its intent to
redeem the Warrants could force the holders to exercise the Warrants and pay the
exercise price at a time when it may be disadvantageous for the holders to do
so, to sell the Warrants at the then current market price when they might
otherwise wish to hold the Warrants, or to accept the redemption price, which is
likely to be substantially less than the market value of the Warrants at the
time of redemption. See "Description of Securities -- Redeemable Warrants".
DEPENDENCE ON KEY PERSONNEL; NEED FOR ADDITIONAL PERSONNEL. The operations
of the Company depend to a significant extent upon the efforts of Timothy M.
Brannan, Chairman of the Board and President, who is substantially responsible
for planning and guiding the Company's direction. In addition, the Company's
success depends upon the contributions of Keith P. Higginson, Chief Financial
Officer, J. Wade Stallings, II, Vice President and General Counsel, Douglas M.
Brannan, Vice President of Sales, and Wyndi D. Ballard, Vice President of
Marketing and Public Relations, each of whose responsibilities for the Company's
operations and strategic planning are very substantial. The loss of any of these
key employees would adversely affect the Company's business. The Company has
obtained $2,000,000 key man life insurance policies on each of the lives of
Messrs. Timothy M. Brannan, Higginson, Stallings and Douglas M. Brannan. See
"Management".
The Company currently has only twelve full-time employees, and will need to
recruit, hire and train additional personnel in order to fulfill its business
objectives. Because of the multifaceted and intensely competitive nature of the
multimedia industry, key personnel often require a unique combination of
creative and technical talents, as well as industry reputation. Such personnel
are in short supply, and the competition for their services is intense. The
process of identifying and recruiting key creative, technical and management
personnel with the requisite combination of skills and other attributes
necessary to execute the Company's strategy is expected to be lengthy. The
Company has entered into three-year employment contracts with each of Messrs.
Timothy M. Brannan, Higginson, Stallings, and Douglas M. Brannan and Ms.
Ballard; however, all other employees are currently subject to at-will
employment agreements, which are generally terminable at any time. The loss of
the services of any key personnel or the Company's failure to attract additional
qualified employees could have a material adverse effect on the Company's
business and results of operations. See "Management."
PRODUCT DELAYS AND LIFECYCLES. The Company expends substantial resources
in connection with the initial launch of a new product, which activities
anticipate a particular retail availability date. Any failure to release a new
product as scheduled could result in the inability to recoup such expenditures
and loss of marketing opportunities, retailer fees and consumer interest.
Consumer preference for multimedia software products is difficult to predict,
and only a small percentage of such products enjoy sustained market acceptance.
The Company's success depends upon its ability to publish new, commercially
successful products and to replace revenues from products at the later stages of
their life cycles. There can be no assurance that new products introduced by the
Company will achieve any significant market acceptance or that if such
acceptance occurs, it will be sustained for any significant period. If the
Company does not anticipate and respond to changing demand for its products in a
timely manner, the Company's business, operating results and financial condition
will be materially adversely affected.
The introduction of new products is subject to the inherent risks of
development and manufacturing delays. The Company has in the past and may in the
future experience delays in introducing its products. In the past, the Company's
working capital deficiency has prevented it from shipping its products in a
timely manner and in sufficient quantities to meet customer demand. A
significant delay in the introduction of, or the presence of a defect in, one or
more new products could have a material adverse effect on the ultimate success
of such products and on the Company's business, operating results and financial
condition, particularly in view
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of the seasonality of the Company's business. Delays in a product introduction
near the end of the Company's third quarter may materially adversely affect
operating results for the entire year, as initial shipments of a product may be
delayed and result in an inability of the Company to capitalize upon the
historical trend of the fourth quarter holiday season being the most
significant, in terms of sales volume, each year. Any such delays could cause
the Company to miss this important selling season or other opportunities and
result in a corresponding negative impact on revenues and results of operations.
See "Business -- Products," and "Business -- Sales and Marketing."
PRICE PROTECTIONS AND PRODUCT RETURNS. Industry practice and competitive
pressures generally require the Company to accept returns from distributors and
retailers of the Company's unsold products, including defective, shelfworn and
damaged products, or to reduce the price of previously shipped products to
enable retailers to sell slow moving inventories. The Company's agreements with
its distributors and retailers generally require that sales to a contracting
distributor or retailer be made at a price no greater than that at which product
is sold to any other like distributor or retailer, respectively, and provide
price protection for on-hand inventory in the form of credits to the contracting
distributor or retailer if the Company sells or discounts a particular product
to another distributor or retailer at a price that is lower than the price at
which that product was sold to the contracting distributor or retailer,
respectively. In addition, the Company's agreements with its retailers and
distributors require it to accept returns of products that are not sold. If all
or a significant portion of products are not purchased by consumers, and
distributors and retailers demand that the Company accept returns of the unsold
products, the Company's business, operating results and financial condition
could be materially adversely affected.
At the time of product shipment, the Company establishes reserves,
including reserves which estimate the potential for future returns based on
seasonal terms of sale and distributor and retailer inventories of the Company's
products, as well as other factors. The Company recognizes revenue from the sale
of its products upon delivery except for sales made to certain distributors
where the right of ownership does not pass at delivery. Product returns or price
protection concessions that exceed the Company's reserves could materially
adversely affect the Company's business, operating results and financial
condition and could increase the magnitude of quarterly fluctuations in the
Company's operating and financial results. Furthermore, if the Company's
assessment of the creditworthiness of its customers receiving product on credit
proves incorrect, the Company could be required to significantly increase the
reserves previously established. There can be no assurance that such future
write-offs will not occur or that amounts written off will not have a material
adverse effect on the Company's business, results of operations and financial
condition.
SIGNIFICANT PRICE REDUCTIONS IN PERSONAL COMPUTER SOFTWARE. Recently,
several major publishers of multimedia software have significantly reduced the
prices of their products with the goal of gaining greater market share.
Competition in Microsoft's Windows application segment from major software
publishers is intensifying, and "competitive upgrade" price discounting among
the major firms is eroding the traditional pricing structures that had
previously existed in the software industry. The Company expects to encounter
increasing price competition in the future. Competitive pressures could result
not only in sustained price reductions, but also in a decline in sales volume.
Such declines could result in a decrease in the revenues from, and gross margins
on, sales of such products in the future and could result in lower cash flow or
operating margins. See "Business -- Competition."
RAPID TECHNOLOGICAL DEVELOPMENT AND SOFTWARE MARKET CHANGES. The market
for interactive multimedia software titles continues to evolve and is dependent
upon a number of variables, including consumer preferences, shipments of new
multimedia PCs, the installed base of multimedia PCs and the number of other
developers and publishers creating interactive multimedia software titles to
satisfy market demand. In addition, consumer preferences for particular software
products and titles are subject to rapid change and are highly reactive to
changes in computer technology. Changes in technology and consumer preferences
may render software being marketed by the Company obsolete. In particular, a
continually expanding consumer demand for content-rich multimedia products has
resulted in short life spans for software products. There can be no assurance
that the Company will be able to acquire innovative new products reflecting
technological change and consumer preferences, or that it will do so in a timely
manner. The inability of the Company to publish multimedia software products for
hardware technology with wide consumer acceptance and with high
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consumer appeal could result in a material adverse affect on the Company's
business, results of operations and financial condition. See
"Business -- Competition."
CHANGING PRODUCT PLATFORMS AND FORMATS. The Company's software products
are intended to be used on personal computer hardware systems built by third
party manufacturers. The operating systems of machines currently being
manufactured are characterized by several competing and incompatible formats or
"platforms", and new platforms will likely be introduced in the future.
Currently, Microsoft Corporation is the dominant supplier of computer operating
systems and frequently coordinates its operating system marketing efforts with
those for its applications software. In the future, interactive multimedia
titles may be accessible through such platforms as telephone, cable network and
direct broadcast satellite delivery. The Company's success is dependent upon,
among other things, its ability to anticipate future changes in platforms and
their acceptance by the market and to develop compatible software for such
platforms, of which there is no assurance. If the Company invests in software
products for a platform that does not achieve significant market penetration,
the Company's planned revenues from those products will be adversely affected
and it may not recover its development investment. If the Company does not
choose to develop or is unable to develop, due to resource constraints or other
factors, software products for a platform that achieves significant market
success in a timely manner, the Company's revenues may also be adversely
affected. Although the Company is optimistic that it can obtain, where
necessary, licenses to use these platforms, no assurances can be given that such
licenses can be obtained or that they can be obtained on commercially reasonable
terms. The inability of the Company to obtain a license to use a particular
platform or platforms could have a material adverse effect on the Company's
business.
To date, all of the Company's products have been produced, and all of its
product development efforts are directed at creating new products, on CD-ROM
format. Although the Company believes that it would be able to develop software
compatible with new formats in a timely manner, a leveling off or decline in
sales of CD-ROMs could have a material adverse effect on the Company's results
of operations. In addition, although the Company believes that most elements of
its operations and business strategy are applicable to and may be utilized in
the creation of multimedia software products for additional platforms, there can
be no assurance that the Company will be able to adapt its products and
operations to emerging hardware platforms or to successfully create multimedia
software titles for such platforms. "Business -- Products."
DEPENDENCE ON PC SALES. Personal computer software sales are highly
dependent upon sales of personal computers. During recent years, segments of the
PC industry have experienced significant economic downturns characterized by
decreased product demand and price erosion. Although the Company does not
believe such factors have materially affected the Company in the past, there can
be no assurance that the Company will not be materially adversely affected if
such situation continues or worsens or by future events in the industry. See
"Business -- Industry Overview."
MANUFACTURING RISK. The production of the Company's products consists of
pressing CD-ROM disks, assembling purchased product components, printing product
packaging and user manuals and packaging finished products, all of which are
performed for the Company by third party vendors in accordance with the
Company's specifications and forecasts. Currently, the Company uses primarily
one vendor for each of these services. While these services are available from
multiple vendors and at multiple sites, there can be no assurance that an
interruption in the manufacture of the Company's products could be remedied
without undue delay and without materially and adversely affecting the Company's
results of operations. The Company does not have contractual agreements with any
of its third party vendors, which may result in an inability to secure adequate
services in a timely manner. In particular, due to the seasonal nature of the
software CD-ROM industry, it is critical that the Company secure adequate
production resources to timely produce and deliver its products for fourth
quarter sales. See "Business -- Manufacturing."
SUBSTANTIAL USE OF PROCEEDS FOR PAST DEBT. A substantial portion of the
proceeds from this Offering will be used to repay past indebtedness. The Company
expects to use (i) approximately $1,620,000 (25.5%) of the net proceeds from
this Offering to redeem the Bridge Notes including interest, and (ii)
approximately $625,000 (9.8%) of the net proceeds from this Offering to repay
the aggregate unpaid principal amount including interest accrued relating to the
Representative Notes owed to the Representative and a corporation controlled by
a family member of the sole stockholder of the Representative, including
interest. Accordingly, a
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significant portion of the debt repayment will benefit the Representative and a
corporation controlled by a family member of the sole stockholder of the
Representative. See "Use of Proceeds", "Capitalization -- Bridge Financing", and
"Underwriting."
BROAD DISCRETION OVER USE OF PROCEEDS BY MANAGEMENT; UNSPECIFIED
ACQUISITIONS. Approximately $1,663,000 (or 26%) of the proceeds are allocated
to working capital. Management will have broad discretion as to the use of such
proceeds. Although the Company presently has no plans, agreements or
understandings to enter into any potential business combination, it does intend
to actively seek and investigate such opportunities as they become available.
The Company would likely finance any such transaction with cash, the issuance of
equity or debt securities, incurrence of indebtedness or any combination of the
foregoing. To the extent that any such transaction would be paid for by the
Company in cash, the Company could decide to use a portion of the net proceeds
from this Offering. See "Use of Proceeds".
PROTECTION OF PROPRIETARY RIGHTS; RISK OF INFRINGEMENT CLAIMS. The Company
regards its software products as proprietary and relies primarily on a
combination of trademark, copyright and trade secret laws, as well as employee
and third party nondisclosure agreements and other methods to protect its
proprietary rights. The Company generally licenses its externally developed
products rather than transferring title and, as is the industry practice, relies
upon "shrink-wrapped," rather than signed, license agreements with end-users.
The enforceability of such licenses has not been conclusively determined. As is
also the standard practice in the industry, none of the Company's CD-ROM
products include any mechanism to prevent or inhibit unauthorized copying. The
Company is not aware of any unauthorized copying, reverse engineering or other
unauthorized distribution of its products' proprietary information, but if such
unauthorized copying were to occur, the Company's business, operating results
and financial condition could be materially adversely affected. Further, the
laws of foreign jurisdictions may not protect the Company's proprietary rights
to the same extent as the laws of the United States. Policing unauthorized use
of a broadly disseminated product such as PC software is very difficult.
Software piracy has been, and can be expected to be, a persistent problem for
participants in the shrink-wrapped software industry, including the Company. See
"Business -- Protection of Proprietary Rights."
As the number of multimedia software products in the industry increases and
the functionality of these products further overlaps, software publishers and
developers may increasingly become subject to infringement claims. There can be
no assurance that third parties will not assert infringement claims against the
Company in the future with respect to current or future products. Although the
Company makes reasonable efforts to ensure that its products do not violate the
intellectual property rights of others, there can be no assurance that claims of
infringement will not be made against the Company. In certain circumstances,
litigation may be necessary to enforce and protect the Company's proprietary
rights. Any such litigation, with or without merit, could be costly and divert
management's attention, which could have an adverse effect on the Company's
business, operating results or financial condition. Adverse determinations in
litigation relating to any of the Company's products could result in the loss of
the Company's proprietary rights, subject the Company to liabilities, require
the Company to seek licenses from third parties or prevent the Company from
selling that product.
PRODUCT LIABILITY EXPOSURE. Sales of the Company's software products
involve the inherent risk of product liability claims against the Company. The
Company currently maintains product liability insurance coverage, however,
product liability insurance is expensive, subject to various coverage
exclusions, and may not be obtainable by the Company in the future on terms
acceptable to the Company. Moreover, the amount and scope of any coverage may be
inadequate to protect the Company in the event that a product liability claim is
successfully asserted against the Company.
CONTROL BY PRESENT STOCKHOLDERS; VOTING TRUST AND IRREVOCABLE PROXY
AGREEMENT. The Company's present stockholders will own 1,600,000 shares of
Common Stock, representing approximately 50% of the total combined voting power
of all of the Common Stock to be outstanding immediately after the Offering. In
addition, the present stockholders of the Company have entered into a voting
trust agreement and irrevocable proxy agreement. Pursuant to the voting trust
agreement and irrevocable proxy agreement, Timothy M. Brannan, the Company's
Chairman and President, is granted the authority to vote all of the shares
subject to the voting trust and the proxy on all matters on which the Company's
stockholders are entitled to vote.
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Mr. Brannan, accordingly, will likely be able to elect all of the Company's
Directors and thereby control the policies of the Company. See "Principal
Stockholders".
POSSIBLE ADVERSE EFFECT ON THE LIQUIDITY OF THE COMPANY'S SECURITIES DUE TO
SECURITIES AND EXCHANGE COMMISSION INVESTIGATION OF THE REPRESENTATIVE AND BLAIR
& CO. AND RECENT SETTLEMENT BY BLAIR & CO. WITH NASD. The Securities and
Exchange Commission (the "Commission") is conducting an investigation concerning
various business activities of the Representative and D.H. Blair & Co., Inc., a
selling group member which will distribute a substantial portion of the Units
offered hereby ("Blair & Co."). The Company has been advised by the
Representative that the investigation has been ongoing since at least 1989 and
that it is cooperating with the investigation. The Representative cannot predict
whether this investigation will ever result in any type of formal enforcement
action against the Representative or Blair & Co.
In July 1997, Blair & Co., its Chief Executive Officer and its head trader
consented, without admitting or denying any violations, to a settlement with
NASD Regulation, Inc. ("NASDR"), the regulatory oversight subsidiary of the
National Association of Securities Dealers, Inc. ("NASD") District Business
Conduct Committee for District No. 10 to resolve allegations of NASD rule and
securities law violations in connection with mark-up and pricing practices and
adequacy of disclosures to customers regarding market-making activities of Blair
& Co. in connection with certain securities issues during the period from June
1993 through May 1995 where Blair & Co. was the primary selling group member.
NASDR alleged the firm failed to accurately calculate the contemporaneous cost
of securities in instances where the firm dominated and controlled after-market
trading, thereby causing the firm to charge its customers excessive mark-ups.
NASDR also alleged the firm did not make adequate disclosure to customers about
its market-making activities in two issues. As part of the settlement, Blair &
Co. has consented to a censure and has agreed to pay a $2 million fine, make
$2.4 million in restitution to retail customers, employ an independent
consultant for two years to review and make recommendations to strengthen the
firm's compliance procedures, and has undertaken for twelve months not to sell
to its retail customers (excluding banks and other institutional investors) more
than 60% of the total securities sold in any securities offering in which it
participates as an underwriter or selling group member. The Chief Executive
Officer of Blair & Co. has agreed to settle failure to supervise charges by
consenting to a censure, the imposition of a $225,000 fine and a 60-day
suspension from associating with any NASD member firm and to take a
requalification examination. The firm's head trader has agreed to settle charges
against him by consenting to a censure, the imposition of a $300,000 fine and a
90-day suspension from associating with any member firm and has undertaken to
take certain requalification examinations. The settlement with NASDR does not
involve or relate to the Representative, its chief executive officer or any of
its other officers or directors.
The Company has been advised that Blair & Co. intends to make a market in
the Company's securities after the Offering. The Company is unable to predict
whether Blair & Co.'s settlement with the NASDR or any unfavorable resolution of
the Commission's investigation will have any effect on such firm's ability to
make a market in the Company's securities and, if so, whether the liquidity or
price of the Company's securities would be adversely affected. See
"Underwriting."
POSSIBLE RESTRICTIONS ON MARKET-MAKING ACTIVITIES IN COMPANY'S
SECURITIES. The Representative has advised the Company that Blair & Co. intends
to make a market in the Company's securities. Regulation M, which was recently
adopted to replace Rule 10b-6, under the Securities Exchange Act of 1934, as
amended (the "Exchange Act"), may prohibit Blair & Co. from engaging in any
market-making activities with regard to the Company's securities for the period
of up to five business days (or such other applicable period as Regulation M may
provide) prior to any solicitation by the Representative of the exercise of
Warrants until the later of the termination of such solicitation activity or the
termination (by waiver or otherwise) of any right that the Representative may
have to receive a fee for the exercise of Warrants following such solicitation.
As a result, Blair & Co. may be unable to provide a market for the Company's
securities during certain periods while the Warrants are exercisable. In
addition, under applicable rules and regulations under the Exchange Act, any
person engaged in the distribution of the Class A Warrants (the "Selling
Securityholders' Warrants") to be issued to holders of the Bridge Warrants (the
"Selling Securityholders") and offered for sale commencing one year from the
date of this Prospectus may not simultaneously engage in market-making
activities with respect to any securities of the Company for the applicable
restricted period prior to the
16
<PAGE> 17
commencement of such distribution. Accordingly, in the event the Representative
or Blair & Co. is engaged in a distribution of the Selling Securityholders'
Warrants, neither of such firms will be able to make a market in the Company's
securities during the applicable restrictive period. Any temporary cessation of
such market-making activities could have an adverse effect on the market price
of the Company's securities. See "Description of Securities -- Registration
Rights", "Shares Eligible for Future Sale" and "Underwriting".
FUTURE SALES OF COMMON STOCK; ESCROWED SHARES. Upon completion of this
Offering, the Company will have 3,200,000 shares of Common Stock outstanding,
excluding shares issuable upon the exercise of warrants and options. The
1,600,000 shares of Common Stock presently outstanding, including the 1,225,000
Escrow Shares, are subject to the volume, manner of sale and public information
requirements of Rule 144 (described below) promulgated under the Securities Act
of 1933, as amended (the "Securities Act"), unless registered under the
Securities Act. The 1,225,000 Escrow Shares will be released only if the Company
achieves certain levels of income or the bid price for shares of its Common
Stock exceed certain thresholds. See "Principal Stockholders -- Escrow
Arrangements." and "Underwriting".
The Company has agreed to file a registration statement within nine months
from the date of this Prospectus to register for resale all of the Selling
Securityholders' Warrants, and the securities issuable upon exercise thereof and
to cause such registration statement to become effective twelve months from the
date of this Prospectus.
Future sales, and the potential for sales of significant amounts, of Common
Stock in the public market after this Offering could have an adverse effect on
the then prevailing market price of the Common Stock.
All of the shares of Common Stock currently outstanding are "restricted
securities" as that term is defined under Rule 144 promulgated under the
Securities Act and under certain circumstances may be sold without registration
pursuant to such rule. The Company's Officers and Directors and holders of all
of the shares of Common Stock and options to purchase Common Stock outstanding
prior to this Offering have agreed with the Underwriter not to offer, sell or
otherwise dispose of any of their shares of Common Stock or other securities
issued by the Company for a period of 13 months after the date of this
Prospectus without the prior written consent of the Representative. Upon
expiration of such 13-month period, all of the shares of Common Stock will be
eligible for resale under Rule 144. In addition, the Company is unable to
predict the effect that sales made under Rule 144, or otherwise, may have on the
then prevailing, market price of the Company's securities although any future
sales of substantial amounts of securities pursuant to Rule 144 could adversely
affect prevailing market prices. See "Principal Stockholders," "Description of
Securities", "Shares Eligible For Future Sale" and "Underwriting".
IMMEDIATE AND SUBSTANTIAL DILUTION. Purchasers of the Units offered hereby
will incur immediate substantial dilution of approximately $2.68 (or 54%) in the
per share net tangible book value of their Common Stock (attributing no value to
the Warrants included in the Units). The current stockholders of the Company
acquired their securities at an average price per share of less than $.01.
Therefore, purchasers of the Units offered hereby will bear a proportionately
greater risk of loss than the Company's current stockholders. See "Dilution".
CHARGES ARISING FROM PRIVATE PLACEMENTS. The Company incurred
approximately $281,000 of debt issuance costs and debt discount associated with
the Bridge Financing completed in November and December 1996. A substantial
portion of such fees will be charged to income upon the repayment of the Bridge
Notes from the proceeds of this Offering and booked for the quarter ending
September 30, 1997. This charge to income will adversely affect the Company's
financial results for that quarter. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations".
CHARGES AND POTENTIAL CHARGES TO EARNINGS. The Commission has taken the
position with respect to escrow arrangements such as that entered into by the
Company and its stockholders that in the event any shares are released from
escrow to the holders who are Officers, Directors, employees or consultants of
the Company, a compensation expense will be recorded for financial reporting
purposes. Accordingly, in the event of the release of the Escrow Shares, the
Company will recognize during the period in which the earnings thresholds are
probable of being met or such Common Stock bid price levels achieved, a
substantial noncash
17
<PAGE> 18
charge (not deductible for income tax purposes) to operations equal to the then
fair market value of such shares, which would have the effect of significantly
increasing the Company's loss or reducing or eliminating earnings, if any, at
such time. The recognition of such compensation expense may have a depressive
effect on the market price of the Company's securities. Notwithstanding the
foregoing discussion, there can be no assurance that the Company will attain the
targets which would enable the Escrow Shares to be released from escrow.
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Potential Charges to Income."
DIVIDENDS UNLIKELY. The Company does not intend to declare or pay cash
dividends on its Common Stock in the foreseeable future. The Company expects
that it will retain all available earnings, if any, to finance and expand its
business. See "Dividend Policy".
ABSENCE OF PRIOR PUBLIC MARKET; ARBITRARY DETERMINATION OF OFFERING AND
EXERCISE PRICES. Prior to this Offering, there has been no public market for
any of the Company's securities and there is no assurance that any such market
will develop, or, if one does develop, that it will be sustained. The initial
public offering price for the Units and the exercise price of the Warrants have
been determined by negotiation between the Company and the Representative and
are not necessarily related to the Company's asset value, net worth or other
established criteria of value.
STOCK MARKET VOLATILITY. General market price declines or market
volatility in the future could adversely affect the price of the Common Stock
and the Warrants. In certain cases, volatility in the price of a given security
can result from the short-term trading strategies of certain market segments.
Such volatility can distort market value and can be particularly severe in the
case of smaller capitalization stocks and immediately before or after an
important corporate event such as a public offering. In recent years, the stock
markets in general, and the securities of technology companies in particular,
have experienced extreme price fluctuations in response to such occurrences as
quarterly variations in operating results, changes in earnings estimates by
analysts, announcements concerning new products, strategic relationships or
technological innovations by individual software publishers and developers,
general conditions in the software computer and entertainment industries and
other events or facts. This pattern of extreme volatility in the stock market,
which in many cases was unrelated to the operating performance of, or
announcements concerning, the issuers of the affected stock may adversely affect
the market price of the Common Stock.
EFFECT OF OUTSTANDING OPTIONS AND WARRANTS. Upon completion of the
Offering, the Company will have outstanding (i) 1,600,000 Class A Warrants to
purchase an aggregate of 1,600,000 shares of Common Stock; (ii) the Selling
Securityholders' Class A Warrants to purchase an aggregate of 750,000 shares of
Common Stock; (iii) the Unit Purchase Option to purchase an aggregate of 160,000
Units; and (iv) options to purchase an aggregate of 66,500 shares of Common
Stock. The Company has an additional 233,500 shares of Common Stock reserved for
issuance under its 1996 Stock Option Plan. For the respective terms of such
Warrants, options and the Unit Purchase Option, the holders thereof are given an
opportunity to profit from a rise in the market price of the Company's Common
Stock with a resulting dilution in the interests of the other stockholders.
Further, the terms on which the Company may obtain additional financing during
that period may be adversely affected by the existence of such options and
warrants. The holders of the Warrants may exercise them at a time when the
Company might be able to obtain additional capital through a new offering of
securities on terms more favorable than those provided therein. In addition,
holders of the Unit Purchase Option and the Selling Securityholders' Warrants
have registration rights with respect to such option and warrants and the
respective underlying securities. Exercise of such registration rights may
involve substantial expense to the Company. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations," "Description of
Securities" "Shares Eligible For Future Sale" and "Underwriting".
NON-REGISTRATION IN CERTAIN JURISDICTIONS OF SHARES UNDERLYING THE
WARRANTS; NEED FOR CURRENT PROSPECTUS. The Class A Warrants constituting part
of the Units offered hereby are detachable from the Units and may be traded
separately immediately upon issuance. Although the Units will not knowingly be
sold to purchasers in jurisdictions in which the Units are not registered or
otherwise qualified for sale, purchasers may buy Units or the components thereof
in the aftermarket in, or may move to, jurisdictions in which the shares
underlying the Class A Warrants are not so registered or qualified during the
period that the Class A Warrants are exercisable. In this event, the Company
would be unable to issue shares to those
18
<PAGE> 19
persons desiring to exercise their Class A Warrants unless and until the
underlying securities could be qualified in such jurisdiction. In addition,
investors in this Offering will not be able to exercise their Class A Warrants,
unless at the time of exercise the Company has a current prospectus covering the
shares of Common Stock underlying the Class A Warrants. No assurances can be
given that the Company will be able to effect any required registration or
qualification or maintain a current prospectus. See "Description of
Securities -- Redeemable Class A Warrants".
POSSIBLE ADVERSE EFFECTS OF AUTHORIZATION OF PREFERRED STOCK; ANTI-TAKEOVER
PROVISIONS. The Company's Board of Directors has the authority to issue up to
5,000,000 shares of preferred stock, $.001 par value ("Preferred Stock"), in one
or more series and to determine the price, rights, preferences and privileges of
the shares of each such series without any further vote or action by the
stockholders. The rights of the holders of Common Stock will be subject to, and
may be adversely affected by, the rights of the holders of any shares of
Preferred Stock that may be issued in the future. The issuance of Preferred
Stock could have the effect of making it more difficult for a third party to
acquire a majority of the outstanding voting stock of the Company, thereby
delaying, deferring or preventing a change of control of the Company. In
addition, certain provisions in the Company's Articles of Incorporation and
By-laws creating a staggered-term Board and relating to supermajority
stockholder approval of certain business combinations by the Company,
restrictions on calling special meetings of stockholders, restrictions on
removal of Directors and restrictions on amendments to the By-laws may
discourage or make more difficult any attempt by a person or group of persons to
obtain control of the Company. See "Description of Securities -- Certain
Statutory and Charter Provisions."
LIMITATION OF LIABILITY OF DIRECTORS AND OFFICERS. The Company's Articles
of Incorporation require the Company to indemnify each of its Officers and
Directors against liabilities and reasonable expenses incurred in any action or
proceeding, including stockholders' derivative actions, by reason of such person
being or having been an Officer or Director of the Company, or of any other
corporation for which he or she serves as such at the request of the Company, to
the fullest extent permitted by Nevada law. The Company's Articles of
Incorporation also limit the liabilities of the Directors and Officers of the
Company for monetary damages for breach of fiduciary duty as a Director or
Officer to the maximum extent permitted by Nevada law. Although such limitation
of liability does not affect the availability of equitable remedies such as
injunctive relief or rescission, the presence of these provisions in the
Articles of Incorporation could prevent the recovery of monetary damages against
Directors and Officers of the Company. See "Management -- Indemnification and
Limitation of Liability".
RISK OF LOW-PRICED STOCK; PENNY STOCK REGULATIONS. If the Company's
securities were delisted from Nasdaq (See "Risk Factors -- Nasdaq Listing and
Maintenance Requirements; Risk of Delisting"), they could become subject to Rule
15g-9 under the Exchange Act, which imposes additional sales practice
requirements on broker-dealers which sell such securities to persons other than
established customers and "accredited investors" (generally, individuals with
net worth in excess of $1,000,000 or annual incomes exceeding $200,000, or
$300,000 together with their spouses). For transactions covered by this rule, a
broker-dealer must make a special suitability determination for the purchaser
and have received the purchaser's written consent to the transaction prior to
sale. Consequently, such rule may adversely affect the ability of broker-dealers
to sell the Company's securities and may adversely affect the ability of
purchasers in this Offering to sell any of the securities acquired hereby in the
secondary market.
The Commission adopted regulations which generally define a "penny stock"
to be any non-Nasdaq equity security that has a market price (as therein
defined) of less than $5.00 per share or with an exercise price of less than
$5.00 per share, subject to certain exceptions. For any transaction involving a
penny stock, unless exempt, the rules require delivery, prior to any transaction
in a penny stock, of a disclosure schedule prepared by the Commission relating
to the penny stock market. Disclosure is also required to be made about
commissions payable to both the broker-dealer and the registered representative
and current quotations for the securities. Finally, monthly statements are
required to be sent disclosing recent price information for the penny stock held
in the account and information on the limited market in penny stocks.
The foregoing required penny stock restrictions will not apply to the
Company's securities if such securities are listed on Nasdaq and have certain
price and volume information provided on a current and continuing basis or meet
certain minimum net tangible assets or average revenue criteria. There can be no
19
<PAGE> 20
assurance that the Company's securities will qualify for exemption from these
restrictions. In any event, even if the Company's securities were exempt from
such restrictions, it would remain subject to Section 15(b)(6)of the Exchange
Act, which gives the Commission the authority to prohibit any person that is
engaged in unlawful conduct while participating in a distribution of a penny
stock from associating with a broker-dealer or participating in a distribution
of a penny stock, if the Commission finds that such a restriction would be in
the public interest.
If the Company's securities were subject to the existing or proposed rules
on penny stocks, the market liquidity for the Company's securities could be
severely adversely affected.
NASDAQ LISTING AND MAINTENANCE REQUIREMENTS; RISK OF DELISTING. The Units,
Common Stock and Warrants meet the current Nasdaq listing requirements and will
be initially included on the Nasdaq SmallCap Market. See "Cover Page". Under the
rules for continued listing on the Nasdaq Stock Market, a company is required to
have at least $2,000,000 in "net tangible assets" ("net tangible assets" equals
total assets less total liabilities and goodwill) or at least $35,000,000 in
total market value or at least $500,000 in net income in two out of its last
three fiscal years, as well as at least 500,000 shares in the public float, at
least $1,000,000 in market value of the public float, a bid price of not less
than $1.00 per share, and meet certain corporate governance standards. Upon
notice of a deficiency in one or more of the maintenance requirements, the
Company would be given 90 days (30 days in the case of the number of
market-makers) to comply with the maintenance standards. Failure of the Company
to meet the maintenance requirements of Nasdaq could result in the Company's
securities being delisted from Nasdaq, with the result that the Company's
securities would trade on the OTC Bulletin Board or in the "pink sheets"
maintained by the National Quotation Bureau Incorporated. As a consequence of
such delisting, an investor could find it more difficult to dispose of or to
obtain accurate quotations as to the market value of the Company's securities.
Among other consequences, delisting from Nasdaq may cause a decline in the stock
price and difficulty in obtaining future financing.
20
<PAGE> 21
USE OF PROCEEDS
The Company estimates that the net proceeds from the sale of the 1,600,000
Units offered hereby will be approximately $6,360,000 ($7,410,000 if the
Underwriters' over-allotment option is exercised in full), after deducting
underwriting discounts and commissions and estimated expenses of this Offering.
The Company intends to apply the net proceeds of this Offering, as follows:
<TABLE>
<CAPTION>
APPROXIMATE OFFERINGS
APPLICATIONS AMOUNT PERCENTAGE
------------------------------------------------------------- ---------- ----------
<S> <C> <C>
Repayment of Bridge Notes, and Representative Notes and $2,245,000 35%
related interest(1)........................................
Acquisition of Software Programs............................. 1,702,000 27
Marketing and Sales(2)....................................... 750,000 12
Working Capital(3)........................................... 1,663,000 26
---------- ---
Total................................................... $6,360,000 100%
========== ===
</TABLE>
- ---------------
(1) The Bridge Notes accrue interest at 10% per annum and are payable upon the
earlier of one year after the date of issuance, or the completion of the
public offering contemplated herein. The proceeds of the Bridge Notes were
used for repayment of a $200,000 loan (and accrued interest thereon) made by
the Representative to the Company in November 1996, payment of accrued
Officer and employee salaries of $76,000, loans by Officers to the Company
of $100,000, loans by others to the Company of $25,000 and working capital
purposes including general and administrative expenses. The Representative
Notes made by D. H. Blair Investment Banking Corp. and Rivkalex Corp., a
corporation controlled by a family member of the sole stockholder of the
Representative, in the aggregate principal amount of $605,000, accrue
interest at 10% per annum and are payable upon the earlier of (i) the
closing of this Offering, (ii) the closing of any other financing by the
Company providing net proceeds of at least $500,000, or (iii) various dates
from October 28, 1997 through February 27, 1998. The proceeds of the
Representative Notes were used for working capital purposes, including
general and administrative expenses. See "Capitalization -- Bridge
Financing", "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Underwriting".
(2) Represents funds to be used to implement the Company's marketing and sales
program, including the hiring of additional personnel, exhibition at trade
shows and production of brochures and sales literature. See
"Business -- Marketing and Sales".
(3) As a result of the Company's relatively long payment cycles, the Company
generally applies a significant portion of its working capital toward
financing its accounts receivable and maintaining sufficient quantities of
inventory on hand. The Company intends to use the portion of the net
proceeds from this Offering allocated to working capital purposes in a
manner consistent with its past practices.
If the Underwriters' over-allotment option is exercised, the amount for
which it is exercised will increase the amount of proceeds allocated to sales
and marketing and working capital.
Until applied as set forth above, all proceeds will be invested in
short-term investment grade instruments or bank certificates of deposit. Income
received from investments or from any Warrant exercise will be added to working
capital and used to fund operations. Investment of the net proceeds in
short-term securities rather than operations could adversely affect the
Company's overall return on its capital.
Although the Company presently has no plans, agreements or understandings
to enter into any potential business combination, it does intend to actively
seek and investigate such opportunities as they become available. The Company
would likely finance any such transaction with cash, the issuance of equity or
debt securities, incurrence of indebtedness or any combination of the foregoing.
To the extent that any such transaction would be paid for by the Company in
cash, the Company could decide to use a portion of the net proceeds from this
Offering. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Liquidity and Capital Resources" and
"Business -- Business Strategy."
21
<PAGE> 22
The foregoing represents the Company's present intentions and best estimate
with respect to the allocation of the proceeds of this Offering based upon its
present plans and business conditions. The Company expects that the net proceeds
of this Offering will enable it to meet its liquidity and capital requirements
for approximately 12 months following completion of the Offering, although the
Company's capital requirements are subject to numerous contingencies associated
with early-stage companies. The Company may be required to seek additional
financing in the event of delays, cost overruns or unanticipated expenses
associated with a company in an early stage of development, or in the event the
Company does not realize anticipated revenues. In addition, the Company may
require additional financing in the future to further expand its product
offerings or to make strategic acquisitions. There is no assurance that
unforeseen events or changed business conditions will not result in the
application of the proceeds of this Offering in a manner other than as described
in this Prospectus. This estimate is based on certain assumptions, which are
subject to change. Future events, including changes in the Company's business
plans, results and economic, competitive or industry conditions, may make shifts
in the allocation of funds necessary or desirable. See "Risk Factors -- Need for
Additional Financing," and "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources."
DIVIDEND POLICY
In August 1997, the Company declared a dividend of approximately 0.33 share
of Common Stock on each then outstanding share of Common Stock. However, the
Company does not intend to declare or pay stock or cash dividends on its Common
Stock (or any other securities) in the foreseeable future. The Company intends
to retain all available earnings to finance and expand its business.
22
<PAGE> 23
DILUTION
The following discussion and tables allocate no value to the Warrants
issued as part of the Units.
The net tangible book value of the Company as of June 30, 1997 was
$(2,239,227) or $(5.97) per share of Common Stock. Net tangible book value per
share is determined by dividing the number of shares of Common Stock outstanding
(excluding 1,225,000 shares held in escrow) into the tangible net worth of the
Company (tangible assets less total liabilities). Without taking into account
any changes in such net tangible book value subsequent to June 30, 1997, other
than to give effect to the sale of 1,600,000 Units by the Company at an initial
public offering price of $5.00 per Unit (after deducting the underwriting
discount and estimated offering expenses payable by the Company), the pro forma
net tangible book value at June 30, 1997, would have been $4,590,493, or $2.32
per common share. This represents an immediate increase in net tangible book
value of $8.29 per common share to existing shareholders and an immediate
dilution of $2.68 (or 54%) per common share to persons purchasing Units in this
Offering ("New Investors"). The following table illustrates this per share
dilution:
<TABLE>
<S> <C> <C>
Initial public offering price per Unit...................... $5.00
Net tangible book value per common share at
June 30, 1997.......................................... $(5.97)
Increase in net tangible book value per common share
attributable to the New Investors in the Units......... $ 8.29
------
Pro forma net tangible book value per common share
after offering......................................... $2.32
-----
Dilution per common share to New Investors(1)(2)............ $2.68
=====
</TABLE>
- ---------------
(1) If the Underwriters exercise the over-allotment option in full, the per
share dilution to investors in the Units would be $2.46.
(2) If the 1,225,000 shares held in escrow were treated as outstanding, the per
share dilution to New Investors would be $3.57.
The following table sets forth on a pro forma basis at June 30, 1997, the
differences between existing shareholders and the New Investors with respect to
the number of shares of Common Stock purchased from the Company, the total
consideration paid to the Company and the average price paid per share:
<TABLE>
<CAPTION>
SHARES PURCHASED
-------------------------------------------- TOTAL CONSIDERATION
NON-ESCROW ESCROW TOTAL -------------------- AVERAGE PRICE
SHARES SHARES SHARES PERCENT AMOUNT PERCENT PER SHARE
---------- --------- --------- ------- ---------- ------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Existing shareholders.... 375,000 1,225,000 1,600,000 50% $ 4,959 0.1% $ .003
New Investors............ 1,600,000 0 1,600,000 50% $8,000,000 99.9% $ 5.00
--------- --------- --------- --- ---------- ---
Total............... 1,975,000 1,225,000 3,200,000 100% $8,004,959 100%
========= ========= ========= === ========== ===
</TABLE>
The foregoing table assumes no exercise of the over-allotment option. If
such option is exercised in full, the New Investors will have paid $9,200,000
for 1,840,000 shares of Common Stock, representing approximately 100% of the
total consideration for approximately 53% of the total number of shares of
Common Stock outstanding (including escrow shares). The foregoing table also
assumes no exercise of the Representative's Unit Purchase Option or any other
options or warrants of the Company and further assumes that all existing
shareholders purchased the Common Stock held by them from the Company at the
price at which such shares were originally sold by the Company. As of the
closing of the Offering, there will be options outstanding to purchase an
aggregate of 66,500 additional shares of Common Stock, which have an exercise
price equal to the initial public offering price of the Units offered hereby. In
connection with a potential product license agreement, the Company anticipates
that it may grant at a date following the closing of this Offering options to
purchase up to 70,000 shares of Common Stock at a price per share not less than
the fair market value of the Common Stock on the date of grant. See
"Management -- 1996 Stock Option Plan".
23
<PAGE> 24
CAPITALIZATION
The following table sets forth the actual capitalization of the Company as
of June 30, 1997 and as adjusted to give effect to (i) the issuance and sale of
the 1,600,000 Units offered hereby and (ii) the repayment of the Bridge Notes
and the Representative Notes out of the net proceeds therefrom as set forth in
"Use of Proceeds". This table should be read in conjunction with the Financial
Statements and the Notes thereto included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
JUNE 30, 1997
---------------------------
AS
ACTUAL ADJUSTED
---------- ----------
<S> <C> <C>
Representative Notes.............................................. $ 410,000(1) $ 0
Notes payable -- Officers......................................... 38,270 38,270
Bridge Notes...................................................... 1,469,120(2) 0
Preferred Stock, $.001 par value, 5,000,000 shares authorized,
none issued..................................................... 0 0
Common Stock; $.001 par value; 20,000,000 shares authorized;
1,600,000 shares issued and outstanding; 3,200,000 shares issued
and outstanding as adjusted(3).................................. 1,600 3,200
Additional paid in capital........................................ (491,103) 5,867,297
Stockholders' equity (deficit).................................... (1,653,868) 4,590,493
---------- ----------
Total capitalization.................................... $ 263,522 $4,628,763
========== ==========
</TABLE>
- ---------------
(1) Consists of 10% notes payable to the Representative in the aggregate
principal amount of $410,000. Does not include $195,000 aggregate principal
amount of Representative Notes, which were made subsequent to June 30, 1997.
See "Underwriting".
(2) The amount set forth for Bridge Notes represents the price of the Units
issued in the Bridge Financing less the unamortized portion of the value
ascribed to the Bridge Warrants ($75,000). Bridge Notes accrue interest at
the rate of 10% per annum and are payable upon the earlier of November 27,
1997 or completion of this Offering. See "Use of Proceeds" and "-- Bridge
Financing".
(3) Does not include: (i) 240,000 shares of Common Stock included in Units which
may be sold pursuant to the Underwriters' over-allotment option and 240,000
shares of Common Stock issuable upon exercise of the Class A Warrants
included in such Units; (ii) 1,600,000 shares of Common Stock reserved for
issuance upon exercise of the Class A Warrants included in the Units offered
hereby; and (iii) 160,000 shares of Common Stock issuable upon exercise of
the Unit Purchase Option and/or 160,000 shares of Common Stock issuable upon
exercise of the Class A Warrants included in such option; (iv) 300,000
shares reserved for issuance under the Company's 1996 Stock Option Plan, of
which options to purchase 66,500 shares will be outstanding at the closing
of the Offering and (v) 750,000 shares of Common Stock issuable upon
exercise of the Selling Securityholders' Warrants to be issued upon
completion of this Offering. See "Principal Stockholders", "Description of
Securities", and "Underwriting".
BRIDGE FINANCING
In November and December 1996, the Company completed the Bridge Financing
consisting of an aggregate of $1,500,000 principal amount of Bridge Notes and
750,000 Bridge Warrants from which it received net proceeds of approximately
$1,294,000 (after deduction of the Placement Agent's commissions and expenses of
such financing). The Bridge Notes are payable, together with interest at the
rate of 10% per annum, on the earlier of November 27, 1997 or the closing of
this Offering. See "Use of Proceeds". The Bridge Warrants entitle the holders
thereof to purchase one share of Common Stock for $3.00, but will be exchanged
automatically on the closing of this Offering for 750,000 Selling
Securityholders' Warrants, each of which will be identical to the Class A
Warrants included in the Units offered hereby (including the $6.50 exercise
price). The Company has agreed to file a registration statement, registering the
Selling Securityholders' Securities for resale. Such registration statement
shall be filed at the Company's expense nine
24
<PAGE> 25
months from the date of this Prospectus and declared effective twelve months
from the date of this Prospectus. The Selling Securityholders have agreed not to
exercise or transfer the Selling Securityholders' Warrants for a period of one
year from the date of this Prospectus. See "Description of Securities --
Registration Rights" and "Shares Eligible for Future Sale".
SELECTED FINANCIAL DATA
The selected financial data set forth below for the years ended December
31, 1995 and 1996 have been derived from the financial statements of the
Company, which together with the notes thereto and the related report of Coopers
& Lybrand L.L.P., are included elsewhere in this Prospectus. The selected
financial data as of and for the six month periods ended June 30, 1996 and 1997
are derived from the Company's unaudited financial statements. The Company's
unaudited financial statements include all adjustments, consisting of only
normal recurring accruals, which the Company considers necessary for a fair
presentation of the financial position and the results of operations for such
periods. Operating results for the years ended December 31, 1995 and 1996 and
the six month periods ended June 30, 1996 and 1997 are not necessarily
indicative of the results that may be expected for future periods. The selected
financial data set forth below should be read in conjunction with the financial
statements of the Company and related notes thereto and "Management's Discussion
and Analysis of Financial Condition and Results of Operations" included
elsewhere in this Prospectus.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
YEAR ENDED YEAR ENDED (UNAUDITED)
DECEMBER 31, DECEMBER 31, ----------------------
1995 1996 1996 1997
------------------ ------------ --------- ----------
<S> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net sales.................................. $1,342,034 $ 424,810 $ 353,144 $ 67,656
Costs and expenses......................... 1,153,891 1,337,148 695,607 1,019,502
Net income (loss).......................... 188,143 (912,338) (342,463) (951,846)
Net loss per common share(1)............... $ (2.54)
Shares used in computing net loss per
common share(1).......................... 375,000
Pro forma net income (loss)(2)............. 109,123 (834,874) (312,385)
Pro forma net income (loss) per common
share(1):................................ $ 0.26 $ (2.11) $ (0.75)
Shares used in computing pro forma net
income (loss) per common share(1):....... 417,334 395,565 416,244
</TABLE>
- ---------------
(1) The Escrow Shares are excluded from the computation of net loss per common
share. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Potential Charges to Income" and Note 13 of Notes
to Financial Statements.
(2) From inception, until November 15, 1996, the Company elected to be treated
as a Subchapter S corporation for federal income tax purposes. As such, all
tax liability flowed through to the individual shareholders. The pro forma
financial data presented herein is as if the Company had been a C
corporation for federal income tax purposes from inception at an assumed tax
rate of 42%.
<TABLE>
<CAPTION>
JUNE 30, 1997
DECEMBER 31, 1995 DECEMBER 31, 1996 (UNAUDITED)
----------------- ----------------- -------------
<S> <C> <C> <C>
BALANCE SHEET DATA:
Current assets............................... $ 491,086 $ 493,506 $ 304,197
Working capital (deficit).................... 173,926 (1,214,783) (2,266,370)
Total assets................................. 521,166 1,053,870 964,841
Total liabilities............................ 353,704 1,755,892 2,618,709
Stockholders' equity (deficit)............... 167,462 (702,022) (1,653,868)
</TABLE>
25
<PAGE> 26
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussions should be read in conjunction with the financial
statements and notes thereto set forth elsewhere in this Prospectus.
GENERAL
The Company was incorporated in November 1994 to publish interactive
multimedia software products for the home PC market. The Company generally
licenses software programs being developed by independent third party developers
in return for which the independent developers generally receive an advance
royalty payment and a future royalty stream based on a percentage of the net
sales of the product. The Company then generally produces, packages and markets
the completed software products under its own name. In addition, the Company has
in the past and may in the future enter into affiliate relationships with other
publishers or developers ("Affiliates") pursuant to which the Company markets
titles owned by an Affiliate under a revenue sharing arrangement.
From inception until August 1995, the Company's activities included
assembling its management team, and obtaining titles for publication. The
Company recognized its first sales revenues in August 1995. As a result of its
start up activity, the Company recorded revenues during only the final five
months of 1995, and it recorded no revenues during the period from November 14,
1994 (inception) through December 31, 1994. In addition, during 1994 and the
first nine months of 1995, the Company had not incurred the expenses necessary
to develop infrastructure nor incurred any significant overhead. In addition,
the founders of the Company did not draw or accrue salaries. Accordingly,
general and administrative expenses during those periods were unusually low.
Further, the home education and entertainment software market is highly
seasonal, with demand typically higher during the year-end buying season. As a
result of its working capital deficiency during the last three quarters of 1996
and the first half of 1997, the Company's net sales were materially hampered by
its inability to launch new products, and in the second and third quarters of
1996, to ship quantities of products sufficient to satisfy customer demand.
Consequently, the Company believes that the comparisons below in "Results of
Operations" are neither meaningful nor representative of future results. In
addition, the Company's product mix and distribution channels have changed
significantly from past periods.
The Company's initial strategy was to bring rapidly to market multiple
products with high visibility in order to establish credibility in the retail
channel. To implement that strategy, the Company relied primarily on licensing
finished products for inclusion in multipack bundles and entering into Affiliate
relationships for the non-exclusive rights to market products from other
companies. As a result of this strategy, the Company sold over 70,000 units of
budget category titles in the last five months of 1995. The Company, however,
recognized minimal profit on these low margin, budget category titles, and in
some cases actually lost money on certain titles. In addition, the Company
experienced greater than expected customer price reductions and product returns
on many of these products.
After establishing an initial portfolio of products in the retail channel,
the Company began to shift its strategy to publishing premium products with
higher gross profit margins. In addition, the Company also began to expand its
retail distribution base. As of December 31, 1995, one large national chain
accounted for approximately 96% of all of the Company's sales. During 1996,
however, the Company began to establish relationships with several distributors
and more retail accounts. During the year ended December 31, 1996, sales to the
Company's primary 1995 account declined as a percentage of net sales to 20%. In
addition, sales to distributors accounted for 54% of the Company's net sales
during the year ended December 31, 1996, and sales to an original equipment
manufacturer ("OEM") represented 11% of net sales during such period. During the
six month period ended June 30, 1997, sales to distributors accounted for 66% of
the Company's net sales as compared to 59% of net sales for the six month period
ended June 30, 1996. The Company had no OEM sales during the six month period
ended June 30, 1997, compared to 12% of net sales for the comparable 1996
period.
As is typical in the interactive multimedia software industry, the Company
depends on the introduction of new titles or sequels to existing titles to
replace declining revenues from older titles. In order to generate
26
<PAGE> 27
revenues in the future, it will be necessary for the Company to obtain rights to
new titles that are developed for the appropriate platforms, are introduced in a
timely manner and are able to achieve market acceptance for a significant period
of time. Consequently, the Company will need to expend financial and other
resources to obtain and market new products.
The Company's quarterly operating results have in the past and are likely
in the future to vary significantly depending on factors such as the timing of
new hardware and software products, the degree of market acceptance of such
products and the introduction of titles competitive with those of the Company.
In addition, the home education and entertainment software business is highly
seasonal. Typically, revenues are highest during the third and fourth calendar
quarters (which includes the holiday buying season), decline in the first
calendar quarter and are lowest in the second calendar quarter. This seasonal
pattern is due primarily to the increased demand for home education and
entertainment software titles during the year-end holiday buying season. In
addition, as demand for fulfillment houses is also greatest in the third and
fourth quarters due to publishers building inventory for holiday sales, an
unanticipated delay in the manufacture of products, particularly during the
fourth quarter, could result in a material adverse effect on the Company's
financial condition and results of operations. Although the Company believes
alternative sources are available, currently the Company utilizes single vendors
for several of its manufacturing functions. The Company expects its future
revenues and operating results will reflect these seasonal factors.
RESULTS OF OPERATIONS
Comparison of Six Month Periods Ended June 30, 1997 and 1996
Net Sales. Net sales decreased $285,488, or 81%, during the six month
period ended June 30, 1997 as compared to the six month period ended June 30,
1996. Net sales for both six month periods were significantly adversely effected
by the Company's ongoing working capital deficiency. Beginning in the second
quarter of 1996, a working capital deficiency prevented the Company from
shipping existing products in a timely manner and in sufficient quantities to
meet customer demand and from acquiring, launching and marketing new products.
This working capital deficiency, which continued through 1997, had an even
greater impact on net sales for the first six months of 1997 as, in addition to
the limited ability to launch new titles in 1997, the Company no longer had the
benefit of continuing sales of products launched during the prior holiday buying
season, which it had for the comparable six month period of 1996.
The Company was dependent on four distributors and two retailers for
approximately 69% of its net sales during the six months ended June 30, 1997.
Allowances for product returns are determined by estimates on a
product-by-product basis. Allowances were approximately $18,000 and $31,000 at
June 30, 1997 and 1996, respectively.
The following table summarizes the composition of the Company's net sales
by product categories for the six-month periods ended June 30, 1996 and 1997.
<TABLE>
<CAPTION>
1996 1997
---------------- ---------------
$ % $ %
-------- --- ------- ---
<S> <C> <C> <C> <C>
Products from Affiliate relationships..................... $ 7,269 2% -- *
Theme Packs............................................... 172,133 49% $23,298 34%
Games..................................................... 150,638 43% 41,270 61%
Educational............................................... 22,274 6% 2,574 4%
Other..................................................... 830 * 513 1%
-------- --- ------- ---
$353,144 100% $67,655 100%
======== === ======= ===
</TABLE>
- ---------------
* Less than 1%.
Gross Profit (Loss). The Company's gross profit decreased from $167,444,
or 47% of net sales, during the six month period ended June 30, 1996 to a gross
loss of $(29,286), or (43)% of net sales, during the corresponding 1997 period.
Cost of goods sold declined from $185,700 during the six month period ended June
30, 1996 to $96,942 during the corresponding 1997 period. The decrease in gross
profit margins in 1997 is
27
<PAGE> 28
attributable to insufficient sales during the 1997 period to offset the up-front
design costs associated with the launch of two new products.
The Company anticipates improved gross profit margins in the future due to
higher sales volumes of new and future titles, which will offset up-front
package design costs. The Company expects sales volume to increase as it
launches new products and expands its marketing efforts and distributions
channels, although there can be no assurance in this regard. In addition, the
Company intends to continue to focus on entertainment and educational titles,
which tend to have higher profit margins.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased to approximately $697,000 during the six month
period ended June 30, 1997, compared with approximately $506,000 during the
corresponding 1996 period. The increase was primarily attributable to the hiring
of additional personnel and the Company's expanded marketing efforts related to
new and future products during the six months ended June 30, 1997. Salaries and
payroll taxes increased from approximately $177,000 during the 1996 period to
approximately $291,000 in the 1997 period also as a result of such additional
personnel. In addition, sales, advertising and marketing costs increased from
approximately $198,000 during the 1996 period to approximately $260,000 during
the 1997 period. The Company anticipates that future selling, general and
administrative expenses will increase in the aggregate as the Company adds
personnel, launches new products and expands its marketing efforts and
distribution channels. Management expects, however, that such expenses will
decrease as a percentage of net sales as the Company's gross revenues from
product sales increase, although there can be no assurances in this regard.
Interest expense. The Company's interest expense increased from $4,000
during the six month period ended June 30, 1996, to approximately $226,000
during the corresponding 1997 period. This increase is primarily attributable to
interest accrued on the Bridge Notes and other short-term notes payable and
amortization of the debt discount and deferred financing costs of the Bridge
Financing. The Company expects future interest expense to decrease as a result
of the repayment of principal and accrued interest on the Bridge Notes and other
short-term notes payable with a portion of the net proceeds of this Offering.
See "Use of Proceeds."
Due to the above, the Company had a net loss for the six month period year
ended June 30, 1997 of $(951,846) or $(2.54) per share, compared to pro forma
net loss of $(312,385) or $(.75) per share for the six month period ended June
30, 1996.
Comparison of Years Ended December 31, 1996 and 1995
Net Sales. Net sales decreased $917,224, or 68%, during the year ended
December 31, 1996 as compared to 1995, despite the fact that 1995 included sales
for only five months, August through December. Net sales for 1996 were adversely
affected by the Company's working capital deficiency in the latter part of the
second quarter, all of the third quarter, and the initial part of the fourth
quarter. This deficiency prevented the Company from shipping existing products
in a timely manner and in sufficient quantities to meet customer demand and from
acquiring and launching new products. In addition, net sales in 1995 included
volume sales of low margin, budget titles. Net sales from products sold pursuant
to affiliate relationships decreased significantly during fiscal 1996 as
compared to the prior year. This reduction was primarily a result of the
Company's business strategy of marketing these particular products for a limited
period in order to establish credibility in the retail channel and generate
initial revenues. The Company presently does not intend to focus on marketing
products sold pursuant to Affiliate relationships, although it may sell such
products from time to time. See "Business."
The Company was dependent on six distributors and four retailers for
approximately 86% of its net sales during 1996. Allowances for product returns
are determined by estimates on a product-by-product basis. Allowances were
approximately $17,000 and $47,000 at December 31, 1996 and 1995, respectively.
28
<PAGE> 29
The following table summarizes the composition of the Company's net sales
by product categories for the years indicated.
<TABLE>
<CAPTION>
1995 1996
------------------ ----------------
$ % $ %
---------- --- -------- ---
<S> <C> <C> <C> <C>
Products from Affiliate relationships.... $ 571,505 43% $ 8,020 2%
Theme Packs.............................. 433,122 32% 247,085 59%
Games.................................... 334,219 25% 146,352 34%
Educational.............................. 3,188 * 22,007 5%
Other.................................... 1,346 *
---------- --- -------- ---
$1,342,034 100% $424,810 100%
========== === ======== ===
</TABLE>
- ---------------
* Less than 1%.
Gross Profits. The Company's gross profit decreased from $441,067, or 33%
of net sales, during the year ended December 31, 1995 to $105,872, or 25% of net
sales, during 1996. Cost of goods sold declined from $900,967 during the year
ended December 31, 1995 to $318,938 during 1996. The decrease in gross profit
margins in 1996 is primarily attributable to the decrease in sales prices in
1996 on products which were released the prior year, the few number of new
titles released in 1996, and an increase in 1996 in the reserve for obsolete and
slow-moving inventory of approximately $40,000. The Company anticipates that
gross profit margins may improve in the future due to increased emphasis on
sales of higher margin products and decreased sales of budget products and theme
multipacks, although there can be no assurance in this regard. In addition, the
Company intends to continue to focus on entertainment and educational titles,
which tend to have higher profit margins.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased to approximately $983,000 during the year
ended December 31, 1996, compared with approximately $247,000 during 1995. The
increase was attributable to the fact that the Company was in a start-up phase
during the 1995 period, and the founders of the Company did not accrue or draw
salaries during that period. In addition, the Company had marginal rent expense
during the year ended December 31, 1995. Salaries and payroll taxes increased
from approximately $84,000 during 1995 to approximately $397,000 in 1996. In
addition, sales, advertising and marketing costs increased from approximately
$66,000 during 1995 to approximately $259,000 during 1996. This increase was
largely attributable to the Company's expansion of its distribution channels
into new retailers and distributors, as well as the launch of new products.
During 1996, the Company also substantially increased its reserves for bad
debts. Due primarily to the bankruptcy filing of a large national software
retailer in 1996, the Company increased its reserves for bad debts from $9,195
at December 31, 1995 to $45,000 at December 31, 1996. In addition, greater
general and administrative costs were incurred in 1996 due to the Company's
relocation to larger offices. The Company anticipates that future selling,
general and administrative expenses will increase in the aggregate as the
Company adds personnel, launches new products and expands its marketing efforts
and distribution channels. Management expects, however, that such expenses will
decrease as a percentage of net sales as the Company's revenues from product
sales increase.
Due to the above, the Company had a pro forma net loss for the year ended
December 31, 1996 of $(834,874) or $(2.11) per share, compared to pro forma net
income of $109,123 or $.26 per share for the year ended December 31, 1995.
LIQUIDITY AND CAPITAL RESOURCES
Since its formation in 1994, the Company has financed its operations
primarily through the equity investments of its founders and credit extended by
its vendors. In recent periods, the Company's expenditures have exceeded its
revenues. As a result of the Company's difficulty in generating sufficient cash
flows from operations, the Company has received a report from its independent
auditors that includes an explanatory paragraph regarding uncertainty as to the
ability of the Company to continue as a going concern. The Company's operating
activities used cash for operations of $944,710 and $602,422 during the year
ended
29
<PAGE> 30
December 31, 1996 and the six month period ended June 30, 1997, respectively,
while revenues for the same periods were $424,810 and $67,656, respectively. The
Company experiences long customer payment cycles for its products, which is
typical in the CD-ROM industry. In addition, the Company's cash flow from
operations can be affected significantly by greater than expected product
returns and pricing reductions. The Company's allowance for estimated returns is
established by taking into consideration historical return rates, sell-through
information and data regarding the mix of products in the distribution channel.
Returns are typically highest in the first two quarters of the calendar year, as
distributors and retailers adjust their inventory product mix following the
year-end holiday buying season.
In November and December 1996, the Company completed the Bridge Financing
of $1,500,000 principal amount of Bridge Notes and 750,000 Bridge Warrants
(which will automatically convert into Class A Warrants upon completion of this
Offering). See "Capitalization -- Bridge Financing." The net proceeds of the
Bridge Financing were approximately $1,294,000 after deducting the Placement
Agent's 10% commission and a 3% non-accountable expense allowance aggregating
$195,000 and other expenses of the Bridge Financing. In addition, from the
period of April 1997 to August 1997, the Representative and a corporation
controlled by a family member of the sole stockholder of the Representative have
loaned the Company an aggregate principal amount of $605,000 bearing interest at
the rate of 10% per annum pursuant to the Representative Notes. The net proceeds
of the Bridge Financing, and the Representative Notes were used to repay
indebtedness, including accrued salaries and employee advanced business
expenses, and trade payables and for working capital purposes, including general
and administrative expenses and the production and marketing of products. The
Company has allocated a portion of the net proceeds of this Offering to repay
the principal and accrued interest on the Bridge Notes, and the Representative
Notes. See "Use of Proceeds" and "Underwriting."
The Company currently has no credit facility with a bank or other financial
institution. The Company will attempt to obtain a credit facility to address
short-term cash flow needs resulting from its slow payment cycles. There can be
no assurance that any such financing will be available if needed, or, if
available will be on terms acceptable to the Company. See "Risk Factors -- Need
for Additional Financing."
The Company is obligated under a long-term lease for its corporate offices
through the year 1999, with minimum annual lease payments of $45,234 in 1997,
$46,421 in 1998 and $43,551 in 1999. Effective November 1, 1996, the Company
entered into three-year employment agreements with five of its executive
officers. The Company expects to make aggregate cash payments and incur
aggregate salary expense as a result of such agreements in the amounts of
approximately $320,000, $320,000 and $266,667 for fiscal years 1997, 1998 and
1999, respectively, subject to increases after 1997 as determined by the Board
of Directors. See "Management -- Employment Agreement" and "-- Certain
Transactions." The Company had no other material capital commitments at June 30,
1997.
The Company anticipates that its expenses will increase as it attempts to
expand its business by acquiring new products and increasing sales and marketing
efforts and other operations. The Company expects to continue to incur losses
until such time as it is able to sell a sufficient volume of products at prices
that provide adequate gross profit to cover operating costs. The Company's
working capital requirements will depend upon numerous factors, including
payment cycles for its shipped products, credit arrangements with suppliers, the
scale-up of its sales and marketing resources, acquisition of new products and
the terms upon which such products are acquired, competitive factors including
costs associated with obtaining adequate levels of retail shelf space, and
marketing activities. The Company expects that the net proceeds of this Offering
will enable it to meet its liquidity and capital requirements for approximately
12 months following completion of the Offering, although the Company's capital
requirements are subject to numerous contingencies associated with early-stage
companies. The Company's capital requirements after such period will depend upon
the extent to which its product sales are able to generate sufficient revenue to
sustain its operations. The Company may be required to seek additional financing
or alter its business plan in the event of product delays, cost overruns or
unanticipated expenses.
Although the Company presently has no plans, agreements or understandings
to enter into any potential business combination, it does intend to actively
seek and investigate such opportunities as they become
30
<PAGE> 31
available. The Company would likely finance any such acquisition with cash, the
issuance of equity or debt securities, incurrence of indebtedness or any
combination of the foregoing. To the extent that any such acquisition would be
paid for by the Company in cash, the Company could decide to use a portion of
the net proceeds from this Offering, use funds from its ongoing operations, seek
financing from a commercial lender or some combination of the foregoing. To
date, the Company has been unable to obtain commercial financing. In addition,
any commercial financing obtained is likely to impose certain financial and
other restrictive covenants upon the Company and result in increased interest
expense. Further, any issuance of additional equity or debt securities to the
sellers in any such acquisitions could result in further dilution to the
existing investors, including those who purchase the Company's securities in
this Offering. See "Risk Factors -- Need for Additional Financing" and
"Business -- Business Strategy."
POTENTIAL CHARGES TO INCOME
The Company expects to incur a charge to income of approximately $70,000
upon repayment of the Bridge Notes. The foregoing charge represents the
unamortized portion of the debt discount, interest and deferred financing costs
of the Bridge Financing. The charge to income will be recorded in the third
quarter of 1997.
Key employees, Officers, Directors and certain stockholders of the Company
have placed 1,225,000 shares of Common Stock in escrow (the "Escrow Shares"), to
be released only upon the Company attaining certain minimum earnings thresholds
or the market price of the Company's Common Stock meeting certain minimum
levels. In the event of the release of Escrow Shares, the Company will recognize
during the period in which the earnings thresholds are probable of being met or
such Common Stock bid price levels achieved, a substantial noncash charge (not
deductible for income tax purposes) to operations equal to the then fair market
value of such shares. By way of example, if (i) all of the Escrow Shares were
released and (ii) on the date of such release, all of the holders of such shares
were employed by the Company and the market price of the Common Stock was
$16.50, the Company would be required to recognize compensation expense of
approximately $20,212,500 with a corresponding increase to additional paid-in
capital. However, there can be no assurance that either the market price of the
Common Stock or the Company's earnings will meet the minimum thresholds
necessary to release any of the Escrow Shares. See "Risk Factors -- Future Sales
of Common Stock; Escrowed Shares" and "Principal Stockholders -- Escrow
Arrangements."
INFLATION
Management does not believe that inflation has had a material effect on the
Company's sales during the past two fiscal years. However, to the extent a
significant increase in the inflation rate were to adversely impact the rate of
consumer purchases of PCs and CD-ROM software, the Company's results of
operations would be adversely affected.
NET OPERATING LOSSES IN SUBCHAPTER S CORPORATION -- CONVERSION TO C CORPORATION
FOR TAX PURPOSES
Prior to November 15, 1996, the Company had elected to be taxed under
Subchapter S of the Internal Revenue Code and corresponding provisions of
Arizona tax laws. As a result of the election, Federal and state income taxes on
the net income of the Company were payable personally by the shareholders.
Accordingly, the statements of operations for all prior years do not include a
provision for Federal and state income taxes. As of November 16, 1996, the
Company became subject to Federal and state income taxes as a result of its
conversion from a Subchapter S corporation to a C corporation.
OUTLOOK
The Company's future operating results and many of the forward-looking
statements contained in this document are dependent upon a number of factors,
including economic factors affecting sales in the software market, the Company's
dependence on key personnel, and the Company's ability to acquire and publish
new software titles, add additional distribution channels and customers, address
the impact of the World Wide Web and the Internet on its markets, enter
successfully into new markets, react to changing technology and
31
<PAGE> 32
effectively manage resources, as well as other factors. See "Risk Factors." The
retail multimedia software market has experienced rapid change in recent years,
including consolidations and financial difficulties. These changes have resulted
in a greater degree of unpredictability as to retailer customer accounts as well
as increased competition for retail shelf space. To the extent any retailers
upon which the Company is dependent were to suffer financial difficulties, the
Company's operations could be materially adversely affected. As a result, the
Company may experience higher product returns and lower product sales. The
impact that market trends and the Company's actions may have on its operations
cannot be accurately measured at this time. A key challenge to the Company's
continued growth is to sell increased volumes of CD-ROMs at competitive prices
and sufficient profit margins. There is a significant amount of competition in
the home-based PC market and the Company's success is substantially dependent
upon continued demand for existing PC products, its ability to market in a
timely manner new products and its ability to meet the pricing and functionality
requirements of the consumer.
32
<PAGE> 33
BUSINESS
This Prospectus contains "forward-looking statements," including statements
regarding, among other items, the Company's growth strategy, future products,
sales, ability to license future software programs and market products and
anticipated trends in the Company's business. Actual results could differ
materially from these forward-looking statements as a result of a number of
factors, including, but not limited to, the Company's early stage of
development, the need for additional financing, intense competition in various
aspects of its business, the seasonal nature of its business, its dependence on
third party authors and key personnel, and other factors described under "Risk
Factors" and elsewhere herein.
The Company publishes interactive multimedia software products providing
education and entertainment as well as reference and personal productivity
titles for the home personal computer ("PC") market. The Company generally
licenses software programs being developed by independent third party
developers. The Company then directs and assists the developers in finishing the
programs according to its specifications, imprints and duplicates the programs
in a media format, packages them in a proprietary manner, and markets and
distributes the finished products under the Piranha name as well as proprietary
titles whenever possible. Since the release of its first title in August 1995,
the Company has licensed and marketed seven titles under its own label including
(i) three "Piranha Packs," each of which offers 10 or 11 individual subject
titles relating to a central theme and (ii) four standalone, individually
packaged titles. In addition, the Company has marketed 13 titles under affiliate
relationships with two third party publishers pursuant to revenue-sharing
agreements. To date, the Company has published all of its titles in CD-ROM
format. In the future, the Company may distribute its products in other media,
such as digital versatile disc ("DVD"), on-line information services,
television-based formats, telephone and cable networks and direct broadcast
satellite, if market acceptance of such formats becomes widespread.
The Company intends to focus its product offerings on "edutainment" titles,
which combine entertainment and educational content, games, reference and
personal productivity titles, and other content titles which it determines to
have market potential. The Company has published and plans to publish titles in
various categories, including entertainment (e.g. Majestic: Alien Encounter, a
deep space adventure game), early childhood education (e.g. Treasure Tales
Presents Alice's Adventures in Wonderland, a children's interactive storybook),
reference (e.g. Academic Edge, a 10 CD educational theme pack), and personal
productivity (e.g. Travel CD Piranha Pack, an 11 CD travel and recreational
theme pack). When practicable, the Company publishes titles which are episodic
in design, thereby facilitating the production of sequential products and the
generation of increased customer loyalty. For example, Syn-Factor, the sequel to
the Company's game, Majestic: Alien Encounter, was released in February 1997.
The Company is also scheduled to release Dead Reckoning, a 3-D action game, and
Cracking the Conspiracy [working title], a 3-D adventure game, during the fourth
quarter of 1997 and the first quarter of 1998, respectively.
The Company's strategy is generally to license its software programs from
independent, third party software developers. The Company believes this strategy
enables it to avoid expending significant financial resources over a lengthy
period of time towards the research and development of a product that may never
achieve significant market acceptance, a substantial burden facing in-house
software development companies. As competition for products from independent
developers intensifies, however, the Company may be required to commit
significant financial resources to third party developers in order to obtain
desirable programs. By drawing upon independent developers the Company is able
to capitalize upon the variety of creative products currently being developed by
a growing number of software developers, an increase made possible in part by
the availability of industry standard authoring tools which assist software
programmers with the technical development of the titles. Pursuant to license
agreements with these developers, the Company pays a royalty based upon sales of
the product and in most instances an up-front advance and/or guaranteed minimum
royalty payment. The Company has also designed one title, Preschool Mother
Goose, with the assistance of consultants, which it then subcontracted to
independent software programmers for development. The Company may follow the
same procedure with additional future titles.
The Company's growth strategy consists of (i) targeting the growing
home-based, consumer PC market, (ii) building the brand recognition of "Piranha"
title offerings, (iii) expanding and enhancing its portfolio of
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interactive multimedia software products by generally licensing software
programs from third party developers who are in the process of developing such
products, (iv) expanding the placement of Piranha products with retailers and
distributors, and (v) seeking out appropriate strategic relationships, including
the acquisition of other software publishers.
The Company presently sells its products to retailers and distributors
through its own direct sales and marketing efforts. The Company's marketing
activities include channel marketing in partnership with its retailers and
distributors; direct advertising in PC periodicals; Internet website demos and
advertising; trade shows; and pre-release marketing. Since its inception in
November 1994, the Company has entered into distribution agreements with several
large national software distributors, as well as a number of other smaller and
specialty distributors. The Company currently places its products with a number
of the largest software retailers (in terms of software sales volume) in the
United States.
The Company's management team has worked closely together for the past
three to six years and all have prior software publishing experience. The
Company was incorporated in Arizona on November 14, 1994 and reincorporated in
Nevada on November 22, 1996. Its corporate headquarters are located at 1839 West
Drake, Suite B, Tempe, Arizona 85283, and its telephone number is (602)
491-0500. The Company's website address is http://www.piranhainteractive.com.
INDUSTRY OVERVIEW
As a result of technological advances, increased functionality, and
declining prices for entry level systems, the PC has become a mass market
consumer electronics product. Industry analysts estimate that the U.S. installed
base of PCs at the end of 1996 had grown to approximately 51 million units. The
demand for multimedia PC software is expected to be largely driven by the rapid
increase in home-based PC use. It is estimated that the installed base of
multimedia home-based PCs in the U.S. will grow from approximately 25 million in
1996 to approximately 70 million by the year 2000. Additionally, the increased
use of PCs in schools, increased quality of production, decreasing cost of PCs
and multimedia software and the demographic increase in teen consumers (who tend
to be heavily concentrated in entertainment software) all suggest significant
future growth in the consumer multimedia software market. Home education and
entertainment software products are currently the fastest growing categories of
retail software sales.
In recent years, tremendous advances in computer hardware and software, as
well as the decreasing cost of such products, have resulted in a rapid expansion
of the number of users in home environments prepared to consume new multimedia
products. As a result, total sales of multimedia software in the U.S. have been
projected to increase from approximately $1.7 billion in 1996 to $2.3 billion in
1997 and $3.0 billion in 1998. However, in recent years, the retail multimedia
software industry has experienced a consolidating trend as regional and smaller
retailers are acquired by retailers with greater resources and access to
capital. As a result, competition among retailers has increased and total sales
of multimedia products have increasingly become concentrated in fewer retailers.
Most of the multimedia products have been delivered on CD-ROMs. In addition,
other systems have evolved for delivery of multimedia products including the
Internet, other proprietary on-line services and television-based systems. The
Company believes that there will be an increasing convergence between CD-ROM and
on-line distribution of multimedia content, with on-line information sources
increasingly used in connection with CD-ROMs to update and supplement the CD-ROM
experience. To the extent that these new delivery systems achieve significant
market acceptance, management believes it will be able to capitalize on this
increasing demand for high quality interactive multimedia.
BUSINESS STRATEGY
As a result of management's experience in the software industry, the
Company believes it has the foundation to become a successful provider of high
quality multimedia software products for the consumer PC market. The Company
intends to focus on the following strategic objectives.
Target Growing Consumer PC Market. The Company is positioning its product
portfolio to take advantage of the fast-growing consumer PC market. The
Company's existing content-rich products -- entertainment, early childhood
education, reference and personal productivity -- are intended for home-based
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PC users from adults to teenagers to pre-schoolers. The Company endeavors to
anticipate this market's demand for particular software in order to provide
products that meet such demand. The Company also seeks to offer unique software
products that will generate demand within this market as well as the education
market.
Publish a Portfolio of Multimedia Software Titles. The Company's objective
is to publish an inventory of diverse software titles. As the installed base of
multimedia PCs grows, consumers increasingly demand a greater variety of content
rich, high quality software products. In response to this demand, independent
software developers are generating a greater number and variety of products.
The Company's strategy is generally to license software programs from
independent developers. The Company intends to capitalize upon this growing pool
of software developed by independent developers by identifying products which
the Company believes have an ability to achieve significant market penetration.
The Company uses a three-step selection process to identify such products. This
process entails a preliminary technical review, sales and marketing analysis,
and legal and financial review. By licensing software programs from third party
developers, the Company generally reduces its front-end financial commitment and
its risk of loss if the product is not ultimately successful. As competition for
products of independent developers intensifies, however, the Company may be
required to make significant front-end financial commitments in order to obtain
desirable products.
Develop Name Recognition for Piranha and its Products. Management believes
that a recognized and respected brand name will enhance initial interest in and
acceptance of new product offerings. In this regard, the Company selected its
name and logo and develops a packaging and advertising concept designed to
generate customer interest and create a Piranha brand image. At the same time,
the Company seeks to build customer loyalty by providing high quality software
products that satisfy customers. In order to create brand name recognition, the
Company initially introduced software products in the lower price ranges in
order to maximize its volume of products sold and secure retail shelf space.
Soon thereafter, the Company began to offer theme-oriented Piranha Packs, each
containing multiple CD-ROM titles, in order to enhance the perceived value and
increase customer recognition of Piranha products. Although budget software and
Piranha Packs will still be considered in appropriate circumstances, the Company
now intends to focus primarily on publishing premium products with higher gross
margins. The Company will continue to seek titles that enhance its name
recognition.
Place Piranha Products with Major Retailers and Distributors. The
Company's strategy is to expand the number of retailers and distributors
carrying its products. Management believes that its prior industry experience
has resulted in a certain degree of credibility for the Company and its products
with retailers and distributors. According to Computer Retail Week, in 1996
approximately 30 retailers accounted for over 90% of total U.S. retail software
sales. To date, the Company has placed products with many of these retail
chains. In addition, software distribution is dominated by several large
distributors. The Company currently has distribution agreements with a few of
these distributors. The Company intends to expand its retailer and distributor
relationships by maintaining and improving its existing accounts and developing
additional national, regional and specialty retail and distribution accounts.
Its strategy is to maintain these relationships and add additional distributor
relationships.
Seek Strategic Partnerships and Acquisition Opportunities. The Company
intends to expand its operations and product line by establishing strategic
partnerships and acquiring other software publishers or developers when
appropriate. Piranha has entered into marketing relationships with two national
companies in connection with certain products lines. The Company's Academic Edge
product was supplied to Apple Computers, Inc. ("Apple") for use by Apple in
conjunction with a nationwide promotion of Apple's hardware through Sears retail
outlets. Academic Edge was one of the products offered in the promotional
material distributed by Apple. Through the promotion, schools were permitted to
redeem free copies of the product from Apple. In addition, the Company was
granted a license from United Airlines to include United's proprietary travel
software package, United Connection, in the Travel CD Piranha Pack. The Company
may also license some of its products near the end of their retail lifecycles to
original equipment manufacturers ("OEMs"). In addition, the Company believes
there are many companies with one or two attractive products
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but a limited number of total products or marketing resources, which may be
attractive candidates for acquisition. The Company intends to pursue these
opportunities to enhance its product portfolio, but there can be no assurance
that any acquisition will be consummated. The Company does not currently have
any plans, agreements or understandings, binding or non-binding, to enter into
any potential business combination. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Liquidity and Capital
Resources."
PRODUCTS
Current Products. The Company has released and currently markets seven
multimedia software titles under its name, three of which are thematic Piranha
Packs of 10 or 11 CD-ROM titles, and also has two executed license agreements
for titles expected to be launched during the fourth quarter of 1997 and the
first quarter of 1998, respectively. Preschool Mother Goose, the Company's most
recent title, was shipped in May 1997. The Company is continually evaluating
other titles submitted to it by independent developers as part of its ongoing
product selection process. All of the Company's products to date have been
released in CD-ROM format. The following table sets forth the titles released,
or to be released, by the Company in each of its three current product families:
<TABLE>
<CAPTION>
PRODUCTS RELEASE DATE
- --------------------------------------------------------------------------- -----------------
<S> <C>
THEME PACKS
Piranha Pack -- Something for Everyone. The Company's first multipack August 1995
includes 10 CD-ROM titles offering a variety of title categories: games,
business and home management, utilities, edutainment, pastimes and
exercise. The Company does not intend to produce any further units of
this product.
Academic Edge Piranha Pack. The 10 CD Academic Edge Piranha Pack includes November 1995
nine curriculum-based titles for subjects such as Biology, Literature,
World History, Art History and more, as well as quizzes to test
comprehension. Also featured are Webster's New Collegiate Dictionary and
the American Concise Encyclopedia. The Company's license for this product
will terminate in November 1997, but the Company is entitled to sell its
then existing inventory for a limited time.
Travel CD Piranha Pack. This 11 CD Theme Pack is comprised of software July 1996
suited for the business and vacation traveler. It includes United
Connection, which allows flight scheduling and reservations with over 500
airlines, 30,000 hotels and 50 car rental companies worldwide. Other
titles include Street Wizard mapping and routing software, National
Parks, Vacation Dreamer, Sports Fishing, Ballooning and Soaring,
Adventures, White Water Rafting, Great Restaurants, Wineries and
Breweries and Explore America.
EARLY CHILDHOOD EDUCATION
Treasured Tales Presents Alice's Adventures in Wonderland. This program is November 1995
an adaptation of Lewis Carroll's classic tale Alice in Wonderland and is
intended for young children. The program is an interactive storybook
created specifically for Windows 95 containing hundreds of animations and
a classical music score. The Company's license for this product has
terminated, but the Company is entitled to sell its existing inventory.
Preschool Mother Goose. This multimedia program leads children through six May 1997
animated learning activities accompanied by narrated direction. Preschool
Mother Goose is designed to teach children the fundamentals of counting,
reading, music appreciation, foreign language and other cognitive skills.
The program includes parent and teacher icons that allow adults to extend
the learning lessons.
</TABLE>
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<TABLE>
<CAPTION>
PRODUCTS RELEASE DATE
- --------------------------------------------------------------------------- -----------------
<S> <C>
ENTERTAINMENT
Majestic: Alien Encounter. This multimedia program is a deep space November 1995
adventure game. The S. S. Majestic, a luxury space cruiser which
inexplicably disappeared on her maiden voyage, has suddenly reappeared in
the Pleiades Nebula. The user's mission is to enter the craft, determine
the fate of her crew and solve the mystery of her ill fated voyage.
Syn-Factor. This multimedia sequel to the game Majestic contains a new February 1997
musical score, expanded gaming theater and improved 3-D graphics. The
user's adventure begins as a crew member aboard a spaceship which has
just been the target of a brutal attack by unknown forces. The ensuing
investigation pits the user against the galaxy's largest corporation.
Dead Reckoning. In this 3-D action game the user battles to the death in a Scheduled for
fight to save the human race. The game features 15 alien battle arenas, Fourth Quarter of
artificial intelligence and multiplayer internet gaming capability. The 1997
Company has launched a website, located at http://www.deadreck.com,
devoted to generating consumer interest in and anticipation of this game.
Cracking the Conspiracy [working title]. In this 3-D adventure game Scheduled for
featuring interactive characters, the user conducts a personal First Quarter of
investigation into the mysterious extraterrestrial events involving Area 1998
51 and Roswell, New Mexico.
</TABLE>
In addition, the Company has marketed 13 titles in partnership with third
party Affiliates, pursuant to revenue sharing arrangements. The Company has no
proprietary rights in the products marketed under such arrangements and receives
a lesser percentage of gross revenues on such products than it does on products
proprietary to the Company.
Product Development. The Company's strategy is to license software
programs from independent software developers. The Company believes that this
strategy minimizes the financial risks associated with in-house research and
development activities and capitalizes upon the large pool of creative, high
quality products currently produced by independent developers. While several
publishers have spent millions of dollars on the research and development of a
single new title, a number of the best selling entertainment software titles in
the United States during recent years were developed by small, independent
developers and were licensed to software publishers. The Company uses a variety
of forums to identify high quality, completed or substantially completed
software programs produced by independent developers which generally lack the
sales, marketing and distribution resources offered by the Company and necessary
to introduce their products into the retail marketplace.
The Company has also designed one title, Preschool Mother Goose, with the
assistance of consultants which it then subcontracted to independent software
programmers for development. The Company may follow the same procedure with
additional future titles. The Company has agreed to pay minimal advance
royalties and future royalties based on product sales to the independent
developers who designed Preschool Mother Goose. Although all of the Company's
current products were developed by independent developers, the Company may fund
in-house development at some time in the future if management deems it
advisable.
The Company's product development activities are conducted with constant
attention given to the sales, marketing and technical support aspects of
publishing a successful title. The Company seeks to identify and attract new
developers through a variety of methods, including regular postings on the
Internet and on-line developer forums, existing developer relationships,
attendance at popular trade shows and conferences, referrals from retailers,
industry reputation and contacts, and developers' agencies. See also "-- Sales
and Marketing".
Once the Company has identified a potential title for publication, the
title is submitted to a three-step selection process. First, the Company
conducts a preliminary technical review to (i) assess the title's technical
operating stability, (ii) determine whether the title's technology and design
meet or exceed the then current
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industry standards and (iii) assess the developer's technical proficiency. Next,
the Company performs a sales and marketing review to assess (i) the potential
market share for the product, (ii) the degree of consumer demand for, and media
interest in, the product and (iii) the potential interest of the Company's
retailers and distributors in the product. Finally, the Company reviews the
legal and financial issues associated with publishing the potential title to
determine (i) the cost to bring the product to market, (ii) the absence of any
perceived risk of intellectual property infringement and (iii) acceptable
license agreement terms.
Before and after a title is published, the Company employs various quality
assurance methods to measure consumer reaction to the product and the
effectiveness of the various marketing programs utilized by the Company and its
retailers and distributors. Focus groups, independent quality assurance teams,
demonstrations and end-user questionnaires are among the methods which the
Company uses in its quality assurance activities. The Company seeks to use the
information received from consumers of its products to remain abreast of and
satisfy consumer expectations for technical stability, performance, content and
market image of its products.
Recent advances in software authoring systems have removed many of the
technical barriers previously associated with software development. These
advances and the rapidly increasing base of installed multimedia hardware have
resulted in an expanding pool of technically sound, content rich software
programs. As a result, the current trend in development has shifted competition
away from purely technical skills to creative ones. This newly emerging pool of
independent developers generally lacks the sales, marketing and distribution
resources offered by publishers such as the Company.
The Company seeks to increase revenues, market predictability and product
lifecycles and limit the effects of seasonality by endeavoring to create a mix
of three types of titles: evergreen titles, hits, and sequels. Evergreen titles
are intended to produce stable sales over a relatively long period of time. In
addition, they may be revised and updated to extend their profitable lifecycles.
Hit titles are developed in response to market trends and are promoted through
aggressive product positioning and rigorous development and quality control
management. Finally, sequels are titles intended to capitalize on the success of
earlier titles by exploiting a consumer base loyal to such titles. Sequels tend
to have a higher degree of market predictability. In the past, the Company's
revenues have been concentrated in only a few products, with three products
resulting in 90% of annual net sales for 1995, two products resulting in 78% of
annual net sales for 1996 and three products resulting in 80% of net sales
during the six month period ended June 30, 1997. However, the Company believes
this concentration to be largely a result of the limited number of products
offered to date, and the Company intends to market a broader variety and number
of titles in the future consistent with its business strategy. See "Risk
Factors -- Accumulated Deficit; Working Capital and Capital Deficits."
SALES AND MARKETING
Customers. The Company sells its products to distributors and directly to
certain retailers. Currently, the retail merchandisers of the Company's products
include computer "superstores", national and regional retail stores, mass
merchandisers, corporate resellers, direct mail accounts, consumer electronic
stores, warehouse clubs and office supply stores. The Company also distributes
its products through several of the largest national distributors which have
access to desirable retail accounts. By making its products available through a
number of large distributors, the Company believes it is able to fill retailers'
orders more quickly and increase the name recognition of the Company and its
products.
For the six month period ended June 30, 1997, 66% of the Company's net
sales were to distributors, 3% of net sales were direct to retailers, and no
sales were to OEMs. Three distributors accounted for 35%, 12% and 10%,
respectively, of the Company's net sales during the first six months of 1997.
Two retailers accounted for approximately 2% and 1%, respectively, of net sales
during the first six months of 1997. Two retailers accounted for approximately
20% and 7%, respectively, during the year ended December 31, 1996. However,
management believes that its sales during the six month period ended June 30,
1997 are not necessarily indicative of the results that may be expected for
future periods as its working capital deficiency experienced during such period
prevented the Company from launching new titles.Although the Company will seek
to expand the number and variety of distribution channels for its products,
sales of its products have in the past
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and may in the future be heavily concentrated among a few retailers. See "Risk
Factors -- Competition for Distribution Channels; Distribution Risks" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations." International sales accounted for 31% of the Company's sales during
the six month period ended June 30, 1997. The Company believes that its
concentration of international sales during the six month period ended June 30,
1997 is a result of decreased overall sales and is not indicative of future
international sales concentration as a percentage of the Company's net sales.
For the year ended December 31, 1996, 54% of the Company's net sales were to
distributors, 32% of net sales were direct to retailers and 11% of net sales
were to an OEM. Three distributors accounted for approximately 21%, 18% and 11%,
respectively, of the Company's net sales during 1996. Two retailers accounted
for approximately 20% and 7%, respectively, and one OEM accounted for 11%, of
the Company's net sales during such period. International sales accounted for
only 3% of the Company's net sales during the year. During the fiscal year ended
December 31, 1995, one retailer accounted for substantially all of the Company's
net sales.
Sales Activities. The Company's sales activities are focused upon
fostering familiarity among the buyers for the various retail chains with the
Company and its products, whether they purchase Piranha products directly from
the Company or through a distributor, building upon the philosophy that retail
stores will put more effort behind and give better placement to products they
are familiar with. In addition, management believes that the key to developing
successful relationships with retail merchants of its products is the ability to
develop an understanding of each retailer's customers, including, what they buy,
how they make their purchases and which marketing programs are most successful
in promoting a particular type of software title. The retail software market is
intensely competitive in terms of shelf space and promotional support. Although
the Company believes that it will continue to secure adequate shelf space and
promotional support from retailers of its products, the competition for such
access is intense and there can be no assurance that the Company will be
successful in this regard.
As the number of home-based PCs increases and the use of multimedia
software becomes more widespread, the number and variety of software retailers
have rapidly increased. Examples of new software retailers include bookstores,
grocery, music and convenience stores and even specialty shops. The Company has
already begun to access these new retail sales channels and has placed its
products in record stores and book stores. In addition to these emerging retail
sales channels, the Company markets its products to alternative markets, such as
international sales, original equipment manufacturers and educational markets.
In addition to its retail customers, the Company sells its products to
distributors who resell such products to various retailers. The Company believes
that access to these distributors permits the Company to more rapidly fill
customer orders and increases the name recognition of Piranha and its products.
To date, the Company has entered into distribution agreements with a few of the
largest national distributors.
Marketing Activities. The Company's marketing activities are organized
around direct advertising, product packaging and public relations and media. The
Company strives to create a highly visible and appealing brand image through its
corporate name and logo, its customer service number, its World Wide Web site
and the design and packaging of its products. The Company pays close attention
to the brand image created through its product packaging and seeks to develop an
appropriate packaging concept and design that will be attractive to its
customers and end-users. The Company's packaging is designed not only to get the
product on the shelf, but also to entice the customer to purchase the product.
In order to generate consumer awareness, the Company advertises in various
trade and general circulation publications. Additionally, the Company often
participates in cooperative marketing efforts with its distributors and
retailers. Retailer marketing programs include in-store premium shelf placement,
flyers, in-store promotions, advertisements and customer service employee
training. In addition, each distributor promotes its products with marketing
programs, including trade publications and catalogs targeted at retail buyers
and in-house education seminars designed to permit vendors such as the Company
an opportunity to increase the distributors' sales force's familiarity with
their products.
The Company intends to aggressively market its new product releases. In
connection with the launch of new products, the Company seeks to generate
initial retailer and distributor interest by sending a "teaser" prior
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to the completion of the new product. The "teaser" is a marketing pre-mailer
designed to draw attention to a product, which also contains brief information
regarding the actual product and its functions.
Once the product is completed, the Company focuses on sending advance
copies of the product to the media and retail and distribution buyers for
review. Management believes that maintaining a relationship with the media is
crucial in receiving the recognition and product reviews needed to support new
product releases and continuing product sales. A number of publications,
including The New York Times and industry magazines, have previously responded
to the Company's products with reviews.
The Company seeks to anticipate consumer demands by establishing channels
of communication between itself and consumers through registration cards, trade
shows and user groups and to find additional avenues for increasing the
visibility for its products and its name. Capitalizing on the rapid increase in
consumer use of the Internet, the Company has developed its own website, which
it uses in connection with its sales and marketing and product development
activities. The website is designed for instant communication, feedback and
product delivery to users. The website includes a Products Forum with full-page
graphical product descriptions and downloadable, interactive game demos; a Sales
Forum where customers can locate and contact resellers; and a Distributor's
Forum with product descriptions and part numbers. In addition, the Company has
launched a website, located at http://www.deadreck.com, devoted to generating
consumer anticipation and interest in its game Dead Reckoning, scheduled to be
released in the fourth quarter of 1997.
INTELLECTUAL PROPERTY LICENSES AND DISTRIBUTION AGREEMENTS
Software Licenses. Each of the Company's software products is authored by
a third party developer which creates each program's "source code", a unique set
of program instructions which are translated into machine language and executed
by an end-user's computer. Once created, each program's source code is
proprietary in nature and is generally the property of the developer, unless
there is an agreement in place to the contrary. The Company does not own the
source code to the software contained in the Piranha Packs published to date,
but has published the products with proprietary packaging and titles. As a
result, the products contained in the Piranha Packs may be sold by the
developers to other publishers, permitting the Company's competition to publish
similar products. The Company's licenses for the software contained in its
multiple CD-ROM Piranha Packs are generally non-exclusive and generally of short
duration (to date ranging from one to two years). Two of the three Piranha Packs
published to date have been in Windows only format and one has been published in
dual platform formats, Windows and Macintosh. Piranha Pack licenses to date have
not contained any rights of first refusal for any future products produced by
the developers. The permitted sales territory for two of the Company's Piranha
Packs is world-wide, while the territory for the third is limited to North
America. All three Piranha Packs published to date are English language only.
Technical support for the software programs in the three Piranha Packs published
to date is the responsibility of the respective third party licensors.
The Company's licenses for the software contained in its standalone,
individually packaged titles are generally exclusive licenses for longer terms
(to date ranging from three years to six years). However, generally the
Company's exclusive license arrangements may become non-exclusive or terminate
if the Company does not satisfy certain performance criteria, such as selling a
minimum amount of units or paying a minimum amount of royalties. In September
1996, the Company's exclusive license for the title Treasured Tales Presents
Alice's Adventures in Wonderland terminated when product sales failed to satisfy
the required minimum threshold. Some of the Company's licenses have become, or
will become, non-exclusive with the passage of specified time periods. The
Company does not own the source code to the software contained in the licensed,
standalone titles published to date, but the license agreements provide that the
Company exclusively owns the proprietary packaging and titles that it develops
for such software programs. One of the individual titles published to date has
been in Windows only format and three titles have been published in dual
platform formats, Windows and Macintosh. One licensed individual title which has
yet to be published by the Company is intended for use on dual platforms,
Windows and Macintosh and a second licensed individual title which has yet to be
published by the Company is intended for use in Windows 95 format only. The
Company has a right of first refusal to the sequels of three of its individual
titles licensed to date.
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The Company has paid advances against royalties for four individual titles
licensed to date and anticipates that it will likely pay advances against
royalties for many future individual titles in order to obtain desirable content
and technology. Such advances may be significantly greater in amount than those
previously paid by the Company in order to obtain products. The permitted sales
territory for the four individual titles published to date, and for the two
additional individual titles which the Company plans to launch in the fourth
quarter of 1997, is world-wide. The Company has the right to publish five of the
individual titles in languages other than English, but the Company currently has
no plans for such publication. The Company is required to supply technical
support to the end users for all four published individual titles and for the
additional titles planned for launch in the fourth quarter of 1997 and the first
quarter of 1998. The Company anticipates that it will be required to supply
technical support for all such future titles as well.
Distribution Agreements. The Company's distribution agreements generally
permit the distributor to sell the Company's products on a non-exclusive basis
for a limited term. Distributors are not generally required to purchase any
minimum amount of products from the Company, and are entitled to make purchases
at prices at least as favorable as those at which the Company sells comparable
products to other distributors. In addition, most of these agreements permit the
distributor to return unsold products and require the Company to indemnify the
distributor against certain intellectual property and product design related
liabilities. Generally, the distribution agreements require the distributors to
pay the Company for products purchased within a specified period of time,
however, two distribution agreements with significant distributors permit such
distributors to delay payment until product is sold by the distributor to retail
customers. Consequently, the Company incurs longer delays in cash receipts for
products distributed through these channels. The Company's distribution
agreements also permit distributors to apply credits against invoices for
certain advertising and marketing efforts associated with the Company's
products.
MANUFACTURING
All of the Company's titles are currently pressed, reproduced, and packaged
at third party fulfillment houses. The Company's printed materials are produced
by third party vendors that ship such materials directly to the fulfillment
house for product assembly and packaging. The Company places orders with such
vendors for production of completed products in amounts specified by the Company
based upon forecasted sales. Most products are shipped directly to distributors
and retailers by the fulfillment houses. An unanticipated delay in the
manufacture of products, particularly during the fourth quarter, could result in
a material adverse effect on the Company's financial condition and results of
operations. Demand for fulfillment houses is greatest in the third and fourth
quarters, as publishers build inventory for holiday sales. Although the Company
has been utilizing one particular fulfillment house, it is negotiating with
several others in order to attempt to reduce such problems.
Generally, the Company is obligated to pay its vendors within 30 days of
shipment, although the Company's customers' payment cycles are often much
longer, generally from between 90 to 120 days. Previously, this discrepancy in
payment cycles has resulted in inconsistent cash flows for the Company, which
condition may recur in the future. The Company does not have contractual
agreements with any of its outside vendors, including its fulfillment house. As
a result, the outside vendors are not committed to provide services or products
to the Company when the Company may require such services or products, and the
Company may not be able to seek indemnification from its vendors for potential
product liability or other manufacturing defects.
COMPETITION
Software Industry. The consumer software industry is intensely competitive
and subject to rapid change. The Company believes that the principal competitive
factors affecting the markets for its titles include content, quality, brand
recognition, price, marketing, distribution, access to shelf space and critical
reviews. In addition, consumer demand for particular software products may be
adversely affected by the increasing number of competitive products from which
to choose, making it difficult to predict the Company's future success in
publishing packaged software products for the retail market. Rapid changes in
technology, product obsolescence and advances in computer hardware require the
Company to develop or acquire new products
41
<PAGE> 42
and to enhance its existing products on a timely basis. The Company's
marketplace has recently experienced a higher emphasis on on-line and Internet
related services and content tailored for this new delivery vehicle. To the
extent that demand increases for on-line products and content, the demand for
the Company's existing product format may decline.
The consumer multimedia market is highly fragmented with products offered
by many vendors. The Company's products compete directly with those of large and
established software companies, such as GT Interactive, Broderbund, and The
Learning Company, as well as a large number of small independent publishers like
the Company. Most of these competitors have greater financial, technical,
marketing, sales and customer support resources, as well as greater name
recognition and access to customers than the Company. Due to the low technical
and economic barriers to entry into the multimedia software market, the Company
anticipates facing additional competition from an increasing number of small,
privately-held competitors. In addition, many large companies with sophisticated
product marketing and technical abilities and financial resources that do not
presently compete with the Company may enter the multimedia software market. For
example, content-rich companies such as Mattel and The Walt Disney Company have
begun to produce and directly market their own titles to the consumer software
market. To the extent that competitors, as a result of their purchasing
capacity, have greater access to financial and other resources or achieve a
performance, price or distribution advantage, the Company's business and results
of operations could be adversely affected. Furthermore, the Company anticipates
that there will be consolidation of the consumer multimedia market around a
smaller number of vendors who may be better positioned and have greater
resources to compete than the Company. The Company will also face increased
competition as it seeks to deliver multimedia content through other new media,
such as the World Wide Web, the Internet and on-line proprietary services.
There is no assurance that the Company will have the resources required to
respond to market or technological changes or to compete successfully in the
future.
Retail Shelf Space. The competition for shelf space in retail stores is
intense. To the extent that the number of consumer software products and
computer platforms increases, this competition for shelf space may further
intensify. At present, the Company's products constitute a small percentage of a
retailer's sales volume, and there can be no assurance that retailers will
provide the Company's products with adequate levels of shelf space and
promotional support. Increased competition could result in loss of shelf space
for, and reduction in sell-through of, the Company's products at retail stores,
as well as significant price competition, any of which could adversely affect
the Company's business, operating results and financial condition.
Due to increased competition for limited retail shelf space and promotional
resources, retailers and distributors are increasingly in a better position to
negotiate favorable terms of sale, including price discounts and product return
policies, as well as cooperative market development funds. Retailers often
require software publishers to pay fees in exchange for preferred shelf space.
The amounts paid to retailers by software publishers and distributors for
preferred shelf space are generally determined on a case by case basis and there
is, as of yet, no industry standard for determining such fees, although larger
publishers and distributors will likely have a competitive advantage in this
regard to the extent they have greater financial resources and negotiating
leverage.
Distribution Channels. Competition for access to distributors, as well as
for retail shelf space and inclusion in OEM sales programs is intense. In
addition, the type and number of distribution channels is increasing to include
non-traditional software retailers such as book, music, video, magazine, toy,
gift, convenience, drug and grocery store chains. Additionally, as technology
changes, the type and number of distribution channels will further change and
new types of competitors, such as cable or telephone companies, and new
distribution channels are likely to emerge. These new distribution channels may
include delivery of software using on-line services or the Internet, which will
necessitate certain changes in the Company's business and operations, including
without limitation, addressing operational challenges such as improving download
time for pictures, images and programs, ensuring proper regulation of content
quality and developing sophisticated security for transmitting payments. Even
within traditional channels of distribution for consumer software products there
has been rapid change among distributors, including consolidations and financial
difficulties. These factors affecting distribution channels are likely to
increase competition and negatively
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<PAGE> 43
affect the Company's business and results of operations. With increasing
concentration in the traditional channels of distribution, the Company's
customers have increased leverage in negotiating favorable terms of sale,
including price discounts and product return policies. In addition, a number of
the Company's larger competitors have attempted, with some success, to enter
into exclusive software distribution arrangements with certain retail outlets.
If the occurrence of these exclusive arrangements increases and the Company is
not able to offer a competitive product line or arrangement, the Company's
operating results may be negatively impacted.
PROTECTION OF PROPRIETARY RIGHTS
The Company regards its software as proprietary and relies primarily on a
combination of trademark, copyright and trade secret laws, as well as employee
and third party nondisclosure agreements and other methods to protect its
proprietary rights. The Company generally licenses its externally developed
products rather than transferring title and, as is the industry practice, relies
upon "shrink-wrapped," rather than signed, license agreements with end-users.
The enforceability of such licenses has not been conclusively determined. As is
also the standard practice in the industry, none of the Company's CD-ROM
products include any mechanism to prevent or inhibit unauthorized copying. The
Company is not aware of any unauthorized copying, reverse engineering or other
unauthorized distribution of its products' proprietary information, but if such
unauthorized copying were to occur, the Company's business, operating results
and financial condition could be materially adversely affected. Further, the
laws of foreign jurisdictions may not protect the Company's proprietary rights
to the same extent as the laws of the United States. Policing unauthorized use
of a broadly disseminated product such as PC software is very difficult.
Software piracy has been, and can be expected to be, a persistent problem for
participants in the software industry, including the Company.
As the number of multimedia software products in the industry increases and
the functionality of these products further overlaps, software publishers and
developers may increasingly become subject to infringement claims. There can be
no assurance that third parties will not assert infringement claims against the
Company in the future with respect to current or future products. Although the
Company makes reasonable efforts to ensure that its products do not violate the
intellectual property rights of others, there can be no assurance that claims of
infringement will not be made against the Company. In certain circumstances,
litigation may be necessary to enforce and protect the Company's proprietary
rights. Any such litigation, with or without merit, could be costly and divert
management's attention, which could have an adverse effect on the Company's
business, operating results or financial condition. Adverse determinations in
litigation relating to any of the Company's products could result in the loss of
the Company's proprietary rights, subject the Company to liabilities, require
the Company to seek licenses from third parties or prevent the Company from
selling that product.
The Company has a federally registered trademark for both the "Piranha
Interactive Publishing" name and its stylized fish logo. The Company has not
filed any other Federal trademark applications, although it may do so in the
future.
The Company believes that its products do not infringe upon the proprietary
rights of third parties. The Company seeks whenever possible to obtain
warranties and indemnification from its third party software developers to
protect the Company from claims of infringement by third parties of their
property rights. However, there can be no assurance that such warranties,
indemnifications and disclaimers will protect the Company from liability arising
from such claims or from any resulting material adverse effects to its business.
EMPLOYEES
The Company currently has twelve full-time employees and expects to hire at
least four additional full-time employees in the next six months. None of the
Company's employees are represented by labor unions. The Company believes that
its relations with its employees are good.
43
<PAGE> 44
PROPERTY
The Company subleases its principal offices in Tempe, Arizona, which are
used to house all of its operations, including marketing, sales and all
administrative operations. The 4,750 square foot facility is subleased pursuant
to an agreement under which the Company is obligated to make minimum annual
rental payments of $45,234 in 1997, $46,421 in 1998 and $43,551 in 1999. The
sublease has a four-year term which expires in November 1999. The Company
believes that its facilities are adequate for its current and foreseeable
operations over the next 12 months.
LEGAL PROCEEDINGS
The Company is not a party to any pending or threatened legal proceedings
that it believes will have a material impact on the Company's business.
44
<PAGE> 45
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The Directors, Director-Nominees and Executive Officers of the Company, and
their respective ages and positions with the Company, are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ----------------------------------- --- -----------------------------------------------
<S> <C> <C>
Timothy M. Brannan................. 39 President, Chief Executive Officer and Chairman
of the Board of Directors
Keith P. Higginson................. 33 Vice President, Chief Financial Officer and
Director
J. Wade Stallings, II.............. 36 Vice President, General Counsel and Director
Douglas M. Brannan................. 31 Vice President, Sales
Wyndi D. Ballard................... 28 Vice President, Marketing and Public Relations
George W. Gregg.................... 30 Vice President, Product Planning and
Development
Ian D. Berman...................... 42 Director-Nominee
Michael D. Flink................... 37 Director-Nominee
</TABLE>
DIRECTORS AND OFFICERS
TIMOTHY M. BRANNAN. Mr. Brannan has served as President, Chief Executive
Officer and Chairman of the Board of the Company since its inception in November
1994. Mr. Brannan served as Executive Vice President for Software Marketing
Corporation ("SMC"), a privately held software publisher, from November 1991
until October 1994. Mr. Brannan served as Executive Vice President for Automap,
Inc. ("Automap"), also a privately held publisher of interactive software, from
November 1991 until June 1993. Mr. Brannan attended Arizona State University
where he studied Business and Marketing.
KEITH P. HIGGINSON. Mr. Higginson has served as Vice President, Chief
Financial Officer and a Director of the Company since its inception in November
1994. From January 1993 until October 1994, Mr. Higginson served as Controller
for SMC. From January 1993 until June 1993, Mr. Higginson also served as
Controller of Automap. Mr. Higginson was self-employed as an accountant from
March through December 1992. From August 1991 until February 1992, Mr. Higginson
was employed as Controller for TimeMax Corporation, a provider of corporate
training and time management materials. Mr. Higginson received a Bachelor's
Degree in Accounting from San Diego State University.
J. WADE STALLINGS, II. Mr. Stallings has served as Vice President, General
Counsel and a Director of the Company since its inception in November 1994. From
February through October 1994, Mr. Stallings served as Vice President and
General Counsel to SMC. Prior thereto, Mr. Stallings was the Coordinator of the
Office of Properties for the Baha'i World Center, an international non-profit
organization from February 1990 until February 1994. Mr. Stallings received a
Bachelor's Degree in Management from the University of Alabama and a Juris
Doctor Degree from Washington and Lee University School of Law.
DOUGLAS M. BRANNAN. Mr. Brannan has served as Vice President, Sales for
the Company since October 1995. Prior thereto, Mr. Brannan served as Director,
Western Sales for Softkey International (subsequently renamed The Learning
Company), a publicly traded software company, from September 1994 until October
1995. From January 1992 until September 1994, Mr. Brannan was Vice President,
Sales, for SMC. In addition, from January 1992 until June 1993, Mr. Brannan was
Director of Sales for Automap. Mr. Brannan received a Bachelor's Degree in
Health Science from San Diego State University.
WYNDI D. BALLARD. Ms. Ballard has served as Vice President, Marketing &
Public Relations for the Company since April 1995. From November 1994 to April
1995, Ms. Ballard served as Director of Public Relations for SC&T International,
a publicly traded corporation developing and marketing sound enhancement
products for the personal computer and video game markets. From June 1991 until
October 1994, Ms. Ballard served as Director of Public Relations and Director of
Marketing for SMC. In addition, from June 1991 to June 1993, Ms. Ballard served
as Director of Public Relations and Marketing for Automap. Ms. Ballard attended
University of Wyoming and Phoenix College where she studied Business and
Marketing.
45
<PAGE> 46
GEORGE W. GREGG. Mr. Gregg has been employed as the Company's Vice
President, Product Planning and Development, since June 1995. From November 1992
through May 1995, Mr. Gregg served as Project Director, Lead Software Developer
and Operations Manager for Mythos Software Corporation, a software developer
which Mr. Gregg also co-founded. In addition, Mr. Gregg worked with several
members of the Company's management while serving as an independent software
design consultant to SMC during the Fall of 1992. Mr. Gregg was employed as a
Research Associate for the Department of Chemistry at the University of Georgia
during the Spring of 1992. Mr. Gregg received a Bachelor's Degree in Chemistry
from Arizona State University and a Master's Degree in Chemistry from the
University of Southern California.
IAN D. BERMAN. Mr. Berman has agreed to become a director of the Company
effective upon the closing of the Offering. In 1991, Mr. Berman co-founded Frost
& Berman Incorporated, an investment banking and financial advisory consulting
firm. Since that time, Mr. Berman has served as Managing Director for the firm,
which focuses exclusively on the entertainment and education software industry.
From 1985 to 1991, Mr. Berman served as a Senior Manager with the Capital
Markets Group for Touche Ross. From 1983 to 1985, Mr. Berman served as a Senior
Analyst with Salomon Brothers, Inc. Mr. Berman is a Certified Public Accountant
and received a Bachelor of Commerce Degree in Accounting and a Master's Degree
in Finance from the University of Witwatersrand University (Johannesburg).
MICHAEL D. FLINK. Mr. Flink has agreed to become a Director of the Company
effective upon the closing of the Offering. Since October 1995, Mr. Flink has
served as the Senior Vice President, Merchandising & Advertising for
Communication EXPO, a communication products superstore. From January 1994 until
September 1995, Mr. Flink served as Vice president of Computer City, a division
of Tandy Corporation, where he was responsible for all merchandising,
advertising and strategic planning functions for the computer and software
retailer. From 1992 through December 1993, Mr. Flink served as Consumer Brand
and Product Management Consultant to IBM. From 1990 through 1992, Mr. Flink
served as President and Chief Operating Officer of R&R Electronics and
Appliance, a regional chain of consumer electronics and appliance superstores.
From 1978 through 1990, Mr. Flink served in various management capacities with
Tandy Corporation's Radio Shack division. Mr. Flink received a Bachelor of Arts
in Communication from North Carolina State University.
Messrs. Douglas M. Brannan and Timothy M. Brannan are brothers. No other
Directors or Officers are related by blood or marriage.
CLASSIFIED BOARD
Pursuant to the Company's Articles of Incorporation and Bylaws, the Board
of Directors is divided into three classes, as nearly equal in number as is
feasible. Each class serves for a term of three years, and election of the
classes is staggered so that one class is elected each year. The Director
serving in Class III, which class term expires in 2000, is Timothy M. Brannan.
The Director serving in Class II, which class term expires in 1999, is Keith P.
Higginson and the Director serving in Class I, which class term expires in 1998,
is J. Wade Stallings, II. Upon the closing of this Offering, the number of
Directors on the Board will be increased to five and Michael D. Flink and Ian D.
Berman, two non-employee directors, will be appointed as Directors to serve in
Classes II and I, respectively. At the Company's 1998 Annual Meeting of
Stockholders, stockholders will vote to elect Class I of the Board.
BOARD COMMITTEES
The Board of Directors has authorized a Compensation Committee that will
commence upon the closing of this Offering. The Compensation Committee will be
comprised of Timothy M. Brannan, Michael D. Flink and Ian D. Berman. The
Compensation Committee will review and recommend to the Board of Directors the
compensation and benefits of all Officers of the Company and also administer the
Company's stock plans, pursuant to which stock options are granted to Officers,
Directors, key employees and consultants. The Board of Directors has also
authorized an Audit Committee to commence upon the closing of this Offering. The
Audit Committee will be comprised of Michael D. Flink and Ian D. Berman. The
Audit Committee will review, with the Company's independent accountants, the
annual financial statements of the Company, and
46
<PAGE> 47
also review the effectiveness of the Company's financial and accounting
functions and organization and make recommendations to the Board of Directors in
that regard.
DIRECTORS' COMPENSATION
Directors are not currently compensated for their services in that capacity
or for serving on committees but are reimbursed for their reasonable expenses
incurred in connection with serving as Directors. Non-employee Directors serving
on the Company's Board currently receive an initial grant of options to purchase
10,000 shares of Common Stock at the time they commence service to the Company
and may receive additional future options at the discretion of the Board. See
"-- 1996 Stock Option Plan".
INDEMNIFICATION AND LIMITATION OF LIABILITY
The Company's Articles of Incorporation and Bylaws require the Company to
indemnify each of its Officers and Directors against liabilities and reasonable
expenses incurred in any action or proceeding, including stockholders'
derivative actions, by reason of such person being or having been an Officer or
Director of the Company, or of any other corporation for which he or she serves
as such at the request of the Company, to the fullest extent permitted by Nevada
law. Pursuant to Nevada law, the Company has adopted provisions in its Articles
of Incorporation and Bylaws that eliminate, to the fullest extent available
under Nevada law, the personal liability of its Directors and Officers to the
Company or its stockholders for monetary damages incurred as a result of the
breach of their duty of care. These provisions neither limit the availability of
equitable remedies nor eliminate Directors' or Officers' liability for engaging
in intentional misconduct or fraud, knowingly violating a law or unlawfully
paying a distribution.
The Company has been advised that it is the position of the Commission that
insofar as the foregoing provision may be invoked to disclaim liability for
damages arising under the Securities Act, such provision is against public
policy as expressed in the Securities Act and is therefore unenforceable.
EXECUTIVE COMPENSATION
The following table sets forth the compensation paid or accrued by the
Company for the services rendered during each of the fiscal years ended December
31, 1996 and 1995, respectively, to the Company's Chief Executive Officer (the
"Named Executive Officer"). No executive officer of the Company earned in excess
of $100,000 during that period.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
ANNUAL
COMPENSATION(1)
------------------
NAME AND POSITION YEAR SALARY BONUS
-------------------------------------------------- ---- ------- ------
<S> <C> <C> <C>
Timothy M. Brannan................................ 1996 $50,250 $1,083
Chairman, President 1995 $12,926 $ 0
</TABLE>
- ---------------
(1) The Company was not formed until November 14, 1994 and no salaries were paid
until October 1995. Effective November 1, 1996, Mr. Brannan became subject
to an employment agreement pursuant to which he is compensated thereafter at
an annual base rate of $75,000.
During each of the Company's fiscal years ended December 31, 1996 and 1995,
respectively, Mr. Brannan did not receive any other annual compensation,
long-term compensation or other compensation.
EMPLOYMENT AGREEMENTS
Effective November 1, 1996, the Company entered into three-year employment
agreements with its senior executive officers, Timothy M. Brannan, Keith P.
Higginson, J. Wade Stallings, II, Douglas M. Brannan and Wyndi D. Ballard. The
agreements provide for base salaries of $75,000, $65,000, $65,000,
47
<PAGE> 48
$65,000 and $50,000 for Mr. Timothy M. Brannan, Mr. Higginson, Mr. Stallings,
Mr. Douglas M. Brannan and Ms. Ballard, respectively, subject to review at least
annually by the Board of Directors. The executives may receive bonuses at the
discretion of the Board. The Company may unilaterally terminate the agreements
for "Cause," which includes (i) conviction of a felony, or (ii) failure to
diligently cure a specified deficiency in the executive's performance within 30
days.
In the event the Company terminates the executive's employment during the
term of the agreement without Cause, or in the event the executive terminates
the agreement for "Good Reason" (as defined in the agreements), which includes
certain changes in the executive's duties or a change in control of the Company,
the Company shall pay to such executive (i) his/her salary through the
termination date plus any accrued but unpaid bonuses and (ii) with respect to
executives other than Timothy M. Brannan, a severance payment equal to the
executive's then current annual salary and an amount equal to the average of all
bonuses paid to the executive in the three years immediately preceding
termination, which the Company has the option to pay over one year. With respect
to Timothy M. Brannan, the severance payment would be equal to two times his
then current annual salary and an amount equal to the average of all bonuses
paid to him in the three years immediately preceding termination, which the
Company has the option to pay over two years. In addition, the Company must
maintain until the first to occur of (i) the executive's attainment of
substitute employment or (ii) two years from the date of termination with
respect to Timothy M. Brannan and one year from the date of termination with
respect to the other executives, the executive's benefits under the Company's
benefit plans to which the executive and his/her eligible beneficiaries were
entitled immediately prior to the date of termination. If the executive
requests, the Company must also assign to the executive any assignable insurance
policy on the life of the executive owned by the Company and at the end of the
period of coverage. If the executive is terminated for Cause or if the executive
terminates his/her employment other than for Good Reason, the Company's only
obligation is to pay the executive his/her base salary and accrued vacation pay
through the date of termination. If any of the executives are terminated without
Cause or resign for Good Reason following a change in control of the Company,
the executive is entitled to two years' severance compensation including
benefits until obtaining alternate employment.
If the executive is incapacitated due to physical or mental illness during
the term of his/her employment, the agreements provide that the Company shall
pay to the executive a lump sum equal to the executive's then current base
salary and the average of all bonuses paid to the executive in the three years
preceding the date of termination due to illness. If the executive dies during
his/her employment, his/her salary through the date of his/her death, any
accrued but unpaid bonuses and any benefits payable pursuant to the Company's
survivor's benefits insurance and other applicable programs and plans then in
effect are payable to his/her estate.
If the executive's employment is terminated, the Company has agreed to
indemnify the executive for claims and expenses associated with certain personal
guarantees, if any, made by the executive. The Company also has agreed to use
its best efforts to secure the release of such personal guarantees following the
Offering. In addition, the Company has agreed to indemnify the executive against
all costs incurred in enforcing his/her rights under the agreement following a
change in control of the Company. See "Certain Transactions."
1996 STOCK OPTION PLAN
The Company's 1996 Stock Option Plan (the "1996 Plan") authorizes the Board
to grant options to Directors, Officers, employees and consultants of the
Company to purchase shares of Common Stock. An aggregate of 300,000 shares of
Common Stock are reserved for issuance upon exercise of options granted or to be
granted under the 1996 Plan. Directors, Officers, employees and consultants
(including independent contractors and software developers) of the Company who,
in the opinion of the Board of Directors, are responsible for the continued
growth and development and the financial success of the Company are eligible to
be granted options by the Board under the 1996 Plan. Options may be nonqualified
options, incentive stock options, or any combination of the foregoing. In
general, options granted under the 1996 Plan are not transferable and expire ten
years after the date of grant. The per share exercise price of any incentive
stock option granted under the 1996 Plan may not be less than the fair market
value of the Common Stock on the date of grant. Incentive stock options granted
to persons who have voting control over 10% or more of the
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<PAGE> 49
Company's capital stock are granted at 110% of the fair market value of the
underlying shares on the date of grant and expire five years after the date of
grant. No option may be granted after December 13, 2006.
The 1996 Plan provides the Board of Directors with the discretion to
determine when options granted thereunder will become exercisable. Generally,
such options may be exercised after a period of time specified by the Board of
Directors at any time prior to expiration. No option granted under the 1996 Plan
is transferable by the optionee other than by will or the laws of descent and
distribution, and each option is exercisable during the lifetime of the optionee
only by the optionee. As of the closing date of the Offering, options to
purchase an aggregate of 66,500 shares of Common Stock at an exercise price of
$5.00 per share will be outstanding under the 1996 Plan. In connection with a
potential product license agreement, the Company anticipates that it may grant
at a date following the closing of this Offering options to purchase up to
70,000 shares of Common Stock at a price per share not less than the fair market
value of the Common Stock on the date of grant. The Company has agreed with the
Underwriters that it will not, without the prior written consent of the
Representative, grant any options to employees that are exercisable at a price
below the initial public offering price of the Units or the fair market value on
the date of grant, for a period of 18 months from the date of this Prospectus.
Possible Need for Additional Plan Securities or Plans. It may become
necessary for the Company to grant options for more shares of Common Stock than
are available under the 1996 Plan in order to attract additional members to its
Board of Directors or Officers, consultants or employees. In such event,
additional shares may be required to be added to the Company's 1996 Plan or new
plans may be adopted with shares reserved for exercise thereunder, either of
which events may have a dilutive effect to shareholders.
CERTAIN TRANSACTIONS
On November 15, 1994, in connection with the founding of the Company, the
Company issued 1,436 shares of Common Stock to Timothy M. Brannan, 1,000 shares
of Common Stock to J. Wade Stallings, II and 1,000 shares of Common Stock to
Keith P. Higginson. On January 1, 1995, the Company issued 564 shares of Common
Stock to Douglas M. Brannan, 564 shares of Common Stock to Wyndi D. Ballard and
282 shares of Common Stock to George Gregg. The per share consideration received
by the Company in each of the aforementioned transactions was $1.00. In November
1996, pursuant to the Company's recapitalization and reincorporation in the
State of Nevada, all of the outstanding shares of Common Stock of the Company,
including the aforementioned shares, were split on an approximately 242-for-1
basis. On August 11, 1997, the aforementioned shares were increased as a result
of a stock dividend declared by the Company's Board of Directors in the amount
of approximately 0.33 share of Common Stock on each then outstanding share of
the Company's Common Stock.
Effective November 1, 1996, the Company entered into three year employment
agreements with Messrs. Timothy M. Brannan, Keith P. Higginson, J. Wade
Stallings, II and Douglas M. Brannan, each an executive officer of the Company.
These agreements provide for a base salary of $75,000, $65,000, $65,000 and
$65,000, respectively, to be paid by the Company to such employees. See
"Management -- Employment Agreements."
On December 4, 1996, the Company reimbursed Timothy M. Brannan, the
Company's President, in the amount of $67,805 for certain business expenses
incurred by Mr. Brannan.
In January 1997, the Company engaged Frost & Berman Incorporated, an
investment banking and financial advisory consulting firm of which Ian Berman, a
Director-Nominee, is Managing Director. Pursuant to this arrangement, Frost &
Berman has agreed to provide financial consulting services to the Company on a
month-to-month basis for a monthly fee of approximately $830.
The Company believes that none of the foregoing transactions were entered
into on terms no less favorable to the Company than may have been available from
a third party. All future transactions between the Company and its Officers,
Directors and 5% stockholders will be on terms no less favorable to the Company
than could be obtained from independent third parties and will be approved by a
majority of the disinterested Directors and a majority of the entire Board of
Directors.
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<PAGE> 50
PRINCIPAL STOCKHOLDERS
The following table sets forth, as of September 15, 1997, certain
information concerning the beneficial ownership of the Company's Common Stock,
by (i) each stockholder known by the Company to own beneficially 5% or more of
the outstanding Common Stock of the Company, (ii) each Director, (iii) each
Director-Nominee, (iv) the Named Executive Officer and (v) all executive
Officers, Director-Nominees and Directors of the Company as a group, and their
percentage ownership before and after this Offering and voting power after this
Offering. See "Description of Securities" for a discussion of the voting and
other rights of holders of the Company's capital stock.
<TABLE>
<CAPTION>
COMMON STOCK
-----------------------------------
NUMBER OF % BEFORE % AFTER
NAME(1) SHARES(2) OFFERING OFFERING
------------------------------------------------------ ---------- -------- --------
<S> <C> <C> <C>
Timothy M. Brannan(3)................................. 1,600,000 100 50
Keith P. Higginson(4)................................. 306,836 19.18 9.59
J. Wade Stallings, II................................. 306,836 19.18 9.59
Douglas M. Brannan.................................... 173,055 10.82 5.41
Wyndi D. Ballard...................................... 173,055 10.82 5.41
Ian D. Berman......................................... 0 0 0(5)
Michael D. Flink...................................... 0 0 0(5)
All Directors, Director-Nominees and executive
officers as a group (8 persons)(3)(5)............... 1,600,000 100 50
</TABLE>
- ---------------
(1) Except as otherwise noted, each of the parties listed above has sole voting
and investment power over the securities listed. The address for all
Officers and Directors of the Company is 1839 West Drake, Suite B, Tempe,
Arizona 85283.
(2) Includes Escrow Shares as follows: Timothy M. Brannan, 337,348 shares; Keith
P. Higginson, individually, 117,461 shares and as trustee, 117,461 shares;
J. Wade Stallings, II, 234,921 shares; Douglas M. Brannan, 132,495 shares;
Wyndi D. Ballard, 132,495 shares; and George W. Gregg, 66,247 shares. See
"-- Escrow Arrangements".
(3) Includes (i) 887,653 shares subject to a Voting Trust Agreement, of which
Timothy M. Brannan is Voting Trustee, and (ii) 271,730 shares subject to an
Irrevocable Proxy Agreement, of which Timothy M. Brannan is proxy holder.
Except as disclosed herein, Mr. Brannan expressly disclaims beneficial
interest in any of such shares. See "-- Voting Trust Agreement and
Irrevocable Proxy Agreement."
(4) Includes 153,418 shares held by a trust of which Mr. Higginson is trustee
and has sole voting power, but in which he disclaims any beneficial
interest.
(5) Excludes options to purchase up to 10,000 shares of Common Stock to be
granted to each of Messrs. Berman and Flink in connection with their
respective appointments to the Board of Directors effective upon the closing
of this Offering.
VOTING TRUST AGREEMENT AND IRREVOCABLE PROXY AGREEMENT
Nine stockholders of the Company owning an aggregate of 1,600,000 shares of
Common Stock, which will represent 50% of the total voting power immediately
after the Offering (47% if the over-allotment option is exercised in full),
entered into a Voting Trust Agreement and an Irrevocable Proxy Agreement ("Proxy
Agreement"), in November 1996. Of the 1,600,000 shares, 1,225,000 shares (which
shares have been placed in Escrow, see "-- Escrow Arrangements", below), are
subject to a Voting Trust Agreement or held directly by the voting trustee, and
375,000 shares are subject to the Proxy Agreement or held directly by the proxy
holder. All 1,600,000 shares also are subject to 13-month Lock-Up Agreements.
See "Underwriting".
Timothy M. Brannan, the President and Chairman of the Company, is
designated as both the trustee of the Voting Trust Agreement and the proxy
holder under the Proxy Agreement, and is empowered to vote all shares subject to
the Voting Trust Agreement and the Proxy Agreement with respect to any matter
subject to
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<PAGE> 51
a vote by the Company's stockholders. Such matters include voting in favor of
the election of himself as a Director and an Officer of the Company and in favor
of ratification or approval of acts of himself as a Director and an Officer in
the conduct of business affairs of the Company, and other acts relating to the
Company, including, but not limited to, dissolution, liquidation, a merger or
consolidation of the Company or the sale of all, or substantially all, of its
assets. Consequently, after the Offering, by virtue of the Voting Trust
Agreement and Proxy Agreement, Mr. Brannan will effectively control 50% of the
total voting power (47% if the over-allotment option is exercised in full) of
the Company.
The agreement of the stockholders to deposit their shares in the Voting
Trust and to grant their proxy under the Proxy Agreement is irrevocable for 13
months following the date of this Prospectus. Thereafter, parties to the Proxy
Agreement may withdraw their respective shares on ten days prior written notice
to the Trustee if they sell them to third parties. Parties to the Voting Trust
Agreement may also withdraw their shares on ten days prior notice if such shares
are not then subject to the Escrow Agreement. The Voting Trust Agreement and the
Proxy Agreement both terminate upon the earliest of five years, the date on
which Mr. Brannan ceases to be an employee of the Company or resigns as Trustee
or Proxy Holder, as applicable, or dies, or upon termination of the Voting Trust
Agreement or the Proxy Agreement by the unanimous written agreement of the
holders of the shares (other than Timothy M. Brannan) subject to the Voting
Trust Agreement or the Proxy Agreement, as applicable.
ESCROW ARRANGEMENTS
In connection with this Offering, present holders of the Company's Common
Stock placed into escrow, on a pro rata basis, an aggregate of 1,225,000 shares
pursuant to an Escrow Agreement, before this Offering (the "Escrow Agreement").
Such stockholders will continue to vote the Escrow Shares, all of which, except
those held by Timothy M. Brannan, are subject to the Voting Trust described
above of which Mr. Brannan is the trustee. The Escrow Shares are not further
assignable or transferrable.
Escrow Shares will be released from the escrow and placed in the Voting
Trust if the Voting Trust is in existence and, if not, to the stockholders as
follows:
1. 300,000 shares held in escrow shall be released therefrom if:
(a) the Company's net income before provision for income taxes and
exclusive of any extraordinary earnings (all as audited and
determined by the Company's independent public accountants) (the
"Minimum Pretax Income") equals at least $2,000,000 during the
fiscal year ending on December 31, 1998 or 1999; or
(b) the Minimum Pretax Income equals at least $3,000,000 during the
fiscal year ending on December 31, 2000; or
(c) the Minimum Pretax Income equals at least $4,000,000 during the
fiscal year ending December 31, 2001; or
(d) commencing at the effective date of the Registration Statement of
which this Prospectus forms a part (the "Effective Date") and
ending 18 months after the Effective Date, the Bid Price (as
defined in the Escrow Agreement) of the Company's Common Stock
shall average in excess of $11.50 per share (subject to adjustment
in the event of any stock splits, reverse stock splits or other
similar events) for 30 consecutive business days; or
(e) commencing 18 months after the Effective Date and ending 36 months
after the Effective Date, the Bid Price shall average in excess of
$15.00 per share (subject to adjustment in the event of any stock
splits, reverse stock splits or other similar events) for 30
consecutive business days; or
(f) the Company is acquired by or merged with or into another entity
during either of the periods referred to above and as a result
thereof the holders of shares of Common Stock not then subject to
escrow (after giving consideration to the release from escrow of
such 300,000 shares and subject to adjustment in the event of any
stock splits, reverse stock splits or other similar events)
receive per share consideration equal or greater than (i) $11.50
per share during the 18-month
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<PAGE> 52
period commencing on the Effective Date; or (ii) $15.00 per share
during the 18-month period commencing 18 months from the Effective
Date.
2. An additional 525,000 shares held in escrow shall be released therefrom
if:
(a) the Minimum Pretax Income equals at least $3,300,000 during the
fiscal year ending on December 31, 1998 or 1999; or
(b) the Minimum Pretax Income equals at least $4,400,000 during the
fiscal year ending on December 31, 2000; or
(c) the Minimum Pretax Income equals at least $5,500,000 during the
fiscal year ending on December 31, 2001; or
(d) commencing at the Effective Date and ending 18 months after the
Effective Date, the Bid Price of the Company's Common Stock shall
average in excess of $12.50 per share (subject to adjustment in
the event of any stock splits, reverse stock splits or other
similar events) for 20 consecutive business days; or
(e) commencing 18 months from the Effective Date and ending 36 months
after the Effective Date, the Bid Price shall average in excess of
$16.50 per share (subject to adjustment in the event of any stock
splits, reverse stock splits or other similar events) for 20
consecutive business days; or
(f) the Company is acquired by or merged with or into another entity
during either of the periods referred to above and as a result
thereof the holders of shares of Common Stock not then subject to
escrow (after giving consideration to the release from escrow of
such 525,000 shares (and the 300,000 shares set forth above, if
not previously released) and subject to adjustment in the event of
any stock splits, reverse stock splits or other similar events)
receive per share consideration equal or greater than (i) $12.50
per share during the 18-month period commencing on the Effective
Date; or (ii) $16.50 per share during the 18-month period
commencing 18 months from the Effective Date.
3. The remaining 400,000 shares held in escrow shall be released therefrom
if:
(a) the Minimum Pretax Income equals at least $3,800,000 during the
fiscal year ending on December 31, 1998 or 1999; or
(b) the Minimum Pretax Income equals at least $5,100,000 during the
fiscal year ending on December 31, 2000; or
(c) the Minimum Pretax Income equals at least $6,400,000 during the
fiscal year ending December 31, 2001; or
(d) commencing at the Effective Date and ending 18 months after the
Effective Date, the Bid Price of the Company's Common Stock shall
average in excess of $12.50 per share (subject to adjustment in
the event of any stock splits, reverse stock splits or other
similar events) for 20 consecutive business days; or
(e) commencing 18 months from the Effective Date and ending 36 months
after the Effective Date, the Bid Price shall average in excess of
$16.50 per share (subject to adjustment in the event of any stock
splits, reverse stock splits or other similar events) for 20
consecutive business days; or
(f) the Company is acquired by or merged with or into another entity
during either of the periods referred to above and as a result
thereof the holders of shares of Common Stock not then subject to
escrow (after giving consideration to the release from escrow of
such 400,000 shares, (and the 825,000 shares set forth above, if
not previously released) and subject to adjustment in the event of
any stock splits, reverse stock splits or other similar events)
receive per share consideration equal to or greater than (i)
$12.50 per share during the 18-month period commencing on the
Effective Date; or (ii) $16.50 per share during the 18-month
period commencing 18 months from the Effective Date.
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<PAGE> 53
The Minimum Pretax Income amounts set forth in 1, 2, and 3 above, assume
the release of all of the Escrow Shares and the conversion into Common Stock of
any outstanding securities which are convertible into Common Stock solely upon
surrender of such convertible securities without the payment of any additional
consideration, but shall be increased proportionally to reflect the issuance of
certain additional shares, including any shares that may be issued upon the
exercise of the Class A Warrants or other options or warrants presently
outstanding or hereafter granted by the Company. The Minimum Pretax Income shall
be calculated exclusive of any extraordinary earnings, including, but not
limited to, any charge to income resulting from the release of the Escrow
Shares. On March 31, 2002, all shares still held in escrow will be forfeited,
which shares will then be placed in the Company's treasury for cancellation
thereof as a contribution to capital.
Distributions, in the event the Company is acquired or merged with or into
another entity, will be made as follows:
(a) if the merger or acquisition proceeds are sufficient to pay the
non-escrowed Common Stock prior to such event up to the applicable
amount per share price set forth in paragraphs 1(f), 2(f) or 3(f)
above, then such number of shares of escrowed Common Stock shall
be released from escrow, pro rata, to enable the holders thereof
to participate in the balance remaining up to the applicable per
share price.
(b) if the merger or acquisition proceeds are sufficient to pay the
then non-escrowed and the then escrowed Common Stock, the full
amount set forth in paragraphs 1(f), 2(f) or 3(f) above, then all
of the Escrow Shares eligible for release pursuant to paragraphs
1(f), 2(f) and/or 3(f) above, shall be released and distributions,
if any, will be made on all Common Stock outstanding, whether or
not previously subject to escrow.
Any money, securities, rights, or property distributed in respect of the
Escrow Shares, including any property distributed as dividends or pursuant to
any stock split, merger, recapitalization, dissolution, or total or partial
liquidation of the Company, shall be held in escrow until release of the Escrow
Shares. Shares in escrow as to which the applicable earnings levels or average
Bid Price criteria set forth above have not been met on or before March 31,
2002, as well as any dividends or other distributions made with respect thereto,
will be contributed to the capital of the Company and canceled. The Company
expects that the release of the Escrow Shares held by Officers, Directors,
employees, and consultants of the Company will be deemed compensatory and,
accordingly, will result in a substantial charge to reportable earnings, which
would equal the fair market value of such shares on the date of release. Such
charge could substantially eliminate the Company's net income for financial
reporting purposes for the period(s) during which such shares are, or become
probable of being, released from escrow. Although the amount of compensation
expense recognized by the Company will not affect the Company's total
stockholder's equity, it may have a negative effect on the market price of the
Company's securities. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and Note 12 of Notes to Financial
Statements.
The earnings levels set forth above were determined by negotiation between
the Company and the Representative and should not be construed to imply or
predict any future earnings by the Company or any increase in the market price
of its securities.
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<PAGE> 54
DESCRIPTION OF SECURITIES
GENERAL
In November 1996, the Board of Directors and the stockholders of the
Company approved the reincorporation of the Company from an Arizona corporation
into a Nevada corporation, by means of a merger of the Arizona corporation into
a Nevada corporation, which merger and the reincorporation became effective as
of November 22, 1996. In connection with the merger, (i) all then outstanding
shares of Common Stock of the Arizona corporation were exchanged for shares of
Common Stock of the Nevada corporation on an approximately 242-for-1 basis, (ii)
the authorized Common Stock was increased and a class of Preferred Stock was
created, and (iii) the shares of the Company's former Common Stock, no par
value, were exchanged for Common Stock, $.001 par value. The Company's
authorized capital stock now consists of (i) 20,000,000 shares of Common Stock,
$.001 par value per share, and (ii) 5,000,000 shares of "blank check" Preferred
Stock, $.001 par value. On August 11, 1997, the Company declared a dividend of
approximately 0.33 share of Common Stock on each then outstanding share of
Common Stock. As a result, immediately prior to this Offering, there were
outstanding 1,600,000 shares of Common Stock (held by nine holders) and no
outstanding shares of Preferred Stock. The Company reincorporated in Nevada
primarily in order to take advantage of Nevada's modern and flexible corporation
laws. In addition, the recent increase in the number of corporations domiciled
in the State of Nevada has had the effect of increasing that state's body of law
relating to corporations, which the Company believes is likely to result in a
greater degree of predictability concerning the outcome of legal matters which
may affect the Company from time to time.
The foregoing and following summary descriptions of capital stock of the
Company are qualified in their entirety by reference to the Company's Articles
of Incorporation, as amended (the "Articles of Incorporation"), and Bylaws (the
"Bylaws"), a copy of each of which is filed as an exhibit to the Registration
Statement of which this Prospectus is a part.
UNITS
Each Unit consists of one share of Common Stock and one redeemable Class A
Warrant. Each Class A Warrant entitles the holder thereof to purchase one share
of Common Stock. The Common Stock and Class A Warrants comprising the Units are
separately transferable immediately upon issuance.
COMMON STOCK
Holders of Common Stock have the right to cast one vote for each share held
of record on all matters submitted to a vote of holders of Common Stock,
including the election of Directors.
Holders of Common Stock are entitled to receive dividends pro rata based on
the number of shares held, when, as and if declared by the Board of Directors,
from funds legally available therefor, subject to the rights of holders of any
outstanding Preferred Stock. In the event of the liquidation, dissolution or
winding up of the affairs of the Company, all assets and funds of the Company
remaining after the payment of all debts and other liabilities, subject to the
rights of the holders of any outstanding Preferred Stock, shall be distributed,
pro rata, among the holders of the Common Stock. Holders of Common Stock are not
entitled to preemptive, subscription, cumulative voting or conversion rights,
and there are no redemption or sinking fund provisions applicable to the Common
Stock. All outstanding shares of Common Stock are, and the shares of Common
Stock offered hereby will be when issued, fully paid and nonassessable.
See "Principal Stockholders -- Voting Trust Agreement and Irrevocable Proxy
Agreement" and "-- Escrow Arrangements" regarding a Voting Trust and Irrevocable
Proxy Agreement relating to 1,600,000 shares of Common Stock and escrow
arrangements relating to 1,225,000 of such shares.
REDEEMABLE CLASS A WARRANTS
Each Class A Warrant entitles the registered holder to purchase one share
of Common Stock at an exercise price of $6.50 at any time through 5:00 P.M., New
York City time, on the fifth anniversary of the date
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<PAGE> 55
of this Prospectus. Commencing one year from the date of this Prospectus, the
Class A Warrants are redeemable by the Company on 30 days' written notice at a
redemption price of $.05 per Class A Warrant if the "closing price" of the
Company's Common Stock for any 30 consecutive trading days ending within 15 days
of the notice of redemption averages in excess of $9.10 per share. "Closing
price" shall mean the closing bid price if listed in the over-the-counter market
on Nasdaq or otherwise or the closing sale price if listed on The Nasdaq
National Market or a national securities exchange. All Class A Warrants must be
redeemed if any are redeemed.
The Class A Warrants will be issued pursuant to a warrant agreement (the
"Warrant Agreement") among the Company, the Representative and American Stock
Transfer & Trust Company, New York, New York, as Warrant Agent, and will be
evidenced by warrant certificates in registered form. The Warrants provide for
adjustment of the exercise price and for a change in the number of shares
issuable upon exercise thereof to protect holders against dilution in the event
of a stock dividend, stock split, combination or reclassification of the Common
Stock or upon issuance of shares of Common Stock at prices lower than the market
price then in effect other than issuances upon exercise of options granted to
officers, employees, Directors and consultants to the Company under the
Company's stock option plans, other outstanding warrants on the date of this
Prospectus or with respect to the Unit Purchase Option.
The exercise price of the Class A Warrants was determined by negotiation
between the Company and the Representative and should not be construed to be
predictive of or to imply that any price increases in the Company's securities
will occur.
A Class A Warrant may be exercised upon surrender of the Warrant
certificate on or prior to its expiration date (or earlier redemption date) at
the offices of American Stock Transfer & Trust Company, New York, New York, as
Warrant Agent, with the form of "Election to Purchase" on the reverse side of
the Warrant certificate completed and executed as indicated, accompanied by
payment of the full exercise price (by certified or bank check payable to the
order of the Company) for the number of securities with respect to which the
Class A Warrant is being exercised. Securities issued upon exercise of Class A
Warrants and payment in accordance with the terms of the Class A Warrants will
be fully paid and nonassessable.
The Class A Warrants do not confer upon the Warrantholder any voting or
other rights of a stockholder of the Company. Upon notice to the Warrantholders,
the Company has the right to reduce the exercise price or extend the expiration
date of the Class A Warrants.
PREFERRED STOCK
The Articles of Incorporation of the Company authorize the issuance of up
to 5,000,000 shares of Preferred Stock, none of which are currently outstanding.
The Board of Directors, within the limitations and restrictions contained in the
Articles of Incorporation and without further action by the Company's
stockholders, has the authority to issue shares of Preferred Stock from time to
time in one or more series and to fix the number of shares and the relative
rights, conversion rights, voting rights, and terms of redemption, liquidation
preferences and any other preferences, special rights and qualifications of any
such series. Any issuance of Preferred Stock could, under certain circumstances,
have the effect of delaying, deferring or preventing a change in control of the
Company and may adversely affect the rights of holders of Common Stock. The
Company has no present plans to issue any shares of Preferred Stock.
CERTAIN STATUTORY AND CHARTER PROVISIONS
The Company's Articles of Incorporation and By-laws contain a number of
provisions relating to corporate governance and the rights of stockholders.
These provisions: (i) establish a classified Board of Directors; (ii) permit the
removal of Directors only for cause and only by vote of stockholders owning two-
thirds of the voting power of the Company; (iii) impose conditions on the
ability of stockholders to nominate persons for the position of Director; (iv)
prohibit stockholders from calling special meetings; and (v) require the consent
of the Board of Directors or the "disinterested" members thereof and/or the
affirmative vote of two-thirds of the Company's voting stock, excluding stock
owned by interested stockholders, to effect certain business combinations with
interested stockholders. An interested stockholder for purposes of this
provision
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<PAGE> 56
means a person who, together with affiliates or associates, beneficially owns,
or beneficially owned within the preceding two-year period, 10% or more of the
Company's combined voting power. For purposes of these provisions, at September
15, 1997, five of the Company's stockholders were deemed to be interested
stockholders. The provisions included in the Company's Articles of Incorporation
and certain provisions in the By-laws may not be amended or repealed without the
affirmative vote of two-thirds of the Company's voting stock, excluding, with
respect to the business combination provision, stock owned by interested
stockholders. See "Management -- Indemnification and Limitation of Liability"
for a discussion of certain indemnification provisions included in the Articles
of Incorporation and By-laws.
The Company believes that these provisions promote the stability and
continuity of the Board of Directors of the Company and assure that stockholders
will receive adequate notice of and an opportunity to consider actions by
stockholders that could materially affect the Company. However, these provisions
could have the effect of deterring unsolicited takeovers or delaying or
preventing changes in control or management of the Company, including
transactions in which stockholders might otherwise receive a premium for their
shares over then-current market prices. In addition, these provisions may limit
the ability of stockholders to approve transactions that they may deem to be in
their best interest.
REGISTRATION RIGHTS
The Company has agreed to file a registration statement registering all of
the 750,000 Class A Warrants to be issued upon the completion of this Offering
in exchange for the Bridge Warrants. See "Capitalization -- Bridge Financing."
The Company has agreed to file such registration statement nine months from the
date of this Prospectus, and to cause it to be effective twelve months from the
date of this Prospectus and to maintain it for the current use by the Selling
Securityholders upon the disposition of the Class A Warrants issued to them and
the securities underlying such warrants. The Company is required to bear the
expense of such registration (except underwriting discounts and commissions). In
addition, the Company has granted certain demand and "piggyback" registration
rights to the Representative related to the securities issuable upon exercise of
the Unit Purchase Option. See "Shares Eligible For Future Sale" and
"Underwriting."
TRANSFER AGENT AND WARRANT AGENT
American Stock Transfer & Trust Company, New York, New York will serve as
Transfer Agent for the Common Stock and Warrant Agent for the Warrants.
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SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of this Offering, the Company will have outstanding an
aggregate of 3,440,000 shares of Common Stock (assuming exercise in full of the
Underwriters' over-allotment option). Of all such shares, the 1,840,000 shares
of Common Stock included in the Units sold in this Offering (assuming exercise
in full of the Underwriters' over-allotment option) will be freely transferable
without restriction under the Securities Act except for any shares purchased by
any person who is or thereby becomes an "affiliate" of the Company, which shares
will be subject to the resale limitations contained in Rule 144 promulgated
under the Securities Act. All of the other shares of Common Stock outstanding
prior to this Offering are "restricted securities" as that term is defined under
Rule 144.
In general, under Rule 144, a person (or persons whose shares are
aggregated), who has beneficially owned restricted securities for at least one
year, may sell within any three-month period a number of restricted shares which
does not exceed the greater of 1% of the then outstanding shares of such class
of securities or the average weekly trading volume during the four calendar
weeks prior to such sale. Sales under Rule 144 are also subject to certain
requirements as to the manner of sale, notice and the availability of current
public information about the Company. Rule 144 also permits, under certain
circumstances, the sale of shares by a person who is not an affiliate of the
Company, with respect to restricted securities that satisfy a two-year holding
period, without regard to the volume or other resale limitations. For shares
issued in consideration of an unsecured or nonrecourse promissory note, the
holding period does not commence until the note is paid in full. The above is a
brief summary of Rule 144 and is not intended to be a complete description of
Rule 144.
All of the current stockholders, including all of the principal
stockholders, Officers and Directors of the Company (including Timothy M.
Brannan as Voting Trustee and Proxy for or direct holder of an aggregate of
1,600,000 shares) holding in the aggregate approximately 1,600,000 shares of
Common Stock, have agreed not to sell, assign or transfer or otherwise dispose
publicly of any of their shares for a period of 13 months from the date of this
Prospectus without the prior written consent of the Representative. Following
the expiration of such period, all 1,600,000 of such shares of Common Stock will
be freely transferrable subject to the requirements of Rule 144; provided,
however, that 1,225,000 of such shares will remain subject to the provisions of
the Escrow Agreement. See "Principal Stockholders -- Escrow Agreements". Prior
to this Offering, there has been no market for any securities of the Company and
the Company is unable to predict the effect that sales under Rule 144, pursuant
to a registered public offering or otherwise, may have on the then prevailing
market price of the Common Stock, but such sales may have a substantial negative
effect on such market price.
As of the closing date of this Offering, options to purchase a total of
66,500 shares of Common Stock will be outstanding under the Company's 1996 Stock
Option Plan. An aggregate of an additional 233,500 shares are available for
future option grants under the Plan. In connection with a potential product
license agreement, the Company anticipates that it may grant at a date following
the closing of this Offering options to purchase up to 70,000 shares of Common
Stock at a price per share not less than the fair market value of the Common
Stock on the date of grant. See "Management -- 1996 Stock Option Plan".
Upon the completion of this Offering, the Company will issue an aggregate
of 750,000 additional Class A Warrants in exchange for the Bridge Warrants
issued in November and December 1996. See "Capitalization -- Bridge Financing".
The Company has agreed to file a registration statement under the Securities Act
within nine months from the date of this Prospectus for use by the Selling
Securityholders upon disposition of the Selling Securityholders' Warrants and
the shares of Common Stock issuable thereunder. The Company shall cause such
registration statement to be declared effective twelve months from the date of
this Prospectus. In addition, each of the Selling Securityholders has agreed not
to transfer or exercise the Selling Securityholders' Warrants for a period of
one year from the date of this Prospectus. Future sales of the Selling
Securityholders' Warrants or the potential for such sales could have an adverse
effect on the respective market prices of the Units, the Common Stock and the
Warrants.
In addition, the Company has agreed to register during the five-year period
commencing one year from the closing date of this Offering, on two separate
occasions upon request of the Representative, the securities issuable upon
exercise of the Unit Purchase Option. The Company has also granted certain
"piggyback" registration rights to holders of the Unit Purchase Option. See
"Underwriting".
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UNDERWRITING
Subject to the terms and conditions of the Underwriting Agreement, the
Underwriters named below, for whom D.H. Blair Investment Banking Corp. is acting
as Representative, have severally agreed to purchase, and the Company has agreed
to sell to them, severally, the respective number of Units set forth opposite
the name of such Underwriter:
<TABLE>
<CAPTION>
NAME NUMBER OF UNITS
---------------------------------------------------------------------- ---------------
<S> <C>
D.H. Blair Investment Banking Corp. .................................. 1,110,000
Baird, Patrick & Co. Inc. ............................................ 70,000
D.H. Blair & Co., Inc. ............................................... 70,000
Westport Resources.................................................... 70,000
Frederick & Company, Inc. ........................................... 40,000
Hornblower & Weeks Incorporated....................................... 40,000
Ormes Capital Markets, Inc. .......................................... 40,000
Smith, Moore & Co. ................................................... 40,000
Sharpe Capital, Inc. ................................................. 40,000
Stuart, Coleman & Co. Inc. ........................................... 40,000
Win Capital Corp. .................................................... 40,000
---------
Total....................................................... 1,600,000
=========
</TABLE>
It is expected that Blair & Co. will distribute as a selling group member a
substantial portion (up to approximately 52%, including the over-allotment
option) of the Units offered hereby. It is also expected that Blair & Co. will
make a market in the Company's securities. Blair & Co. is substantially owned by
family members of J. Morton Davis. Mr. Davis is the sole stockholder of the
Representative.
The Underwriters have advised the Company that they propose to offer the
Units to the public at the public offering price set forth on the cover page of
this Prospectus and that it may allow to selected dealers who are members of the
National Association of Securities Dealers, Inc. concessions, not in excess of
$.26 per Unit, of which not more than $.10 per Unit may be reallowed to certain
other dealers. After this Offering, the public offering price, concessions and
reallowances may be changed by the Representative.
The Company has agreed to pay the Representative a non-accountable expense
allowance equal to 3% of the aggregate offering price of the Units offered
hereby (including any Units purchased pursuant to the over-allotment option), of
which $40,000 has been paid.
The Company has granted an option to the Underwriters, exercisable for 30
days from the date of this Prospectus, to purchase up to 240,000 additional
Units at the public offering price set forth on the cover page of this
Prospectus, less the underwriting discounts and commissions, solely to cover
over-allotments, if any, made in connection with the sale of the Units offered
hereby, subject to the right of the Representative to elect, in its sole
discretion, to exercise such option individually, and not as representative of
the several Underwriters.
The Company has agreed to sell to the Representative and its designees, for
nominal consideration, the Unit Purchase Option to purchase up to 160,000 Units,
substantially identical to the Units being offered hereby. The Unit Purchase
Option will be exercisable during the three-year period commencing two years
from the date of this Prospectus at an exercise price equal to $6.50 per Unit,
subject to adjustment in certain events to protect against dilution, and are not
transferable for a period of two years from the date of this Prospectus except
to officers of the Representative or to members of the selling group, including
Blair & Co. or its officers. The exercise price and all other terms of any
Common Stock or Class A Warrants issuable to the Representative upon exercise of
the Unit Purchase Option will be substantially identical to those sold in this
Offering except that the Class A Warrants issued to the Representative are not
subject to redemption by the Company. The Company has agreed to register during
the five-year period commencing one year from the date of the closing of this
Offering, on two separate occasions upon request of the Representative, the
58
<PAGE> 59
securities issuable upon exercise of the Unit Purchase Option under the
Securities Act, the initial such registration to be at the Company's expense and
the second at the expense of the holders. The Company has also granted certain
"piggy-back" registration rights to holders of the Unit Purchase Option.
The Company has agreed to indemnify the Underwriters against certain
liabilities in connection with this Offering, including liabilities under the
Securities Act.
During the five-year period from the date hereof, in the event the
Representative originates a financing or a merger, acquisition or transaction to
which the Company is a party, the Representative will be entitled to receive a
finder's fee in consideration for origination of such transaction. The fee is
based on a percentage of the consideration paid in the transaction ranging from
7% of the first $1,000,000 to 2 1/2% of any consideration in excess of
$9,000,000.
In connection with the Bridge Financing in November and December 1996, the
Representative served as placement agent and received an aggregate of $195,000
from the Company as commission and non-accountable expense allowance.
In November 1996, the Representative loaned the Company $200,000, which
bore interest at the rate of 10% per annum. The loan was repaid out of the
proceeds of the Bridge Financing. From April through August 28, 1997, the
Representative and Rivkalex Corp, a corporation controlled by a family member of
the sole stockholder of the Representative, loaned the Company an aggregate
principal amount of $605,000, which loans bear interest at a rate of 10% per
annum. The proceeds of these loans were used by the Company for its general
working capital purposes, including employee payroll. The Company intends to use
approximately $625,000 (9.8%) of the net proceeds from this Offering to repay
these loans, including accrued interest thereon. See "Use of Proceeds".
The Company has agreed not to solicit Warrant exercises other than through
the Representative unless the Representative declines or is unable to make such
solicitation. Except for any Warrants held by the Representative at the time of
exercise, commencing one year form the date of this Prospectus, upon any
exercise of the Class A Warrants, the Company will pay the Representative a fee
(the "Warrant Fee") of 5% of the aggregate exercise price if (i) the market
price of the Company's Common Stock on the date the Class A Warrants are
exercised is greater than the then exercise price of the Class A Warrants; (ii)
the exercise of the Class A Warrants was solicited by a member of the National
Association of Securities Dealers, Inc. designated in writing by the
Warrantholder as having solicited the exercise; (iii) the Class A Warrants are
not held in a discretionary account; (iv) disclosure of compensation
arrangements is made both at the time of the offering and at the time of
exercise of the Class A Warrants; and (v) the solicitation of exercise of the
Class A Warrants was not in violation of Regulation M promulgated under the
Exchange Act. The Representative may reallow a portion of such fee to members of
the National Association of Securities Dealers, Inc. The costs of the
Representative's solicitation of exercise or redemption of the Class A Warrants
will be borne by the Company.
Regulation M, which was recently adopted to replace Rule 10b-6, of the
Exchange Act may prohibit Blair & Co. from engaging in any market making
activities with regard to the Company's securities for the period of up to five
business days (or such other applicable period as Regulation M may provide)
prior to any solicitation by the Representative of the exercise of Class A
Warrants until the later of the termination of such solicitation activity or the
termination (by waiver or otherwise) of any right that the Representative may
have to receive a fee for the exercise of Class A Warrants following such
solicitation. As a result, Blair & Co. may be unable to provide a market for the
Company's securities during certain periods while the Warrants are exercisable.
The Company has agreed to nominate a designee of the Representative to the
Company's Board of Directors for a period of five years from the date hereof, if
so requested by the Representative. Any such Director will receive the same
compensation, if any, which is paid to Directors who are not employees of the
Company and shall be reimbursed all reasonable expenses in connection with
attending all meetings of the Board or any committees thereof. The
Representative has not yet designated its nominee, and such nominee is not
expected to be an officer, director or affiliate of the Representative.
59
<PAGE> 60
All of the Company's current stockholders, Officers and Directors have
agreed not to sell, assign, transfer or otherwise dispose publicly any of their
shares of Common Stock for a period of 13 months after the date of this
Prospectus without the prior written consent of the Representative.
The Commission is conducting an investigation concerning various business
activities of the Representative and Blair & Co., a selling group member which
will distribute a substantial portion of the Units offered hereby. The Company
has been advised by the Representative that the investigation has been ongoing
since at least 1989 and that it is cooperating with the investigation. The
Representative cannot predict whether this investigation will ever result in any
type of formal enforcement action against the Representative or Blair & Co.
In July 1997, Blair & Co., its Chief Executive Officer and its head trader
consented, without admitting or denying any violations, to a settlement with
NASDR, District Business Conduct Committee for District No. 10 to resolve
allegations of NASD rule and securities law violations in connection with
mark-up and pricing practices and adequacy of disclosures to customers regarding
market-making activities of Blair & Co. in connection with certain securities
issues during the period from June 1993 through May 1995 where Blair & Co. was
the primary selling group member. NASDR alleged the firm failed to accurately
calculate the contemporaneous cost of securities in instances where the firm
dominated and controlled after-market trading, thereby causing the firm to
charge its customers excessive mark-ups. NASDR also alleged the firm did not
make adequate disclosure to customers about its market-making activities in two
issues. As part of the settlement, Blair & Co. has consented to a censure and
has agreed to pay a $2 million fine, make $2.4 million in restitution to retail
customers, employ an independent consultant for two years to review and make
recommendations to strengthen the firm's compliance procedures, and has
undertaken for 12 months not to sell to its retail customers (excluding banks
and other institutional investors) more than 60% of the total securities sold in
any securities offering in which it participates as an underwriter or selling
group member. The Chief Executive Officer of Blair & Co. has agreed to settle
failure to supervise charges by consenting to a censure, the imposition of a
$225,000 fine and a 60-day suspension from associating with any NASD member firm
and to take a requalification examination. The firm's head trader has agreed to
settle charges against him by consenting to a censure, the imposition of a
$300,000 fine and a 90-day suspension from associating with any member firm and
has undertaken to take certain requalification examinations. The settlement with
NASDR does not involve or relate to the Representative, its chief executive
officer or any of its other officers or directors.
The Company has been advised that Blair & Co. intends to make a market in
the Company's securities after the Offering. The Company is unable to predict
whether Blair & Co.'s settlement with NASDR or any unfavorable resolution of the
Commission's investigation will have any effect on such firm's ability to make a
market in the Company's securities and, if so, whether the liquidity or price of
the Company's securities would be adversely affected.
Prior to this Offering, there has been no public market for the Company's
securities. Accordingly, the offering prices of the Units offered hereby and the
terms of the Class A Warrants have been determined by negotiation between the
Company and the Representative and are not necessarily related to the Company's
asset value, net worth or other established criteria of value. Among the factors
considered in determining such prices and terms, in addition to prevailing
market conditions, include the history of and the prospects for the industry in
which the Company competes, the present state of the Company's development and
its future prospects, an assessment of the Company's management and the
Company's capital structure.
The Underwriters have informed the Company that they do not expect sales to
discretionary accounts to exceed 5% of the total number of the Units offered
hereby.
In connection with the Offering, the Underwriters and certain selling group
members may engage in certain transactions that stabilize, maintain or otherwise
affect the market price of the Units, the Common Stock and the Class A Warrants.
Such transactions may include stabilization transactions effected in accordance
with Rule 104 of Regulation M, pursuant to which such persons may bid for or
purchase the Units, the Common Stock and the Class A Warrants for the purpose of
pegging, fixing or maintaining the market price of such securities. The
Underwriters may also create a short position in the Units by selling more Units
60
<PAGE> 61
in connection with the Offering than it is committed to purchase from the
Company, and in such case the Representative may reduce all or a portion of that
short position by purchasing the Units, the Common Stock and the Class A
Warrants in the open market. The Representative also may also elect to reduce
any short position by exercising all or any portion of the over-allotment option
described herein. In addition, the Representative may impose "penalty bids" on
certain Underwriters and selling group members. This means that if the
Representative purchases shares of Common Stock or Class A Warrants in the open
market to reduce the Underwriters' short position or to stabilize the price of
the Common Stock or the Class A Warrants, they may reclaim the amount of the
selling concession from the Underwriters and selling group members who sold
those shares or Class A Warrants as part of the Offering. Any of the
transactions described in this paragraph may stabilize or maintain the market
price of the Units, the Common Stock and the Class A Warrants at a level above
that which might otherwise prevail in the open market.
Neither the Company nor the Underwriters make any representation or
prediction as to the direction or magnitude of any effect that the transactions
described above may have on the price of the Units or the securities underlying
the Units. In addition, neither the Company nor the Underwriters make any
representation that the Underwriters will engage in such transactions or that
such transactions, once commenced, will not be discontinued without notice.
LEGAL MATTERS
Certain legal matters with respect to the Company and the validity of the
securities offered hereby will be passed upon for the Company by Squire, Sanders
& Dempsey L.L.P., Phoenix, Arizona. Certain legal matters will be passed upon
for the Underwriters by Bachner, Tally, Polevoy & Misher, LLP, New York, New
York.
EXPERTS
The balance sheets as of December 31, 1995 and 1996 and the statements of
operations, stockholders' equity (deficit) and cash flows for the years ended
December 31, 1995 and 1996 included in this Prospectus have been included herein
in reliance on the report, which includes an explanatory paragraph concerning
the substantial doubt about the Company's ability to continue as a going
concern, of Coopers & Lybrand L.L.P., independent accountants, given on the
authority of that firm as experts in accounting and auditing.
AVAILABLE INFORMATION
The Company has filed with the Commission a Registration Statement on Form
SB-2 under the Securities Act with respect to the Units, Warrants and Common
Stock offered hereby. This Prospectus constitutes a part of the Registration
Statement and does not contain all of the information set forth therein and in
the exhibits thereto, certain portions of which have been omitted as permitted
by the rules and regulations of the Commission. For further information with
respect to the Company and the Units, Warrants and Common Stock offered hereby,
reference is hereby make to such Registration Statement and exhibits. Statements
contained in this Prospectus as to the contents of any document are not
necessarily complete and in each instance are qualified in their entirety by
reference to the copy of the appropriate documents filed with the Commission.
The Registration Statement and the reports and other information to be
filed by the Company following the Offering in accordance with the Exchange Act
can be inspected and copied at the principal office of the Commission at Room
1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and at
the following regional offices of the Commission: 7 World Trade Center, New
York, NY 10048 and Citicorp Center, 500 West Madison Street, Suite 1400,
Chicago, IL 60661. Copies of such materials may be obtained from the Public
Reference Section of the Commission at its principal office at 450 Fifth Street,
N.W., Washington, D.C. 20549, upon payment of the fees prescribed by the
Commission. In addition, the Commission maintains a website (http://www.sec.gov)
that contains reports, proxy and information statements and other information
regarding registrants, such as the Company, that file electronically with the
Commission.
61
<PAGE> 62
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Accountants..................................................... F-2
Financial Statements:
Balance Sheets as of December 31, 1995 and 1996, and June 30, 1997 (unaudited)...... F-3
Statements of Operations for the years ended December 31, 1995 and 1996, and the six
month periods ended June 30, 1996 and 1997 (unaudited)........................... F-4
Statements of Stockholders' Equity (Deficit) for the years ended December 31, 1995
and 1996, and the six months ended June 30, 1997 (unaudited)..................... F-5
Statements of Cash Flows for the years ended December 31, 1995 and 1996, and the six
month periods ended June 30, 1996 and 1997 (unaudited)........................... F-6
Notes to Financial Statements......................................................... F-7
</TABLE>
F-1
<PAGE> 63
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
Piranha Interactive Publishing, Inc.
We have audited the accompanying balance sheets of Piranha Interactive
Publishing, Inc. (the "Company") as of December 31, 1995 and 1996, and the
related statements of operations, stockholders' equity (deficit) and cash flows
for the years ended December 31, 1995 and 1996. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits 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 financial statements referred to above present fairly,
in all material respects, the financial position of Piranha Interactive
Publishing, Inc. as of December 31, 1995 and 1996, and the results of its
operations and its cash flows for the years then ended, in conformity with
generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 2 to the
financial statements, the Company has experienced difficulty in generating
sufficient cash flows from operations which raises substantial doubt about its
ability to continue as a going concern. Management's plans in regards to this
matter are also described in Note 2. The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
/s/ COOPERS & LYBRAND L.L.P.
- ---------------------------------------------------------
COOPERS & LYBRAND L.L.P.
Phoenix, Arizona
January 27, 1997,
except for Note 15, as to which the date is
September 9, 1997.
F-2
<PAGE> 64
PIRANHA INTERACTIVE PUBLISHING, INC.
BALANCE SHEETS
DECEMBER 31, 1995 AND 1996, AND JUNE 30, 1997
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31, JUNE 30,
1995 1996 1997
------------ ------------ -----------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.......................... $202,216 $ 246,732 $ 25,961
Accounts receivable, net of allowance for returns
of $46,541, $17,221 and $18,000 and doubtful
accounts of $9,195, $45,000 and $10,000,
respectively.................................... 137,663 4,420 12,626
Inventories........................................ 143,119 137,807 187,008
Prepaid expenses................................... 8,088 104,547 78,602
-------- ---------- -----------
Total current assets....................... 491,086 493,506 304,197
Property and equipment, net.......................... 25,563 71,274 70,777
Deferred offering costs.............................. 297,587 500,600
Debt issuance costs.................................. 186,887 84,759
Other assets......................................... 4,517 4,616 4,508
-------- ---------- -----------
Total assets............................... $521,166 $1,053,870 $ 964,841
======== ========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable................................... $248,052 $ 68,964 $ 320,540
Accrued liabilities................................ 5,000 207,397 364,907
Accounts payable -- officers....................... 64,108 6,000
Notes payable...................................... 1,431,928 1,879,120
-------- ---------- -----------
Total current liabilities.................. 317,160 1,708,289 2,570,567
Notes payable -- officers............................ 33,000 36,426 38,270
Other liabilities.................................... 3,544 11,177 9,872
-------- ---------- -----------
Total liabilities.......................... 353,704 1,755,892 2,618,709
-------- ---------- -----------
Commitments (Note 12)
Stockholders' equity (deficit):
Preferred stock, $.001 par value; 5,000,000 shares
authorized; no shares issued and outstanding
Common stock, $.001 par value; 20,000,000 shares
authorized; 1,781,972, 1,600,000 and 1,600,000
shares issued and outstanding, respectively..... 1,782 1,600 1,600
Additional paid-in capital......................... 3,741 (491,103) (491,103)
Retained earnings (deficit)........................ 161,939 (212,519) (1,164,365)
-------- ---------- -----------
Total stockholders' equity (deficit)....... 167,462 (702,022) (1,653,868)
-------- ---------- -----------
Total liabilities and stockholders' equity
(deficit)................................ $521,166 $1,053,870 $ 964,841
======== ========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE> 65
PIRANHA INTERACTIVE PUBLISHING, INC.
STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1995 AND 1996,
AND THE SIX MONTH PERIODS (UNAUDITED) ENDED JUNE 30, 1996 AND 1997
<TABLE>
<CAPTION>
SIX MONTHS ENDED
---------------------------
JUNE 30, JUNE 30,
DECEMBER 31, DECEMBER 31, 1996 1997
1995 1996 ----------- -----------
------------ ------------ (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Net sales................................. $1,342,034 $ 424,810 $ 353,144 $ 67,656
Cost of goods sold........................ 900,967 318,938 185,700 96,942
---------- --------- --------- ---------
Gross profit (loss)..................... 441,067 105,872 167,444 (29,286)
Selling, general and administrative
expenses................................ 247,458 982,827 505,907 697,027
---------- --------- --------- ---------
Income (loss) from operations........... 193,609 (876,955) (338,463) (726,313)
Interest expense.......................... 5,466 35,383 4,000 225,533
---------- --------- --------- ---------
Net income (loss)....................... $ 188,143 $ (912,338) $(342,463) $(951,846)
========== ========= ========= =========
Net (loss) per common share............... $ (2.54)
=========
Shares used in computing net (loss) per
common share............................ 375,000
=========
Pro forma net income (loss) data
(unaudited):
Income (loss) before income taxes....... $ 188,143 $ (912,338) $(342,463)
Pro forma income tax benefit
(expense)............................ (79,020) 77,464 29,079
---------- --------- ---------
Pro forma net income (loss)............. $ 109,123 $ (834,874) $(312,385)
========== ========= =========
Pro forma net income (loss) per common
share:.................................. $ 0.26 $ (2.11) $ (0.75)
========== ========= =========
Shares used in computing pro forma net
income (loss) per common share:......... 417,334 395,565 416,244
========== ========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE> 66
PIRANHA INTERACTIVE PUBLISHING, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
FOR THE YEARS ENDED DECEMBER 31, 1995 AND 1996,
AND THE SIX MONTHS (UNAUDITED) ENDED JUNE 30,1997
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL RETAINED
------------------- PAID-IN EARNINGS
SHARES AMOUNT CAPITAL (DEFICIT) TOTAL
--------- ------ --------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1994.......... 1,290,583 $1,291 $ 2,709 $ (3,704) $ 296
Issuance of common stock............ 491,389 491 1,032 1,523
Distributions to stockholders....... (22,500) (22,500)
Net income.......................... 188,143 188,143
--------- ------ --------- ----------- -----------
Balance, December 31, 1995.......... 1,781,972 1,782 3,741 161,939 167,462
Distributions to stockholders....... (45,000) (45,000)
Repurchase common stock............. (181,972) (182) (382) (5,182) (5,746)
Reclassification of S Corporation
accumulated deficit............... (588,062) 588,062
Issuance of warrants................ 75,000 75,000
Issuance of stock options........... 18,600 18,600
Net loss............................ (912,338) (912,338)
--------- ------ --------- ----------- -----------
Balance, December 31, 1996.......... 1,600,000 $1,600 $(491,103) $ (212,519) $ (702,022)
--------- ------ --------- ----------- -----------
Net loss............................ (951,846) (951,846)
--------- ------ --------- ----------- -----------
Balance, June 30, 1997
(unaudited)....................... 1,600,000 $1,600 $(491,103) $(1,164,365) $(1,653,868)
========= ====== ========= =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE> 67
PIRANHA INTERACTIVE PUBLISHING, INC.
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1995 AND 1996, AND THE
SIX MONTH PERIODS (UNAUDITED) ENDED JUNE 30, 1996 AND 1997
<TABLE>
<CAPTION>
SIX MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, JUNE 30,
DECEMBER 31, DECEMBER 31, 1996 1997
1995 1996 (UNAUDITED) (UNAUDITED)
------------ ------------ ----------- -----------
<S> <C> <C> <C> <C>
Cash flows from operating activities:
Net income (loss)........................ $ 188,143 $ (912,338) $(342,463) $(951,846)
Adjustments to reconcile net income
(loss) to net cash provided by (used
in) operating activities:
Depreciation and amortization......... 6,256 41,187 6,371 150,673
Interest on notes
payable -- officers................. 3,000 3,426 4,267 1,844
Allowance for bad debts and sales
returns............................. 55,736 6,485 8,737 (34,120)
Reserve for obsolescence.............. 39,494 26,331 1,330
Issuance of stock options for
services............................ 18,600
Net changes in operating assets and
liabilities:
Accounts receivable................. (193,399) 126,758 122,805 25,914
Related party receivables........... 4,000
Inventories......................... (143,119) (34,182) (25,945) (50,531)
Prepaid expenses.................... (8,088) (96,459) (16,269) (177,068)
Accounts payable.................... 248,052 (179,088) 31,088 251,577
Accrued liabilities................. 5,000 33,774 48,192 181,111
Other liabilities................... 3,544 7,633 8,389 (1,306)
--------- --------- --------- ---------
Net cash provided by (used in)
operating activities........... 169,125 (944,710) (128,497) (602,422)
--------- --------- --------- ---------
Cash flows from investing activities:
Purchase of property and equipment....... (32,196) (60,686) (40,177) (10,748)
Sale of property plant and equipment..... 600
Increase in other assets................. (3,662) (320)
--------- --------- --------- ---------
Net cash used in investing
activities..................... (35,258) (61,006) (40,177) (10,748)
--------- --------- --------- ---------
Cash flows from financing activities:
Proceeds from accounts and notes
payable -- officers................... 89,326 63,309 19,693 22,000
Proceeds from notes payable.............. 1,724,979 410,000
Deferred offering costs.................. (128,964) (23,601)
Repayment of accounts and notes
payable -- officers................... (127,417) (16,000)
Repayments of notes payable.............. (224,979)
Payment of debt issuance costs........... (205,950)
Issuance of common stock................. 1,523
Repurchase of common stock............... (5,746) (5,746)
Distributions to stockholders............ (22,500) (45,000) (45,000)
--------- --------- --------- ---------
Net cash provided by (used in)
financing activities........... 68,349 1,050,232 (31,053) 392,399
--------- --------- --------- ---------
Net increase (decrease) in cash and cash
equivalents.............................. 202,216 44,516 (199,727) (220,771)
Cash and cash equivalents, beginning of
year..................................... 202,216 202,216 246,732
--------- --------- --------- ---------
Cash and cash equivalents, end of year..... $ 202,216 $ 246,732 $ 2,489 $ 25,961
========= ========= ========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE> 68
PIRANHA INTERACTIVE PUBLISHING, INC.
NOTES TO FINANCIAL STATEMENTS
1. ORGANIZATION AND OPERATIONS:
Piranha Interactive Publishing, Inc. (the "Company") was incorporated in
Arizona on November 14, 1994. The Company publishes interactive multimedia
software products providing education and entertainment as well as reference and
personal productivity titles for the home personal computer market. The Company
produces its products by generally licensing software programs being developed
by independent third party developers, imprinting them in media format,
duplicating, packaging, marketing and distributing them.
On November 22, 1996, the Board of Directors and the stockholders of the
Company approved the reincorporation of the Company from an Arizona corporation
into a Nevada corporation, by means of a merger of the Arizona corporation into
a Nevada corporation, which merger and the reincorporation became effective as
of November 22, 1996. In connection with the merger (i) all outstanding shares
of common stock of the Arizona corporation were exchanged for shares of common
stock of the Nevada corporation on an approximately 242-to-1 basis, (ii) the
authorized common stock was increased and a class of preferred stock was
created, and (iii) the shares of the Company's former common stock, no par
value, were changed into common stock, $.001 par value. The Company's authorized
capital stock now consists of (i) 20,000,000 shares of common stock, $.001 par
value per share, and (ii) 5,000,000 shares of preferred stock, $.001 par value.
All references to the number of common shares outstanding and to per share
information in the financial statements have been adjusted to reflect the
conversion on a retroactive basis. See Note 15.
2. SIGNIFICANT ACCOUNTING POLICIES:
Basis of Presentation
The financial statements have been prepared assuming the Company will
continue as a going concern. The Company has experienced difficulty in
generating sufficient cash flows from operations. Management is seeking
additional financing to meet working capital needs for operations. In addition,
the Company plans to increase revenues through new products while controlling
costs. Since there is no assurance that management will complete their plans,
there is substantial doubt about the Company's ability to continue as a going
concern. The financial statements do not include any adjustments that might be
necessary should the Company be unable to continue as a going concern.
Newly Issued Accounting Standards
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128, Earnings Per Share ("SFAS 128"). SFAS
128 will change the computation, presentation and disclosure requirements for
earnings per share. SFAS 128 requires presentation of "basic" and "diluted"
earnings per share, as defined, on the face of the income statement for all
entities with complex capital structures. SFAS 128 is effective for financial
statements issued for periods ending after December 15, 1997 and requires
restatement of all prior period earnings per share amounts. The Company is
studying the impact that this pronouncement will have on its earnings per share
calculations.
In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income
("SFAS 130"). This statement establishes standards for reporting and display of
comprehensive income and its components (revenues, expenses and gains and
losses) in a full set of financial statements and becomes effective for fiscal
years beginning after December 31, 1997. The Company is currently studying the
impact of this pronouncement.
F-7
<PAGE> 69
PIRANHA INTERACTIVE PUBLISHING, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Interim Financial Information (Unaudited)
The unaudited interim financial statements for the six month periods ended
June 30, 1997 and 1996 have been prepared on the same basis as the audited
financial statements and, in the opinion of management, include all adjustments,
consisting of only normal recurring adjustments, necessary for a fair
presentation of the financial position and results of operations in accordance
with generally accepted accounting principles. The results of operations for the
interim periods are not necessarily indicative of the operating results for the
full year.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
For purposes of the statements of cash flows, the Company considers all
highly liquid investments with a maturity of three months or less at the time of
acquisition to be cash equivalents.
Inventories
Inventories are stated at the lower of cost or market. Cost is determined
on a first-in, first-out basis. Inventories consist primarily of finished goods,
packaging, supplies and manuals.
Debt Issuance Costs
The costs incurred in connection with the notes payable have been
capitalized. The capitalized costs are being amortized using the effective
interest method over the term of the notes payable.
Property and Equipment
Property and equipment are stated at cost. Depreciation is provided on
depreciable assets by the straight-line method over estimated useful lives while
leasehold improvements are amortized by the straight-line method over the
shorter of estimated useful lives or the remaining lease terms.
When items are retired or disposed of, the cost and accumulated
depreciation or amortization are removed from the accounts and any gain or loss
is included in the statements of operations.
Organizational Costs
Costs incurred in organizing the Company have been capitalized and are
included in other assets. Organizational costs are being amortized over five
years using the straight-line method.
Deferred Offering Costs
Costs incurred, related to the Company's proposed public offering (Note
11), have been capitalized. Upon successful completion of the public offering,
these costs will be offset against the proceeds received or if not successful
will be expensed.
F-8
<PAGE> 70
PIRANHA INTERACTIVE PUBLISHING, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Revenue Recognition
The Company sells its products to original equipment manufacturers,
distributors, and retailers. Revenues are recognized upon delivery except for
sales made to certain distributors where the right of ownership does not pass at
delivery. In those instances, revenue recognition is deferred until resale by
the distributor. The Company's agreements with distributors and retailers allow
for stock rotation. Reserves are provided for stock rotation and returns based
on industry and past experience. These reserves are established at the time of
shipment and reduce gross sales to arrive at net sales as presented in the
accompanying statement of operations. These reserves are reflected as an
allowance for returns. It is the policy of the Company's customers to offset any
returns as reductions against payments on accounts receivable.
On occasion, the Company purchases finished products from other software
publishers for resale to the Company's customers. These purchases are made under
the terms of revenue sharing arrangements. These transactions are accounted for
as the purchase and resale of inventory.
Royalties
The Company, at times, is required to pay royalties to independent software
developers. Up-front advances of a portion of these royalties may also be
required. These prepayments are capitalized and included in prepaid expenses.
The prepayments are amortized to cost of goods sold based on net sales. If and
when it is determined sales of a product associated with a prepayment are not
going to be sufficient to cover the prepayment, the prepaid royalties are
expensed.
Co-op Advertising
Co-op advertising represents credits granted by the Company to its
customers to advertise the Company's products in circulars, catalogs or other
advertisements sponsored by the customer or for special shelf placement or other
types of in-store promotion. Any such advertising is specifically approved by
the Company and the associated costs are expensed as incurred.
Stock-based Compensation
The Company has elected to measure compensation expense related to employee
stock purchase options using Accounting Principles Board Opinion No. 25, and has
provided the necessary pro forma disclosures of net income and earnings per
share as if the fair value based method of accounting, defined by Financial
Accounting Standard No. 123, had been applied.
Income Taxes
Prior to November 15, 1996, the Company elected to be treated as a
Subchapter S Corporation for federal income tax purposes. As such, all tax
liability flowed through to the individual shareholders. Effective November 15,
1996, the Company became a C Corporation and began using the liability method
for income taxes. Deferred income taxes reflect the impact of temporary
differences between the amount of assets and liabilities recognized for
financial reporting purposes and such amounts recognized for tax purposes.
Deferred tax balances are adjusted to reflect tax rates, based on current tax
laws, that will be in effect in the years in which the temporary differences are
expected to reverse.
3. CONCENTRATION OF RISK:
Financial instruments subject to credit risk consist primarily of cash,
cash equivalents, and accounts receivable. At times, the Company's cash
deposited in financial institutions may be in excess of federally insured
limits. In the normal course of business, the Company extends unsecured credit
to its customers.
F-9
<PAGE> 71
PIRANHA INTERACTIVE PUBLISHING, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Additionally, the Company has certain sales concentrations. As of and for the
year ended December 31, 1996, the following concentrations existed:
Accounts Receivable
Three customers comprised approximately 50%, 28% and 17%, respectively, of
the accounts receivable balance as of December 31, 1996. One customer comprised
approximately 69% of the accounts receivable balance as of December 31, 1995.
Customer Sales
Five customers comprised approximately 21%, 20%, 18%, 11% and 11%,
respectively, of net sales for the year ended December 31, 1996. One customer
comprised approximately 96% of net sales for the year ended December 31, 1995.
Sales By Product
Major product lines, as a percentage of net sales, for the years ended
December 31, 1995 and 1996 were as follows:
<TABLE>
<CAPTION>
1995 1996
---- ----
<S> <C> <C>
Product A...................................................... 43% 2%
Product B...................................................... 25% 35%
Product C...................................................... 22% 3%
Product D...................................................... 10% 43%
Product E...................................................... 13%
</TABLE>
Manufacturing and Distribution
All of the Company's titles are currently pressed, reproduced, and packaged
at third party fulfillment houses. The Company's printed materials are produced
by third party vendors that ship such materials directly to the fulfillment
house for product assembly and packaging. The Company places orders with such
vendors for production of completed products in amounts specified by the Company
based upon forecasted sales. All products are shipped directly to distributors
and retailers by the fulfillment houses. As demand for fulfillment houses is
greatest in the third and fourth quarters due to publishers building inventory
for holiday sales, an unanticipated delay in the manufacture of products,
particularly during the fourth quarter, could result in a material adverse
effect on the Company's financial condition and results of operations. Currently
the Company has been utilizing one fulfillment house.
The retail multimedia software market has experienced rapid change in
recent years, including consolidations and financial difficulties. To the extent
any retailers upon which the Company is dependent were to suffer financial
difficulties, the Company's operations could be materially adversely affected.
4. FAIR VALUE OF FINANCIAL INSTRUMENTS:
The Company's financial instruments include cash and cash equivalents,
accounts receivable, accounts payable and notes payable. The carrying amounts of
cash equivalents, accounts receivable, accounts payable, and notes payable
approximate fair value at December 31, 1995 and 1996 as a result of the short
maturity of these instruments. The carrying value of the notes payable to
officers approximates fair value at December 31, 1995 and 1996 based on the
estimated interest rates for similar types of borrowing arrangements.
F-10
<PAGE> 72
PIRANHA INTERACTIVE PUBLISHING, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
5. INVENTORIES:
Inventories consist of the following:
<TABLE>
<CAPTION>
JUNE 30,
DECEMBER 31, DECEMBER 31, 1997
1995 1996 (UNAUDITED)
------------ ------------ -----------
<S> <C> <C> <C>
Packaging supplies and manuals........ $ 40,927 $ 30,909 82,253
Finished goods........................ 102,192 146,392 145,579
-------- -------- -------
143,119 177,301 227,832
Less reserve for obsolescence......... 39,494 40,824
-------- -------- -------
$143,119 $137,807 187,008
======== ======== =======
</TABLE>
6. PROPERTY AND EQUIPMENT:
Property and equipment consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1995 1996
------------ ------------
<S> <C> <C>
Office furniture................................... $ 8,834 $ 8,834
Office equipment................................... 5,969 27,481
Computer equipment................................. 16,793 20,463
Leasehold improvements............................. 35,504
-------- --------
31,596 92,282
Less accumulated depreciation...................... (6,033) (21,008)
-------- --------
$ 25,563 $ 71,274
======== ========
</TABLE>
7. NOTES PAYABLE:
Notes payable consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1995 1996
------------ ------------
<S> <C> <C>
Notes payable, interest at 10%, net of unamortized
debt discount of $68,072, due on the earlier of
November 27, 1997 or the close of the proposed
initial public offering.......................... $ $1,431,928
Notes payable -- officers, interest at 10%, due
August 1, 1999................................... 33,000 36,426
-------- ----------
33,000 1,468,354
Less current portion............................... 1,431,928
-------- ----------
$ 33,000 $ 36,426
======== ==========
</TABLE>
The outstanding balance of notes payable -- officers includes accrued
interest of $3,000 and $6,426 at December 31, 1995 and 1996, respectively.
8. RELATED PARTY TRANSACTIONS:
At December 31, 1995, the Company owed $64,108 to several officers of the
Company for Company expenses funded by these officers.
F-11
<PAGE> 73
PIRANHA INTERACTIVE PUBLISHING, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The Company rented office space from an officer of the Company during 1995.
Rental expense was approximately $6,000.
On July 1, 1996, the Company entered into a one-year consulting agreement
with a stockholder who is otherwise unaffiliated with the Company. As
compensation for the stockholder's future services in pursuing and arranging
potential business combinations, the Company has agreed to pay an amount not to
exceed 2.5 percent of the total consideration involved in such a combination to
the stockholder minus any retainer advanced to the stockholder. The agreement
also calls for a $50,000 non-refundable retainer to be paid in monthly
installments over the term of the agreement and a commitment to grant an option
to purchase 12,000 shares of common stock (subsequently increased to 16,000 as
described in Note 15) following the adoption of a stock option plan. The
agreement is renewable for one-year terms by mutual consent of the parties. On
December 4, 1996, the Company paid the outstanding balance of the retainer in
full and is recognizing expense ratably over the term of the agreement.
9. ADVERTISING:
Total advertising expense, including co-op advertising, was $2,975 and
$148,590 and for the years ended December 31, 1995 and 1996, respectively.
10. INCOME TAXES:
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at December 31,
1996 are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
1996
------------
<S> <C>
Deferred tax assets:
Current:
Net operating loss carryforwards............... $ 40,886
Allowance for bad debts and sales returns...... 26,133
Accrued expenses............................... 9,912
Inventories.................................... 16,587
--------
93,518
--------
Deferred tax liabilities:
Non-current:
Depreciation................................... 2,515
--------
Net deferred tax assets............................. 91,003
Valuation allowance................................. (91,003)
--------
$ 0
========
</TABLE>
The reconciliation of the effective income tax rate to the federal
statutory rate is as follows:
<TABLE>
<CAPTION>
1996
-----
<S> <C>
Federal income tax rate............................... 34.0%
Effect of net operating loss carryforward and
valuation allowance................................. (34.0)%
-----
Effective income tax rate............................. 0.0%
=====
</TABLE>
F-12
<PAGE> 74
PIRANHA INTERACTIVE PUBLISHING, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
11. EQUITY:
Preferred Stock
The Company is authorized to issue up to 5,000,000 shares of preferred
stock, with a par value of $.001, in one or more series and to fix the powers,
designations, preferences, and rights of each series. No series have been issued
to date.
Stock Option Plan
During December 1996, the Board of Directors of the Company established the
1996 Stock Option Plan ("1996 Plan") which authorizes them to grant options to
directors, employees and consultants of the Company to purchase shares of common
stock. An aggregate of 200,000 shares of common stock (subsequently increased to
300,000 as described in Note 15) are reserved for issuance upon exercise of
options granted under the 1996 Plan. In general, options granted under the 1996
Plan are not transferable, expire ten years after date of grant and the exercise
price may not be less than fair market value of common stock on grant date and
no options may be granted with an exercise price less than the initial public
offering price.
On December 13, 1996, the Company issued an option under the 1996 Plan to
purchase 12,000 shares of common stock (subsequently increased to 16,000 as
described in Note 15) to a stockholder of the Company (see Note 8) at an
exercise price of $5.00 per share. The option becomes fully vested on September
1, 1997, and may be exercised at any time prior to August 31, 2002. The
compensation cost recognized in income for this option for the year ended
December 31, 1996 was $18,600 based on the fair value of the option. This fair
value was estimated on the date of grant using the Black-Scholes option-pricing
model with the following assumptions: no dividends are expected to be declared;
expected volatility of 75 percent, risk-free interest rate of 6 percent; options
are not expected to be exercised for 4.5 years; and the estimated fair value of
the underlying stock based on the historical stock prices of similar public
entities following a comparable period in their lives, of $3.00 per share. As of
December 31, 1996, no options have been exercised or forfeited.
Warrants
The Company issued 750,000 warrants in connection with the $1,500,000 of
notes payable. The warrants entitle the holders to purchase one share of common
stock for $3.00; however, these warrants will be exchanged automatically for
750,000 Selling Securityholders' Warrants upon the close of the proposed public
offering, each of which will be identical to the Class A warrants (including the
exercise price of $6.50) included in the Offering Units. These warrants were
valued at $75,000 and recorded as notes payable discount, which is being
amortized over the term of the notes payable using the effective interest
method.
Proposed Initial Public Offering
The Company signed a letter of intent, in October 1996, with an underwriter
for a proposed initial public offering (the "Offering") of 1,200,000 units
("Offering Units") (subsequently increased to 1,600,000 units as described in
Note 15), consisting of one share of common stock, one Class A warrant and one
Class B warrant. Each Class A warrant is exercisable at any time during the five
years following the date of the Offering to purchase one share of common stock
for $6.50, subject to adjustment. Each Class B warrant is exercisable at any
time during the five years following the date of the Offering to purchase one
share of common stock for $8.75, subject to adjustment. The Company may redeem
such warrants at $.05 per warrant if the Company's stock price meets certain
price levels. (See Note 15)
In connection with the public offering, the present holders of the
Company's common stock have been required to place 825,000 shares of common
stock (subsequently increased to 1,225,000 shares as described in Note 15) in an
escrow account to be released only upon the Company attaining certain minimum
earnings thresholds or the market price of the Company's common stock meeting
certain minimum levels. In the event
F-13
<PAGE> 75
PIRANHA INTERACTIVE PUBLISHING, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
the requirements for the release of the escrow shares are attained, the Company
will be required to recognize compensation expense based on the share price at
the date of release. On March 31, 2001 (subsequently extended to March 31, 2002
as described in Note 15), all shares still held in escrow will be forfeited,
which shares will then be placed in the Company's treasury for cancellation
thereof as a contribution to capital.
12. COMMITMENTS:
Equity
The Company has agreed to sell to the representative of the underwriters
(the "Representative"), for nominal consideration, the option to purchase up to
160,000 Units ("Unit Purchase Option"), substantially identical to the Offering
Units. The Unit Purchase Option will be exercisable during the three-year period
commencing two years from the date of the Offering at an exercise price equal of
$6.00 per Unit, (subsequently increased to $6.50 as described in Note 15)
subject to adjustment. The Unit Purchase Option is not transferable for a period
of two years from the date of the Offering except to officers of the underwriter
or to members of the selling group. The exercise price and all other terms of
any common stock, Class A warrants or Class B warrants (which B warrants were
subsequently removed as described in Note 15) issuable to the Representative
upon exercise of the Unit Purchase Option will be substantially identical to
those sold in the offering except that the warrants issued to the Representative
are not subject to redemption by the Company. (See Note 15)
During the five-year period starting November 27, 1996, in the event the
Representative originates a financing or a merger, acquisition or transaction to
which the Company is a party, the Representative will be entitled to receive a
finder's fee in consideration for origination of such transaction. The fee is
based on a percentage of the consideration paid in the transaction.
Royalties
The Company has entered into several different license and distribution
agreements (the "Agreements") with independent software developers. The
Agreements generally provide that in return for the Company's exclusive right to
produce, market and sell certain software products, the developers of these
products are entitled to royalties based on a percentage of the product's net
sales. If certain performance criteria are not met, such as selling a minimum
amount of units or paying a minimum amount of royalties, the Company may lose
its right for exclusivity or the agreement may terminate. The Agreements expire
through October 2000. Royalty expense for the years ended December 31, 1995 and
1996 was $72,547 and $90,307, respectively, and was included in the cost of
goods sold. Also, the Company was required to make certain up-front advances
related to royalties. The unamortized up-front advances, included in prepaid
expenses, were $8,008 and $62,169 at December 31, 1995 and 1996, respectively.
Leases
The Company is obligated under a long-term operating lease for its
corporate offices through the year 1999. Annual rent commitments under this
operating lease are as follows:
<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31,
----------------------------------------------------------
<S> <C>
1997................................................... $ 45,234
1998................................................... 46,421
1999................................................... 43,551
--------
$135,206
========
</TABLE>
Rent expense amounted to $3,804 and $45,738 for the years ended December
31, 1995 and 1996, respectively.
F-14
<PAGE> 76
PIRANHA INTERACTIVE PUBLISHING, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
13. UNAUDITED PRO FORMA DATA:
The following pro forma data has been presented on the statements of
operations:
a. Income tax benefit (expense) has been presented as if the Company
was a C corporation. The income tax benefit (expense) was calculated
assuming an effective tax rate of 42%.
The pro forma tax benefit (expense) consists of:
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31,
1995 1996
------------ ------------
<S> <C> <C>
Current benefit (expense):
Federal.................................. $(63,969) $ 62,746
State.................................... (15,051) 14,718
-------- --------
$(79,020) $ 77,464
======== ========
</TABLE>
Total pro forma provision for income taxes differs from the "expected"
pro forma tax expense of 34% principally due to state income taxes for all
periods and only partial benefit from the net operating loss for the year
ended December 31, 1996. A valuation allowance is required on the pro forma
deferred tax asset resulting from the net operating loss for the year ended
December 31, 1996 due to the uncertainty surrounding the realization of
such asset.
b. Net income (loss) per share is computed using the weighted average
number of common shares outstanding during each period after giving
retroactive effect to the recapitalization (see Note 1). As the conditions
for release of the escrow shares (see Note 11) have not been met nor will
they be met upon the mere passage of time, the escrow shares have been
considered contingently issuable and, accordingly, have been excluded from
the weighted average number of common shares outstanding used for the
calculation of the primary net income (loss) per share. The escrow shares
are considered common stock equivalents in determining fully diluted net
income per share; however, in 1995 after giving effect to the higher level
of earnings required under the escrow agreement, the escrow shares have
been excluded from the computation as their effect would be antidilutive.
All common stock equivalents are excluded from the computation of net loss
per share as their effect would be antidilutive.
14. SUPPLEMENTAL CASH FLOW INFORMATION:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
1996
------------
<S> <C>
Cash paid for:
Interest.............................................. $ 20,643
Schedule of non-cash investing and financing activities:
Issuance of stock options for services................ $ 18,600
Warrants issued in connection with notes payable...... $ 75,000
</TABLE>
15. SUBSEQUENT EVENT
On March 21, 1997, the Company and the Representative agreed to revise the
terms of the Offering Units to exclude the issuance of the Class B Warrant. The
Representative's unit purchase option was also revised to exclude the Class B
Warrant. All other terms and conditions of the Offering remain unchanged.
On April 29, 1997 and May 28, 1997, the Company issued short-term notes
payable to the Representative for $160,000 and $250,000, respectively. The notes
payable bear interest at 10% and mature on the earlier of
F-15
<PAGE> 77
PIRANHA INTERACTIVE PUBLISHING, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
October 28, 1997 and November 28, 1997, respectively, or the closing of any
public offering or other financing by the Company providing net proceeds of at
least $500,000.
On July 5, 1997 and August 4, 1997, respectively, the Company issued
short-term notes payable to the Representative for $90,000 and to a corporation
controlled by a family member of the sole stockholder of the Representative for
$75,000. The notes payable bear interest at 10% and mature on the earlier of
January 1, 1998 and February 1, 1998, respectively, or the closing of any public
offering or other financing by the Company providing net proceeds of at least
$500,000.
On August 11, 1997, the Company and the Representative agreed to further
revise the terms of the Offering by increasing the number of Offering Units from
1,200,000 to 1,600,000 units. The Company has also agreed to increase the number
of units included in the Unit Purchase Option issuable to the Representative
from 120,000 Units to 160,000 Units. In connection with these revisions, the
present holders of the Company's common stock will be required to increase the
number of common shares held in escrow from 825,000 to 1,225,000. The date at
which any remaining shares in escrow are forfeited has been extended from March
31, 2001 to March 31, 2002.
As of August 11, 1997, the Company declared a dividend equal to
approximately 0.33 share of Common Stock as to each then outstanding share of
Common Stock. All references to the number of common shares outstanding, common
shares reserved for issuance under the 1996 Stock Option Plan, and per share
information in the financial statements have been adjusted to reflect the
dividend on a retroactive basis.
On August 11, 1997, the Board of Directors of the Company authorized an
additional 33,333 shares of common stock reserved for issuance upon exercise of
options granted under the 1996 Stock Option Plan.
On August 28, 1997, the Company issued a short-term note payable to a
corporation controlled by a family member of the sole stockholder of the
Representative for $30,000. The note payable bears interest at 10% and matures
on the earlier of February 27, 1998, or the closing of any public offering or
other financing by the Company providing net proceeds of at least $500,000.
On September 9, 1997, the Company and the Representative agreed to revise
the terms of the unit purchase option to increase the exercise price to $6.50
per unit.
F-16
<PAGE> 78
=========================================================
NO DEALER, SALESMAN OR OTHER PERSON IS AUTHORIZED TO GIVE ANY INFORMATION
OR MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS WITH RESPECT TO THE
OFFERING MADE HEREBY. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL ANY
OF THE SECURITIES OFFERED HEREBY IN ANY JURISDICTION WHERE, OR TO ANY PERSON TO
WHOM, IT IS UNLAWFUL TO MAKE SUCH AN OFFER. NEITHER THE DELIVERY OF THIS
PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE AN
IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE INFORMATION SET FORTH HEREIN OR
IN THE BUSINESS OF THE COMPANY SINCE THE DATE HEREOF.
------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary......................... 3
Risk Factors............................... 7
Use of Proceeds............................ 21
Dividend Policy............................ 22
Dilution................................... 23
Capitalization............................. 24
Selected Financial Data.................... 25
Management's Discussion and Analysis of
Financial Condition and Results of
Operations............................... 26
Business................................... 33
Management................................. 45
Certain Transactions....................... 49
Principal Stockholders..................... 50
Description of Securities.................. 54
Shares Eligible for Future Sale............ 57
Underwriting............................... 58
Legal Matters.............................. 61
Experts.................................... 61
Available Information...................... 61
Financial Statements....................... F-1
</TABLE>
------------------
UNTIL OCTOBER 13, 1997 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL
DEALERS EFFECTING TRANSACTIONS IN THE UNITS, WHETHER OR NOT PARTICIPATING IN
THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS IN ADDITION
TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS
AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
=========================================================
=========================================================
[PIRANHA LOGO]
LOGO
1,600,000 UNITS
------------------------
PROSPECTUS
------------------------
D.H. BLAIR INVESTMENT
BANKING CORP.
SEPTEMBER 18, 1997
=========================================================
