AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON FEBRAURY 16, 1999
REGISTRATION NO. 333-66099
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------
AMENDMENT NO. 7 TO
FORM SB-2
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------
DIGITAL LAVA INC.
(NAME OF SMALL BUSINESS ISSUER IN ITS CHARTER)
------------
Delaware 7371 95-4584080
(State or Other (Primary Standard (I.R.S.
Jurisdiction of Industrial Classification Employer identification
Incorporation Or Code Number) No.)
Organization)
10850 Wilshire Boulevard, Suite 1260 10850 Wilshire Boulevard, Suite 1260
Los Angeles, CA 90024 Los Angeles, CA 90024
(310) 470-1149 (Address of Principal Place or
(Address and Telephone Number Intended Principal Place
of Principal Executive Offices) of Business)
------------
Joshua D.J. Sharfman
Chief Executive Officer
Digital Lava Inc.
10850 Wilshire Boulevard, Suite 1260
Los Angeles, California 90024
(310) 470-1149
(Name, Address, And Telephone Number Of Agent For Service)
COPIES TO:
Jeffrey D. Abbey, Esq. Lawrence B. Fisher, Esq.
Ehrenreich Eilenberg Krause & Zivian LLP Orrick, Herrington & Sutcliffe LLP
11 East 44th Street 30 Rockefeller Plaza
New York, New York 10017 New York, New York 10112
(212) 986-9700 (212) 506-5000
------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO PUBLIC: As soon as
practicable after this registration statement becomes effective.
<PAGE>
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering: [_]
If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering: [_]
If this form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering: [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
check the following box: [_]
<TABLE>
<CAPTION>
Calculation of Registration Fee
Title of each Class Amount Propose Maximum Proposed Maximum Amount of
of Securities to to be Offering Price Aggregate Offering Registration
be Registered (1) Registered Per Unit (2) Price (2) Fee
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Units, comprised of two shares of
common stock, par value $.0001
per share, and one redeemable common
stock purchase warrant, each exercisable
for one share of common stock(3) ......................... 1,380,000 $ 15.10 $20,838,000 --
Common stock, par value
$.0001 per share(4) ...................................... 2,760,000 $ 7.50 $20,700,000 $ 5,755
Redeemable common stock
purchase warrants(5) ..................................... 1,380,000 $ .10 $ 138,000 $ 39
Common stock issuable upon exercise of
redeemable warrants ...................................... 1,380,000 $ 9.00 $12,420,000 $ 3,453
Representative's
warrants (6) ............................................. 120,000 $ .0001 $ 24 --
Common stock issuable upon exercise of
representative's warrants (6) ............................ 240,000 $ 12.375 $ 2,970,000 $ 828
Redeemable warrants issuable upon
exercise of representative's
warrants (6) ............................................. 120,000 $ .16 $ 19,800 $ 6
Common stock issuable upon
exercise of redeemable warrants
issuable upon exercise of
representative's
warrants (6) ............................................ 120,000 $ 12.375 $ 1,485,000 $ 414
Common stock (7) .......................................... 880,436 $ 7.50 $ 6,603,270 $ 1,840
- ------------------------------------------------------------------------------------------------------------------------------------
Total ..................................................... $44,336,094 $ 12,435
</TABLE>
(1) Pursuant to Rule 416, there are also being registered additional securities
as may become issuable pursuant to the anti-dilution provisions of the
redeemable warrants, the representative's warrants and the redeemable
warrants underlying the representative's warrants.
(2) Estimated solely for the purpose of calculating the registration fee
pursuant to Rule 457(a) of the Securities Act of 1933.
(3) Includes 180,000 units that the underwriters have the option to purchase to
cover over-allotments, if any.
<PAGE>
(4) Includes 360,000 shares of common stock that the underwriters have the
option to purchase to cover over-allotments, if any.
(5) Includes 180,000 redeemable common stock purchase warrants that the
underwriters have the option to purchase to cover over-allotments, if any.
(6) In connection with the registrant's sale of the securities offered, the
registrant is granting to the representative of the several underwriters
warrants to purchase 240,000 shares of common stock and 120,000 redeemable
common stock purchase warrants.
(7) Consists of currently outstanding shares held by selling stockholders.
------------
THE REGISTRANT AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS
MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A
FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT
SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8 (A) OF THE
SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.
<PAGE>
The information contained in this preliminary prospectus is not complete and may
be changed. These securities may not be sold until the registration statement
filed with the securities and exchange commission is effective. This prospectus
is not an offer to sell nor does it seek an offer to buy these securities in any
jurisdiction where the offer or sale is not permitted.
Subject to Completion, Dated February 16, 1999
DIGITAL LAVA INC.
1,200,000 Units
This is an initial public offering of 1,200,000 units of Digital Lava Inc.
Each unit consists of two shares of common stock and one redeemable common stock
purchase warrant. The common stock and the warrants will be separately tradeable
immediately following the completion of this offering.
No public market currently exists for the units. We anticipate that the
initial public offering price will be $15.10 per unit, which consists of $7.50
per share for each of the two shares of common stock and $.10 per warrant. The
common stock and the warrants have been approved for listing on the American
Stock Exchange under the symbols "DGV" and "DGV.WS," respectively. The units are
not listed on the American Stock Exchange.
The selling stockholders identified in this prospectus are offering an
additional 880,436 shares of common stock.
See "Risk Factors" beginning on page 6 to read about certain factors you
should consider before buying the units.
-----------------------
Neither the Securities and Exchange Commission nor any other regulatory
body has approved or disapproved these securities or passed upon the accuracy or
adequacy of this prospectus. Any representation to the contrary is a criminal
offense.
-----------------------
Per Unit Total
-------- -----
Public offering price................................... $ $
Underwriting discounts and commissions.................. $ $
Proceeds to Digital Lava................................ $ $
The underwriters may purchase up to an additional 180,000 units from
Digital Lava at the initial public offering price less the underwriting
discount. The underwriters are offering the units on a firm commitment basis.
DIRKS & COMPANY, INC.
The date of this prospectus is __________ __, 1999.
<PAGE>
[Inside Front Cover Page]
[Top of the Page: VideoVisor... desktop video that works. A solution for
distance learning, corporate training and communications applications."]
[Center: Picture of VideoVisor screen, including picture of speaker, a chart of
the broadbrand methods of connecting FDDI networks and captions pointing to the
individual components of the network.]
[Bottom of the Page: Awards received by Digital Lava for its products and a
slogan, "Digital Lava... we're changing the way the world views video"]
-2-
<PAGE>
TABLE OF CONTENTS
<TABLE>
<S> <C>
Prospectus Summary ............................................................................................ 4
Risk Factors .................................................................................................. 6
Because we have a limited operating history, we may not achieve anticipated revenues ..................... 6
We have sustained losses in the past and expect to sustain losses in the future .......................... 6
Our future profitability is uncertain .................................................................... 6
We may be unable to operate as a going concern because we have suffered recurring losses
from operations and have a working capital deficiency .................................................. 6
We are likely to be in default on certain promissory notes if this offering is not completed ............. 6
The representative lacks experience which may have a negative impact on liquidity and price .............. 7
The loss of a major customer may harm our business ....................................................... 7
The market in which we compete is new and uncertain ...................................................... 7
We are dependent on the continued employment of Sharfman and Stigler ..................................... 7
The representative may continue to have influence over us ............................................... 7
The representative's warrants may affect our ability to raise additional capital ......................... 7
Our redemption of the warrants may force holders to make an investment decision before
they are ready ......................................................................................... 8
You cannot sell the shares underlying the warrants if we do not have an effective registration
statement .............................................................................................. 8
We need two independent directors or we may be de-listed from Amex ....................................... 8
Use of Proceeds ............................................................................................... 9
Dividend Policy ............................................................................................... 10
Capitalization ................................................................................................ 11
Dilution ...................................................................................................... 12
Selected Financial Information ................................................................................ 14
Management's Discussion and Analysis of
Financial Condition and Results of
Operations ............................................................................................... 15
Business ...................................................................................................... 20
Management .................................................................................................... 30
Certain Transactions .......................................................................................... 35
Principal Stockholders ........................................................................................ 37
Selling Stockholders .......................................................................................... 38
Description of Securities ..................................................................................... 40
Shares Eligible for Future Sale ............................................................................... 44
Underwriting .................................................................................................. 45
Legal Matters ................................................................................................. 47
Experts ....................................................................................................... 47
Additional Information ........................................................................................ 47
Index to Financial Statements ................................................................................. F-1
</TABLE>
-3-
<PAGE>
PROSPECTUS SUMMARY
DIGITAL LAVA INC.
Digital Lava is a provider of software products and services related to the
use of video for corporate training, communications, research and other
applications. Our vPrism(TM) software allows users to organize video content,
link video to other types of files and publish video on compact discs or digital
video discs, or "stream" the video information over intranets or the Internet.
Our award-winning VideoVisor(TM) software allows users to manage, manipulate and
integrate video with other information on their computers, much like word
processors manipulate textual data.
Streaming technology allows an Internet or intranet user to access
information in a file before the file is completely downloaded. As a result,
large files containing video and audio information can be heard or seen almost
immediately, even with slower connections. We believe that the continuing
emergence of the Internet as a mass communications medium and the advent of
related new technologies such as streaming presents a significant new market
opportunity for software applications that enhance the effectiveness and
productivity of persons who rely on video information. We believe that our
software technology provides a more compelling and productive user experience
than broadcast television and videotape, allowing the Internet to effectively
compete with these traditional video delivery methods.
We were formed as a limited liability company in July 1995 and merged into
a Delaware corporation in November 1996. Our address is 10850 Wilshire
Boulevard, Suite 1260, Los Angeles, California 90024, and our telephone number
is (310) 470-1149. Our Web site can be accessed at www.digitallava.com.
Information contained on our Web site is not part of this prospectus.
THE OFFERING
Securities Offered 1,200,000 units, each unit
consisting of two shares of common stock
and one redeemable common stock purchase
warrant. The common stock and the
warrants will be separately tradeable
immediately following the completion of
this offering.
Common Stock Outstanding
Before the Offering 1,996,092 shares; excludes outstanding
options, the underwriters' over-
allotment option and warrants.
Common Stock Outstanding
After the Offering 4,396,092 shares; excludes outstanding
options, the underwriters' over
-allotment option and warrants.
Warrants Outstanding
After the Offering 1,200,000 warrants.
Use of Proceeds Product development, sales and
marketing, repayment of indebtedness,
facilities and other capital
expenditures, expansion of internal
operations and working capital and
general corporate purposes.
Amex Symbols common stock "DGV"
warrants "DGV.WS"
-4-
<PAGE>
SUMMARY FINANCIAL INFORMATION
For information concerning the computation of net loss per share, see note
2 of notes to financial statements. Pro forma information gives effect to the
following recapitalization:
o conversion of the Series A, B, B-1 and C convertible preferred stock;
o the recording of a dividend to the holders of the Series B and C
convertible preferred stock due to a change in conversion ratios;
o the return and cancellation of shares of common stock and Series A
preferred stock held by certain officers of Digital Lava;
o the conversion of certain notes payable, accrued interest on the notes
and warrants issued in connection with the notes into common stock and
the recording of an extraordinary loss on the extinguishment of debt
based upon the difference in the fair value of (1) the notes, accrued
interest and warrants converted and (2) the common stock issued in
exchange; and
o the conversion of certain warrants exercisable for shares of common
stock into common stock.
The pro forma, as adjusted information also gives effect to:
o the sale of common stock and warrants offered at an initial public
offering price of $7.50 per share of common stock and $.10 per
warrant;
o the repayment of outstanding notes payable in the aggregate principal
amount of $3,353,500 and accrued interest and fees in the amount of
$468,472 at September 30, 1998;
o the proceeds from the issuance of $550,000 in principal amount of
bridge notes and warrants issued in December 1998 and the repayment of
the bridge notes from the proceeds of the offering; and
o the recognition of the unamortized portion of the debt discount
associated with the notes payable and bridge notes as an expense.
<TABLE>
<CAPTION>
Year Ended Nine Months Ended
------------------------------------ --------------------------------------
December 31, 1996 December 31, 1997 September 30, 1997 September 30, 1998
----------------- ----------------- --------------------- --------------
<S> <C> <C> <C> <C>
Statement of Operations Data:
Revenues ........................................... $ -- $ 564,572 $ 376,468 $ 1,147,632
Cost of revenues ................................... -- 122,976 101,620 244,339
----------- ----------- ----------- -----------
Gross profit ....................................... -- 441,596 274,848 903,293
----------- ----------- ----------- -----------
Operating costs and expenses:
Selling, general and administrative ............ 1,522,757 3,316,961 2,337,115 2,773,240
Research and development ....................... 421,087 445,162 322,385 334,142
----------- ----------- ----------- -----------
Total operating costs and expenses .......... 1,943,844 3,762,123 2,659,500 3,107,382
----------- ----------- ----------- -----------
Loss from operations ............................... (1,943,844) (3,320,527) (2,384,652) (2,204,089)
Interest expense ................................... 450,563 924,842 762,517 1,057,131
Net loss ........................................... $(2,384,657) $(4,245,369) $(3,147,169) $(3,261,220)
=========== =========== =========== ===========
Basic and diluted loss per share ................... $ (93.00) $ (31.14) $ (23.75) (22.05)
=========== =========== =========== ===========
Weighted average common shares used in
basic and diluted loss per share ............... 25,641 136,353 132,492 147,933
=========== =========== =========== ===========
</TABLE>
<TABLE>
<CAPTION>
September 30, 1998
-----------------------------------------------------------
Pro Forma
Balance Sheet Data: Actual Pro Forma As Adjusted
---------------- --------------------- ----------------
<S> <C> <C> <C>
Cash and cash equivalents......................................... $ 11,786 $ 11,786 $ 11,154,214
Working capital (deficit)......................................... (6,117,681) (4,348,323) 10,219,033
Total assets...................................................... 603,366 603,366 11,433,156
Total liabilities................................................. 6,629,003 4,859,645 1,122,079
Total stockholders' (deficit) equity.............................. (6,025,637) (4,256,279) 10,311,077
</TABLE>
-5-
<PAGE>
RISK FACTORS
Because we have a limited operating history, we may not achieve anticipated
revenues. We were originally formed as a limited liability company in July 1995
and were merged into a corporation in November 1996. We did not recognize any
revenue until 1997. Therefore, we have only a limited operating history upon
which you may judge our performance and prospects. As a result of our limited
operating history and the emerging nature of the markets in which we compete, we
may not be able to achieve anticipated revenues.
We sustained losses in the past and expect to sustain losses in the future.
We have incurred significant losses since inception and we expect to continue to
incur substantial operating losses for the foreseeable future. As of September
30, 1998, we had an accumulated deficit of $10,229,518.
Our future profitability is uncertain. We expect that our sales and
marketing, product development and administrative expenses will increase in the
future and, as a result, will need to generate significant revenues to achieve
profitability. Despite significant investments in sales and marketing and
product development, we may not be able to sustain our growth in revenues,
including revenues from software license fees, in the future. To become
profitable, we must, among other things:
o successfully develop and deliver new products and services;
o respond quickly and effectively to competitive, market and technological
developments;
o expand sales and marketing operations;
o broaden customer support capabilities; and
o control expenses.
We may not be able to achieve profitability in the future.
We may be unable to operate as a going concern because we have suffered
recurring losses from operations and have a working capital deficiency. Our
independent accountants have included an explanatory paragraph stating that our
financial statements have been prepared assuming that we will continue as a
going concern and that we have suffered recurring losses from operations and
have a working capital deficiency which cause substantial doubt as to our
ability to do so.
We are likely to be in default on certain promissory notes if this offering
is not completed. Of an aggregate principal amount of $5,319,500 of promissory
notes which are currently outstanding, we will be repaying an aggregate
principal amount of $3,903,500 of these notes from the net proceeds of this
offering. An aggregate principal amount of $1,750,000 of notes matured on
November 20, 1998. All of the holders of these notes have agreed to extend the
maturity date of their notes until the earlier of February 19, 1999 or the
consummation of this offering.
As of January 1, 1999, we were in default on the repayment of an additional
aggregate principal amount of 3,019,500 of promissory notes. Holders of an
aggregate principal amount of $2,832,000 of these notes agreed to extend the
maturity date of their notes until the earlier of February 19, 1999 or the
consummation of this offering. Holders of an aggregate principal amount of
$187,500 of these notes previously agreed to extend the maturity date of their
notes to June 30, 1999; however, because the closing of this offering did not
occur by December 31, 1998, the entire principal amount of their notes became
due and payable. The holders have agreed to waive the default and in
consideration we have agreed to pay the entire principal amount of their notes,
and accrued interest, upon the consummation of this offering.
If this offering is not completed by February 19, 1999, and we are unable
to reach an agreement with each of the holders to extend the term of the notes
which are now due on that date, then we will be in default on all of these notes
and the holders may foreclose on our assets. In this event, it is unlikely that
we will be able to complete this offering.
-6-
<PAGE>
The representative lacks experience which may have a negative impact on
liquidity and price. Dirks & Company, Inc., the representative of the
underwriters, has limited experience as a manager and as an underwriter of
public offerings of securities. The representative's lack of experience may have
a negative impact on the liquidity and price of our securities following the
completion of this offering.
The loss of a major customer may harm our business. In the past, we derived
a majority of our revenues in each period from one or two customers. For the
nine months ended September 30, 1998, two customers accounted for approximately
58.6% and 17.3%, respectively, of revenues. For the nine months ended September
30, 1997, a separate customer accounted for 64.8% of revenues. We do not have a
contract with any of these customers. Although the volume of sales for our
customers varies from year-to-year, the loss of a major customer could have a
material adverse effect on our business.
The market in which we compete is new and uncertain. The market for our
video-based products and services is in the early stage of development and is
evolving rapidly. The development of a market for our technology also depends on
increased use of the Internet and intranets for information, publication,
distribution and commerce relating to video and multimedia. Critical issues
concerning use of the Internet and intranets, including security, reliability,
cost, ease of use and quality of service, remain unresolved and may affect the
growth of and the degree to which business is conducted over the Internet and
intranets. As a result, demand and market acceptance for our technology is
uncertain. We cannot assure you that the market for our technology will continue
to emerge or become sustainable. If the market for our products and services
fails to grow, develops more slowly than expected or becomes saturated with
competing products or services, our business will be materially adversely
affected.
We are dependent on the continued employment of Sharfman and Stigler. As an
emerging technology company, we are particularly dependent on the continued
employment and performance of Joshua Sharfman, Chief Executive Officer, and
Thomas Stigler, Vice President of Sales and Business Strategy, both of whom have
been instrumental in the development and commercialization of our technology.
Mr. Sharfman will be our President upon completion of this offering. We have
entered into employment agreements with Messrs. Sharfman and Stigler which
commence on the closing date of this offering and expire two years later.
Messers. Sharfman and Stigler will each receive an annual base salary of
$230,000, 40,000 stock options exercisable at the initial public offering price
per share of common stock and a one-time cash bonus of $60,000. A state court
may determine not to enforce, or only partially enforce, certain provisions of
these agreements. We do not maintain any key man life insurance. The loss of the
services any of our executive officers or key employees could have a material
adverse effect on our business, financial condition and results of operations.
The representative may continue to have influence over us. Following the
completion of this offering, the representative may designate one person for
election to our board of directors for five years from the effective date of the
registration statement and refuse to allow us to sell or offer for sale any
securities for six months from the date of this prospectus, except in connection
with strategic transactions or mergers and acquisitions. Accordingly, the
representative will continue to have influence over our operations following the
completion of this offering. The representative's interests may not be
consistent with those of our stockholders. The representative's designee on our
board of directors could be in a position to cast a deciding vote on a matter of
importance. Also, the representative could limit our ability to obtain financing
at a time when we may think it desirable to do so.
The representative's warrants may affect our ability to raise additional
capital. Upon the consummation of the offering, we will sell to the
representative and/or its designees, for nominal consideration, warrants to
purchase up to 240,000 shares of common stock and/or 120,000 warrants. The
holders of the representative's warrants will have, at nominal cost, the
opportunity to profit from a rise in the market price of the common stock and/or
warrants without assuming the risk of ownership, with a resulting dilution in
the interest of other security holders. As long as the representative's warrants
remain unexercised, our ability to obtain additional capital might be adversely
affected. Moreover, the representative may exercise the representative's
warrants at a time when we would, in all likelihood, be able to obtain any
needed capital through a new offering of our securities on terms more favorable
than those provided by the representative's warrants.
-7-
<PAGE>
Our redemption of the warrants may force holders to make an investment
decision before they are ready. Commencing 18 months after the date of this
prospectus, the warrants will be subject to redemption. If we decide to redeem
the warrants, holders of the warrants will lose their rights to purchase shares
of common stock issuable upon exercise of the warrants unless the warrants are
exercised before they are redeemed. Upon receipt of a notice of redemption,
holders may be forced to make an investment decision regarding their warrants
before they are ready to do so.
You cannot sell the shares underlying the warrants if we do not have an
effective registration statement. The warrants are not exercisable unless, at
the time of the exercise, we have a current prospectus covering the shares of
common stock issuable upon exercise of the warrants, and the shares have been
registered, qualified or deemed to be exempt under the securities laws of the
state of residence of the exercising holder of the warrants. Although we have
agreed to use our best efforts to keep a registration statement covering the
shares of common stock issuable upon the exercise of the warrants effective for
the term of the warrants, if we fail to do so for any reason, the warrants may
be deprived of value.
The common stock and warrants are detachable and separately transferable
immediately following completion of this offering. Purchasers may buy warrants
in the aftermarket or may move to jurisdictions in which the shares underlying
the warrants are not so registered or qualified during the period that the
warrants are exercisable. In that event, we would be unable to issue shares to
those persons desiring to exercise their warrants, and holders of warrants would
have no choice but to attempt to sell the warrants in a jurisdiction where a
sale is permissible or allow them to expire unexercised.
We need two independent directors or we may be de-listed from Amex. We
currently have only one independent director on our board of directors.
Following completion of this offering, we will be adding at least two additional
independent directors to our board of directors. The American Stock Exchange
requires us to have at least two independent directors within 90 days of the
completion of this offering. If we do not have at least two independent
directors by that date, our securities may be de-listed by Amex which could
severely impair the liquidity of our securities.
You should carefully consider the risk factors described above and other
information in this prospectus before deciding to purchasing units. This
prospectus contains forward-looking statements that involve risks and
uncertainties. These statements can be identified by the use of words such as
"may," "will," "expect," "anticipate," "estimate," "continue," or other similar
words. These statements discuss future expectations, contain projections of
results of operations or of financial condition, or state other
"forward-looking" information. When considering these statements, you should
keep in mind the risk factors and other cautionary statements in this
prospectus. The risk factors and other factors noted throughout this prospectus,
including certain risks and uncertainties, could cause our actual results to
differ materially from those contained in any forward-looking statement.
-8-
<PAGE>
USE OF PROCEEDS
The net proceeds to Digital Lava from the sale of the securities offered in
this offering, after deduction of underwriting discounts and other estimated
expenses relating to the offering, are estimated to be approximately
$14,964,000, or $17,328,660 if the over-allotment option is exercised in full.
Digital Lava intends to use the net proceeds as follows:
Percent
Net of
Proceeds Total
----------- ----
Product development expenses ...................... $ 3,000,000 20.0%
Sales and marketing expenditures .................. 5,000,000 33.4
Facilities and other capital expenditures ......... 400,000 2.7
Expansion of internal operations .................. 300,000 2.0
Repayment of certain indebtedness ................. 4,469,247 29.9
Working capital and general corporate purposes .... 1,794,753 12.0
----------- ----
Total ............................. $14,964,000 100%
=========== ====
Product development expenses. Digital Lava intends to significantly
increase its investment in product development activities associated with the
development of new products and the enhancement of existing products, and also
expects to make expenditures for the licensing of technology, the acquisition of
additional software products and the hiring of software engineers and
development management.
Sales and marketing expenditures. Digital Lava intends to increase its
sales and marketing efforts by increasing the size of its sales and marketing
staff, increasing advertising and trade show related activities, expanding the
level of technical support offered to its dealers and customers and opening
sales offices in several locations.
Facilities and other capital expenditures. Digital Lava intends to lease
additional space for sales and administrative offices, and to invest in
additional computers, networking systems, furniture, fixtures, leasehold
improvements, and related equipment.
Expansion of internal operations. Digital Lava intends to expand internal
operations, including further improvement of its management information systems
and the continued development of its Web site.
Repayment of certain indebtedness. Digital Lava intends to repay:
o an aggregate principal amount of $1,750,000 of promissory notes,
originally issued from November 1997 through February 1998, bearing
interest at 12% per annum, and a 10% success fee due when paid;
o an aggregate principal amount of $953,500 of promissory notes,
originally issued from April 1997 through July 1997, plus accrued
interest on a portion of these notes;
o an aggregate principal amount of $650,000 of promissory notes
originally issued from March 1996 through March 1997, plus a success
fee of $130,000; and
o an aggregate principal amount of $550,000 of promissory notes issued
on December 1, 1998, bearing interest at 12% per annum, including a
$300,000 promissory note issued to Henry Stigler, father of James and
Thomas Stigler.
The proceeds from all of these loans were used for research and development,
sales and marketing and working capital and general corporate expenses,
including rent, salaries and wages, consulting fees and
-9-
<PAGE>
other general corporate purposes. No officers, directors or other related
parties will benefit from the proceeds allocated for payment of the notes.
Working capital and general corporate purposes. Digital Lava intends to use
approximately $250,000 of the net proceeds to pay consultants' fees and employee
bonuses due upon completion of this offering. In addition, net proceeds will be
used for payment of rent, accrued and on-going expenses, salaries and wages,
consulting fees and other general corporate purposes.
The table above represents Digital Lava's best estimate of the allocation
of the net proceeds of the offering, based upon the current status of its
operations, its current plans and current economic conditions. The amount and
timing of expenditures will vary depending upon a number of factors, including
progress of Digital Lava's operations, technical advances, terms of
collaborative arrangements, and changes in competitive conditions. Digital Lava
also expects, when the opportunity arises, to acquire or invest in complementary
businesses, products or technologies. Digital Lava has no present
understandings, commitments or agreements with respect to any material
acquisition or investment. Digital Lava reserves the right to change the amount
of the net proceeds that will be used for any purpose to the extent that
management determines that a change is advisable. Accordingly, management will
have broad discretion as to the application of the net proceeds of the offering.
Stockholders may not agree with management's determination as to the use of
proceeds and Digital Lava cannot predict that the proceeds will be invested to
yield a favorable return.
Digital Lava anticipates that the net proceeds from this offering and cash
provided by operations will allow it to meet its cash requirements for at least
12 months following the date of this prospectus. On occasions in the past,
Digital Lava has had to raise capital prior to when it had originally
anticipated. Digital Lava has had some difficulty raising capital in the past
and may not be able to obtain capital on a timely basis, on favorable terms, or
at all. If Digital Lava is unable to obtain financing, or generate funds from
operations sufficient to meet its needs, it business, financial condition and
results of operations will be materially adversely affected.
Pending application of the net proceeds of the offering, Digital Lava
intends to invest the net proceeds in short-term, interest bearing securities,
such as bank certificates of deposit, United States government obligations or
money market instruments.
DIVIDEND POLICY
Digital Lava has never declared or paid any cash dividends on its capital
stock. Digital Lava presently intends to reinvest earnings to fund the
development and expansion of its business and, therefore, does not anticipate
paying cash dividends on its common stock in the foreseeable future. The
declaration of dividends in the future will be at the discretion of the board of
directors and will depend upon the earnings, capital requirements and financial
position of Digital Lava, general economic conditions and other pertinent
factors. As part of our recapitalization, we will record a dividend of $690,469
to holders of our Series B and C convertible preferred stock.
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<PAGE>
CAPITALIZATION
The following table sets forth the capitalization of Digital Lava as of
September 30, 1998, (a) on an actual basis, (b) on a pro forma basis and (c) on
a pro forma, as adjusted basis. The adjustments for the pro forma information
and for the pro forma, as adjusted information are described in detail in the
introductory narrative to the "Summary Financial Information."
Shares of common stock outstanding does not include 250,000 shares of
common stock reserved for issuance under Digital Lava's stock option plan, of
which 139,622 shares will be subject to outstanding options upon completion of
this offering, and 628,109 shares of common stock issuable upon exercise of
outstanding warrants. This table should be read in conjunction with Digital
Lava's financial statements and the notes to the financial statements appearing
elsewhere in this prospectus.
<TABLE>
<CAPTION>
September 30, 1998
---------------------------------------------
Pro Forma
Actual Pro Forma As Adjusted
------------ ------------ ------------
<S> <C> <C> <C>
Notes payable, net of debt discount $ 4,632,749 $ 3,269,095 --
============ ============ ============
Stockholders' deficit:
Convertible preferred stock, $.0001 par value; Series A, B, B-1 and C;
5,000,000 shares authorized; 98,349 shares issued
and outstanding, actual (liquidation preference of $1,626,965); none issued
and outstanding pro forma and pro forma as adjusted 9 -- --
Common stock, $.0001 par value; 35,000,000 shares
authorized; 131,524 issued and outstanding, actual; 1,996,092 shares
issued and outstanding, pro forma; 4,396,092 issued
and outstanding, pro forma as adjusted 13 199 439
Additional paid-in capital 4,203,859 10,227,303 25,282,352
Accumulated deficit (10,229,518) (14,483,781) (14,971,714)
------------ ------------ ------------
Total stockholders' deficit and total capitalization $ (6,025,637) $ (4,256,279) $ 10,311,077
============ ============ ============
</TABLE>
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<PAGE>
DILUTION
As of September 30, 1998, the pro forma net tangible book value (deficit)
of Digital Lava was $(4,545,391), or approximately $(2.28) per share of common
stock. Pro forma net tangible book value (deficit) per share represents the
amount of total tangible assets less total liabilities divided by the number of
shares of common stock issued and outstanding, after giving effect to the
recapitalization, including:
o the recording of an extraordinary loss on the extinguishment of debt based
upon the difference in the fair value of (1) the notes, accrued interest
and warrants converted and (2) the common stock issued in exchange; and
o the recording of a dividend to the holders of the Series B and C
convertible preferred stock due to the change in the conversion ratios.
After giving effect to the adjustments for the pro forma, as adjusted
information as described in detail in the introductory narrative to the "Summary
Financial Information," the net tangible book value of Digital Lava at September
30, 1998 would have been $10,311,077, or approximately $2.35 per share of common
stock. This represents an immediate increase in net tangible book value of $4.63
per share of common stock to existing stockholders and an immediate dilution in
net tangible book value of $5.15 per share of common stock, or approximately
68.7%, to new investors. The following table illustrates this per share
dilution:
Assumed initial public offering price
per share of common stock.......................... $7.50
Pro forma net tangible book value (deficit)
prior to the offering.............................. $(2.28)
Increase per share attributable to the offering........ 4.63
------
Pro forma, as adjusted, net tangible book value per
share after the offering........................... 2.35
-----
Dilution per share to new investors ................... $5.15
=====
If the over-allotment option is exercised in full, the pro forma, as
adjusted, net tangible book value after the offering would have been $12,675,737
or $2.67 per share of common stock, resulting in dilution to new investors of
$4.83 per share of common stock.
The following table summarizes, as of September 30, 1998, on a pro forma
basis to reflect the same adjustments described above, the number of shares of
common stock purchased from Digital Lava, the total consideration paid and the
average price per share paid by (a) existing stockholders of common stock, and
(b) new stockholders in the offering, assuming the sale of the units offered in
this offering. The calculations are based upon total consideration given by new
investors and existing stockholders before any deduction of underwriting
discounts and offering expenses payable by Digital Lava. The calculations
regarding the existing stockholders give effect to the recapitalization
described in detail in the introductory narrative to the "Summary Financial
Information." The calculations regarding the new investors attribute no value to
the warrants.
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<PAGE>
<TABLE>
<CAPTION>
Shares Purchased Total Consideration Average
-------------------- ---------------------- Price
Number Percent Amount Percent Per Share
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Existing stockholders ..... 1,996,092 45% $ 2,729,499 13% $1.37
New investors ............. 2,400,000 55% 18,000,000 87% $7.50
--------- --- ---------- ---
Total 4,396,092 100% $20,729,499 100%
========= === =========== ===
</TABLE>
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<PAGE>
SELECTED FINANCIAL INFORMATION
The following table presents selected financial data for Digital Lava. The
historical selected financial data as of December 31,1997 and for the years
ended December 31, 1996 and 1997 are derived from and should be read in
conjunction with the audited financial statements of Digital Lava included
elsewhere in the prospectus. The historical selected financial data of Digital
Lava as of December 31, 1996 is derived from audited financial statements of
Digital Lava not included in this prospectus. The historical selected financial
data as of September 30, 1998 and for nine months ended September 30, 1997 and
1998 are derived from and should be read in conjunction with the unaudited
financial statements of Digital Lava included elsewhere in the prospectus. In
the opinion of management, the unaudited financial statements include all
material adjustments, consisting of only normal, recurring adjustments,
necessary for a fair presentation of the financial position and results of
operations for the period. Our independent accountants have included an
explanatory paragraph stating that our financial statements have been prepared
assuming that we will continue as a going concern and that we have suffered
recurring losses from operations and have a working capital deficiency which
cause substantial doubt about our ability to do so. The financial statements do
not include any adjustments that might result from the outcome of this
uncetainty. The data presented below should be read in conjunction with
"Managements Discussion and Analysis of Financial Condition and Results of
Operations" and the financial statements and accompanying notes appearing
elsewhere in the prospectus.
For information concerning the computation of net loss per share, see note
2 of notes to financial statements. The adjustments for the pro forma
information are described in detail in the introductory narrative to the
"Summary Financial Information."
<TABLE>
<CAPTION>
Year Ended Nine Months Ended
------------------------------------ --------------------------------------
December 31, 1996 December 31, 1997 September 30, 1997 September 30, 1998
----------------- ----------------- ------------------ ------------------
<S> <C> <C> <C> <C>
Statement of Operations Data:
Revenues:
Software licenses ............................. $ -- $ 273,989 $ 131,804 $ 832,090
Consulting and services ....................... -- 290,583 244,664 315,542
----------- ----------- ----------- -----------
Total revenues ............................. -- 564,572 376,468 1,147,632
----------- ----------- ----------- -----------
Cost of revenues:
Software licenses ............................. -- 1,968 1,059 7,708
Consulting and services ....................... -- 121,008 100,561 236,631
----------- ----------- ----------- -----------
Total cost of revenues ..................... -- 122,976 101,620 244,339
----------- ----------- ----------- -----------
Gross profit ...................................... -- 441,596 274,848 903,293
----------- ----------- ----------- -----------
Operating costs and expenses:
Selling, general and administrative ........... 1,522,757 3,316,961 2,337,115 2,773,240
Research and development ...................... 421,087 445,162 322,385 334,142
----------- ----------- ----------- -----------
Total operating costs and expenses ......... 1,943,844 3,762,123 2,659,500 3,107,382
----------- ----------- ----------- -----------
Loss from operations .............................. (1,943,844) (3,320,527) (2,384,652) (2,204,089)
Interest expense .................................. 450,563 924,842 762,517 1,057,131
Net loss .......................................... $(2,384,657) $(4,245,369) $(3,147,169) $(3,261,220)
=========== =========== =========== ===========
Basic and diluted loss per share .................. $ (93.00) $ (31.14) $ (23.75) (22.05)
=========== =========== =========== ===========
Weighted average common shares used in
basic and diluted loss per share .............. 25,641 136,353 132,492 147,933
=========== =========== =========== ===========
<CAPTION>
September 30, 1998
-------------------------------
Balance Sheet Data: December 31, 1996 December 31, 1997 Actual Pro Forma
----------------- ----------------- ----------- -----------
<S> <C> <C> <C> <C>
Cash and cash equivalents ......................... $ 5,185 $ 173,262 $ 11,786 $ 11,786
Working capital (deficit) ......................... (1,022,306) (3,713,347) (6,117,681) (4,348,323)
Total assets ...................................... 100,598 525,678 603,366 603,366
Total liabilities ................................. 1,034,180 4,142,923 6,629,003 4,859,645
Total stockholders' deficit ....................... (933,582) (3,617,245) (6,025,637) (4,256,279)
</TABLE>
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<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis of the financial condition and
results of operations of Digital Lava should be read in conjunction with Digital
Lava's financial statements and the notes to the financial statements and the
other financial information included elsewhere in this prospectus. In addition
to historical information, this Management Discussion and Analysis of Financial
Condition and Results of Operations and other parts of this prospectus contain
forward-looking information that involve risks and uncertainties. Digital Lava's
actual results could differ materially from those anticipated by forward-looking
information as a result of certain factors, including but not limited to, those
set forth under "Risk Factors" and elsewhere in this prospectus.
Overview
Digital Lava Inc. originally operated as LAVA, L.L.C., a New Jersey limited
liability company that was formed in July 1995. In November 1996, LAVA, L.L.C.
merged into Digital Lava Inc., a Delaware corporation. As part of this
transaction, the ownership interests in LAVA, L.L.C. were exchanged for shares
of Series A, Series B, Series B-1 and Series C convertible preferred stock of
Digital Lava Inc.
Digital Lava invested significant resources in sales, marketing,
development and other operating activities during the nine-month period ended
September 30,1998. Digital Lava believes that its success depends largely on
building superior technology and quality into its products, extending its
technological lead on the competition and developing brand recognition early in
a product's life cycle. Accordingly, Digital Lava expects to continue spending
heavily on these activities in the near future. Despite these heavy investments
in marketing and product development, the historical growth in software license
fees may not be sustainable in the future. In light of Digital Lava's limited
operating history and rapid improvements in technology and marketing of its
products, Digital Lava believes that period-to-period comparisons of its
revenues and operating results, including its gross profit and operating
expenses as a percentage of total net revenues, are not necessarily meaningful
and should not be relied upon as indications of future performance.
Digital Lava has incurred significant net losses and negative cash flows
from operations since inception, and as of September 30, 1998, had an
accumulated deficit of $10,229,518. Digital Lava intends to continue to invest
heavily in technology and infrastructure development, and marketing and
promotion. As a result, Digital Lava believes that it will continue to incur
operating losses and negative cash flows from operations for the foreseeable
future and that the rate at which these losses will be incurred may increase
from current levels. There can be no assurance that Digital Lava will be able to
achieve or sustain revenue growth, profitability, or positive cash flow on
either a quarterly or annual basis.
Results of Operations
Comparison of Nine Months Ended September 30, 1998 to Nine Months Ended
September 30, 1997
Revenues
Revenues increased to $1,147,632 for the nine months ended September 30,
1998 from $376,468 for the nine months ended September 30, 1997. The increase of
$771,164 or 204.8% was primarily due to an increase in sales of VideoVisor
products to new customers. Software license revenues accounted for approximately
72.5% and 35.0% of revenues for the nine months ended September 30, 1998 and
1997, respectively. Consulting and services revenues accounted for approximately
27.5% and 65.0% of revenues for the nine months ended September 30, 1998 and
1997, respectively. Digital Lava's largest customer accounted for approximately
58.6% and 64.8% of revenues for the nine months ended September 30, 1998 and
1997, respectively. Digital Lava anticipates that software license revenue will
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<PAGE>
continue to account for a larger share of revenues for the foreseeable future.
Cost of Revenues
Cost of revenues consist primarily of the cost of materials, freight and
applicable labor incurred for the delivery of the product or service. Costs of
revenues increased to $244,339, or 21.2% of revenues, for the nine months ended
September 30, 1998 from $101,620, or 27.0% of revenues, for the nine months
ended September 30, 1997. This increase was primarily due to the increase in
subcontractor cost incurred in the first nine months of 1998. Digital Lava
expects its cost of revenue to continue to increase in dollar amount while
declining as a percentage of revenue as Digital Lava expands its customer base.
Operating Costs and Expenses
Selling, General and Administrative Expense. Selling, general and
administrative expenses consist primarily of salaries, taxes and benefits and
related costs for general corporate functions, including executive management,
finance, accounting, facilities, legal, fees for professional services and
depreciation and amortization. Selling, general and administrative increased to
$2,773,240, or 241.6% of revenues, for the nine months ended September 30, 1998,
from $2,337,115, or 620.8% of revenues, for the nine months ended September 30,
1997. The increase was primarily due to increases in public relations efforts,
trade shows, additional personnel and professional fees required to build an
infrastructure to support Digital Lava's products and anticipated growth. In
addition, selling, general and administrative expenses for the nine months ended
September 30, 1998 and September 30, 1997 included non-cash compensation
expenses of $396,381 and $789,055, respectively, which represent the granting of
stock options and warrants to non-employees in exchange for services rendered to
Digital Lava. Digital Lava expects that it will incur additional selling,
general and administrative expenses in absolute dollars as Digital Lava
continues to hire personnel and incurs expense related to the further growth of
the business and its operation as a public company.
Research and Development Expenses. Research and development expenses
consist primarily of expenditures related to technology and software development
expenses. Research and development expenses increased to $334,142, or 29.1% of
revenues, for the nine months ended September 30, 1998 from $322,385, or 85.6%
of revenues, for the nine months ended September 30, 1997. The dollar increase
was primarily due to the increased number of developers needed to accelerate the
release of products in 1998 and to expand research efforts in the area of Web
enabled applications. Research and development expenses decreased as a
percentage of revenue because of the growth level in revenues relative to the
growth in the cost structure for research and development. Digital Lava believes
that significant investments in technology and content development are required
to maintain a technological lead and remain competitive and, therefore, expects
that its research and development expenses will continue to increase in absolute
dollars for the foreseeable future; however, research and development expenses
are presently anticipated to continue to decline as a percentage of revenues.
Interest Expense. Interest expense includes interest income from Digital
Lava's cash balances, interest expense related to Digital Lava's financing
obligations and the amortization of debt discount. Interest expense increased to
$1,057,131 for the nine months ended September 30, 1998 from $762,517 for the
nine months ended September 30, 1997. The increase was primarily due to the
amount of notes payable issued by Digital Lava in the nine month period ended
September 30, 1998. Interest expense for the nine months ended September 30,
1998 and September 30, 1997 included amortization of debt discount and issuance
costs related to warrants issued in connection with notes payable of $544,905
and $617,608, respectively.
Net Loss. For the nine months ended September 30, 1998, Digital Lava's net
loss totaled $3,261,220 as
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<PAGE>
compared to $3,147,169 for the nine months ended September 30, 1997.
Comparison of Year Ended December 31, 1997 to Year Ended December 31, 1996.
Revenues
Revenues increased to $564,572 for the year ended December 31, 1997 from
zero for the year ended December 31, 1996. The increase in revenues were
primarily due to the realization of the impact of sales of vPrism and VideoVisor
which were released in 1997, and associated services revenue. Software license
revenues accounted for approximately 48.5% of revenues for the year ended
December 31, 1997 while consulting and services revenues accounted for
approximately 51.5% of revenues for the same period. Digital Lava's largest
customer accounted for approximately 43.1% of revenues for the year ended
December 31, 1997. Digital Lava anticipates that software license revenue will
account for a larger share of revenues in the future.
Cost of Revenues
Costs of revenues for the year ended December 31, 1997 were $122,976, or
21.8% of revenues. There were no cost of sales for the year ended December 31,
1996. This increase was primarily due to the increase in material and labor cost
incurred in delivering the products and services. Digital Lava expects its cost
of revenue to continue to increase in dollar amount while declining as a
percentage of revenue as Digital Lava expands its customer base.
Operating Costs and Expenses
Selling, General and Administrative Expense. Selling, general and
administrative expenses were $3,316,961, or 587.5% of revenues, and $1,522,757
for the years ended December 31, 1997 and 1996, respectively. The increase was
primarily due to increases in trade shows, additional personnel and legal and
professional fees required to build an infrastructure to support Digital Lava's
products and anticipated growth. In addition, selling, general and
administrative expenses for the years ended December 31, 1997 and 1996 included
non-cash compensation expenses of $866,589 and $261,996, respectively, which
represent the granting of stock options and warrants to non-employees in
exchange for services rendered to Digital Lava.
Research and Development Expenses. Research and development expenses were
$445,162, or 78.9% of revenues, and $421,087 for the years ended December 31,
1997 and 1996, respectively. The increase was primarily due to the increased
number of developers and professional services needed to release vPrism and
VideoVisor in 1997.
Interest Expense. Interest expense increased to $924,842 for the year ended
December 31, 1997 from $450,563 for the year ended December 31, 1996. The
increase is due to the amount of notes payable issued by Digital Lava in 1997.
Interest expense for the years ended December 31, 1997 and 1996 included
amortization of debt discount and issuance costs related to warrants issued in
connection with notes payable of $716,433 and $396,368, respectively.
Net Loss. For the year ended December 31, 1997, Digital Lava's net loss
totaled $4,245,369 as compared to $2,384,657 for the year ended December 31,
1996.
Net Operating Loss Carryforwards. At December 31, 1997, Digital Lava had
available net operating loss carryforwards of approximately $2,800,000 to offset
future taxable income for federal and state tax purposes. The utilization of the
loss carryforwards to reduce future income taxes will depend upon Digital
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<PAGE>
Lava's ability to generate sufficient taxable income prior to the expiration of
the net operating loss carryforwards. The federal and state carryforwards expire
beginning in the years 2011 and 2005, respectively. However, the Internal
Revenue Code of 1986 limits the maximum annual use of net operating loss and tax
credit carryforwards in certain situations where changes occur in the stock
ownership of a corporation. As a result of this offering, a change in ownership
is likely to occur which would substantially restrict Digital Lava's use of the
net operating loss carryforwards for federal and state income tax purposes.
Liquidity and Capital Resources
Since its inception, Digital Lava has financed its operations primarily
through the private placement of its convertible preferred stock, common stock
and convertible notes. As of September 30, 1998, Digital Lava had $11,786 in
cash.
Net cash used in operating activities increased to $2,195,803 for the year
ended December 31, 1997 from $1,664,962 for the year ended December 31, 1996
resulting primarily from increasing net losses and decreased to $898,372 for the
nine months ended September 30, 1998 from $1,583,410 for the nine months ended
September 30, 1997 primarily due to increasing revenues.
Cash flows used in investing activities decreased to $55,620 for the year
ended December 31, 1997 from $105,519 for December 31, 1996 resulting primarily
from the reduced investment in computers and related equipment and increased
from $54,185 for the nine months ended September 30, 1997 to $313,104 for the
nine months ended September 30, 1998 primarily due to costs incurred in
connection with this offering.
Net cash provided by financing activities increased to $2,419,500 for 1997
from $1,769,680 for 1996. The increase was due to the increase in the issuance
of equity and notes payable. Net cash provided by financing activities decreased
to $1,050,000 for the nine months ended September 30, 1998 from $1,719,500 for
the nine months ended September 30, 1997. The decrease was due primarily to a
reduction in proceeds from notes payable received in the nine months ended
September 30, 1998.
Digital Lava's capital requirements depend on numerous factors, including
market acceptance of Digital Lava's products and services, the amount of
resources Digital Lava devotes to investments in its products, the resources
Digital Lava devotes to marketing and selling its services and its brand
promotions and other factors. Digital Lava has experienced a substantial
increase in its capital expenditures since its inception consistent with the
growth in Digital Lava's operations and staffing, and anticipates that this will
continue for the foreseeable future. Additionally, Digital Lava will continue to
evaluate possible investments in businesses, products and technologies, and
plans to expand its sales and marketing programs and conduct more aggressive
brand promotions. Digital Lava currently anticipates that the net proceeds of
the offering and available funds will be sufficient to meet its anticipated
needs for working capital and capital expenditures for at least the next 12
months.
Digital Lava intends to use approximately $250,000 of the net proceeds of
this offering to pay consultants' fees and employee bonuses due upon completion
of this offering. In addition, during the two-year period following the closing
of this offering, Digital Lava is committed to pay approximately $1,100,000 in
salaries and consulting fees under certain employment and consulting agreements.
If the net proceeds of the offering, together with Digital Lava's
internally generated cash flow, are not sufficient to satisfy its financing
needs, Digital Lava will be required to seek additional funding through bank
borrowings, additional public or private sales of its securities, including
equity securities, or through other arrangements. Digital Lava currently has no
credit facility or other committed sources of capital, however it intends to
secure a credit facility after the completion of the offering. There can be no
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<PAGE>
assurance that additional funds, if required, will be available to Digital Lava
on favorable terms, if at all.
Digital Lava recently raised $550,000 of capital through the issuance of
promissory notes and warrants to help it meet its cash requirements until it
receives the net proceeds from this offering. The notes will be paid at the
closing of this offering. In connection with the issuance of the notes, Digital
Lava issued warrants to purchase an aggregate of 275,000 shares of common stock
at 130% of the initial public offering price per share.
Digital Lava granted a security interest in all of its assets to investors
participating in the bridge financing completed in February 1998 as collateral
to secure Digital Lava's obligations to the investors under the $1,750,000 of
promissory notes issued in connection with the bridge financing. In connection
with the recapitalization, Digital Lava has also granted a security interest in
all of its assets to holders of an aggregate principal amount of $187,500 of
promissory notes who agreed to extend the term of their notes to June 30, 1999.
Recently Issued Accounting Standards
Effective January 1, 1998, Digital Lava adopted the provisions of SFAS No.
130, "Reporting Comprehensive Income." SFAS No. 130 establishes standards for
reporting comprehensive income, defined as all changes in equity from non-owner
sources. Adoption of SFAS No. 130 did not have a material effect on Digital
Lava's financial position or results of operations.
Effective January 1, 1998, Digital Lava adopted the provisions of SFAS No.
131, "Disclosures about Segments of an Enterprise and Related Information." SFAS
No. 131 establishes standards for the way public enterprises report information
about operating segments in annual financial statements and requires those
enterprises to report selected information about operating segments in interim
financial reports issued to stockholders. Adoption of SFAS No. 131 did not have
a material effect on Digital Lava's financial position or results of operations.
Effective January 1, 1998, Digital Lava adopted American Institute of
Certified Public Accountants Statement of Position 97-2, "Software Revenue
Recognition" ("SOP 97-2"). SOP 97-2 generally requires revenue earned on
software arrangements involving multiple elements such as software products,
upgrades, enhancements, post-contract customer support, installation and
training to be allocated to each element based on the relative fair values of
the elements. The adoption of SOP 97-2 did not have an effect on Digital Lava's
financial position or results of operations.
Year 2000 Risk
Many currently installed computer systems and software products are coded
to accept only two digit entries in the date code field. As a result, software
that records only the last two digits of the calendar year may not be able to
distinguish whether "00" means 1900 or 2000. This may result in software
failures or the creation of erroneous results. We believe that our products and
internal systems are currently year 2000 compliant. We have confirmed our year
2000 compliance by obtaining representations by third party vendors of their
products' year 2000 compliance, as well as specific testing of our products. We
have not incurred significant costs to date complying with year 2000
requirements and we do not believe that we will incur significant costs for
these purposes in the foreseeable future. However, should products or systems
maintained by third parties or our products and systems fail to be year 2000
compliant, despite the representations of third parties and the testing of our
products, we could incur significant expenses to remedy any problems and our
business could be seriously damaged.
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<PAGE>
BUSINESS
Overview
Digital Lava is a provider of software products and services related to the
use of video for corporate training, communications, research and other
applications. Digital Lava's product line includes vPrism(TM) and VideoVisor(TM)
software. vPrism allows users to organize and manage video, link video to other
types of data and publish video, together with linked data, as VideoCapsule(TM)
files on compact discs and digital video discs, or stream the video information
over private intranets or the Internet. VideoVisor allows users to access
VideoCapsule files and manage, manipulate and integrate video with other
information on their desktop computers. Digital Lava's VideoVisor software won
the "Best New Streaming Product" award at the Desktop Video Communications (DVC)
1998 Spring Conference in Santa Clara, California and a "Networked Multimedia
People's Choice Award" at the 1998 DVC Fall Conference in Boston and a "NewMedia
Invision 98 award" in a competition sponsored by NewMedia magazine.
Streaming technology allows an Internet or intranet user to access
information in a file before the file is completely downloaded. As a result,
large files containing audio and video can be heard or seen almost immediately,
even with slower connections. Digital Lava believes that this streaming
technology presents a significant new market opportunity for software
applications that enhance the effectiveness and productivity of professionals
and consumers who rely on video information. Digital Lava also believes that as
the Internet continues to evolve as a mass communications medium and as
corporations, educational institutions and government agencies seek to eliminate
the high cost and time requirements of travel through the increased use of
video, more video content, including business, distance learning - instruction
where the student is removed from the instructor - and consumer programs, will
be delivered over the Internet. RealNetworks, one of Digital Lava's strategic
partners and a leader in the streaming media market, has already registered over
35 million users of its RealPlayer Internet software. Digital Lava believes that
its software technology is essential to this evolution because it provides a
more compelling and productive user experience than broadcast television and
videotape, allowing the Internet to effectively compete with these traditional
video delivery methods.
Digital Lava's customers include large corporations and business
enterprises, such as:
o Shell Chemicals Company;
o American General Life Insurance Company
o Ardent Software, Inc.;
o ASI Entertainment, Inc.;
o Bellcore;
o Diedrich Coffee, Inc.; and
o Rand Corporation.
Our customers also include schools, universities and research institutions such
as:
o Northwestern University;
o Los Angeles Unified School District;
o The Smithsonian Institute; and
o Educational Testing Service.
Industry Background
Digital Lava believes the demand for its software applications in the
corporate training, communications and distance learning markets will be fueled
by trends and technologies that enable computer-based and Internet-based video
training and communications to be used increasingly as substitutes for
videotapes,
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instructor-led training, live meetings and other traditional forms of
communications and training. These trends and technologies include:
o the growth of multimedia-capable computers and sophisticated computer
networks;
o advances in personal computer processing power;
o high speed communications capabilities;
o the emergence of the Internet and corporate intranets for a wide variety of
business applications; and
o the continued growth of streaming media applications.
Streaming technology enables the transmission and playback of continuous
"streams" of multimedia content, such as audio and video, over a computer
network. The introduction of streaming media technology from companies such as
RealNetworks, Microsoft and Apple Computer are now providing software developers
the opportunity to efficiently deliver significant media content and
applications over the Internet and private intranets. On the Internet, many
businesses and content providers now offer audio, video and other multimedia
information. RealNetworks estimates that more than 145,000 hours per week of
live audio and video content are broadcast over the Internet using its streaming
technology, with a substantially greater amount of recorded media already stored
and available on the Internet.
Digital Lava believes that the use of streaming media by businesses and
other users is growing. Lotus Development Corporation, makers of Lotus Notes,
the market leader in collaborative software, recently announced its plan to
integrate RealNetworks' RealPlayer with Lotus Notes client software, enabling 25
million Lotus Notes users worldwide to view and hear streaming media content at
their desktops. Additionally, Netscape Communications Corporation recently
announced that it plans to distribute RealNetworks' RealPlayer software as an
integral part of its Netscape Communicator browser software, providing Netscape
users with access to streaming media content without separately having to
download the RealPlayer software.
The overall market for business and training software is expected to grow
over the next several years. According to International Data Corporation, a
leading information technology consulting company, the worldwide business
software applications market is expected to double over the next five years,
with license revenues from business software applications growing from $50
billion in 1997 to over $100 billion in 2002.
In the United States, corporations are making substantial investments to
train their employees. Video, in the form of videotapes, is already widely used
within corporations to record and distribute training and communications
content. A 1997 U.S. corporate training study conducted by Training Magazine
found that 74 percent of the respondents were using videotapes for training. The
same survey also found that U.S. companies budgeted an estimated $58.6 billion
for employer-provided training in 1997. Digital Lava believes that training on
new information technologies within corporations is growing rapidly worldwide.
According to a recent study published by International Data Corporation's
Information Technologies, Training and Education Services research program, the
information technologies' training and education market is expected to surpass
$28.3 billion by 2002.
Although there can be no assurance that the increased use of videotapes in
training will result in sales of its products, Digital Lava believes that its
technology can take advantage of the growing demand for business, video
training, communications and distance learning applications. Digital Lava's
software and services provide a rapid, flexible, and low-cost alternative to
videotapes, instructor-led training, live meetings, and other traditional forms
of communications and training.
Digital Lava's Solution
Today, most computer video applications provide the user with a passive
experience, similar to viewing a television program or videotape. Digital Lava's
software provides a fast and easy way to transform
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video information into highly interactive multimedia programs, and to deliver
them at a fraction of the cost of live meetings or of developing custom
multimedia or computer-based-training programs. Digital Lava's software
products, vPrism and VideoVisor, are designed to be easily integrated into a
personal computer system.
With Digital Lava's vPrism software, creators of videotape can rapidly
develop and implement programs to transform the passive viewing experience into
an interactive multimedia application that can be easily used by desktop
computer users within a network. Any video, including corporate training videos
and videos of classroom lectures, can be linked with digitally formatted files
or programs, including Web pages, documents, images and transcripts. With
VideoVisor software, users can view, navigate and manipulate video integrated
with a variety of other types of related information such as text, graphics,
animation and image. Digital Lava's software allows for easy integration of
digital video and audio content with other types of information that are
typically stored on the Internet, a corporate intranet, or locally on the user's
computer or server.
Digital Lava believes that the markets for its software and services will
expand as related technologies, like streaming media and the Internet, continue
to mature. Digital Lava's products and services can provide solutions for
distance learning, training and communications in a variety of industries. For
example, universities and local school districts can use published interactive
video to deliver stored instructional content to students at their desks.
Hospitals can publish and deploy medical video training to allow teams of
doctors in different locations to diagnose and treat patients. Sales
professionals can deliver video-enhanced presentations to prospective customers
and train on new products. Manufacturing companies can achieve efficiencies by
offering factory floor workers just-in-time video training. Other video
applications include sales and reseller training for the introduction of new
products, skills training, new employee orientation training, information
technology and systems training, and both internal and external corporate
communications.
Strategy
Digital Lava's objective is to be the leading provider of software related
to the use of video and other multimedia content over the Internet and
intranets. To achieve this objective, Digital Lava's strategy includes the
following key elements:
Extend Technology Leadership. Having received three different product
awards in 1998, Digital Lava intends to continue to maintain its reputation for
quality and innovation by expanding the features and breadth of its publishing
and desktop video software. Digital Lava believes that its software can be
expanded to support additional features and functions, including the
synchronized deployment of additional types of data and enhanced manipulation of
digital video. As part of this strategy, Digital Lava has devoted and will
continue to commit significant resources to the further development of its
technology.
Build Brand Recognition and Strengthen Sales and Marketing Efforts. Digital
Lava believes that its technology leadership, market position and brand name are
significant assets that can be used to maintain and increase market share and
diversify revenue base. Digital Lava intends to capitalize on the growth in
demand for its software by continuing to develop, market and support
industry-leading products and services. Digital Lava believes that the
introduction of new products and services will expand its user base and build
greater brand recognition. Digital Lava also plans to strengthen its marketing,
sales and customer support efforts as the size of its market opportunity and
customer base increases. Digital Lava will continue to target large corporations
and major universities and educational institutions as customers.
Pursue Strategic Relationships. Digital Lava has independent software
vendor, licensing, development, distribution and reseller relationships with a
number of software industry leaders. Digital
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Lava intends to continue to establish strategic relationships with
industry-leading hardware, software and content companies.
Enhance and Expand Internal Operations. Digital Lava intends to invest
substantially in operations and systems in anticipation of future growth. This
effort includes:
o improving its management information systems ;
o opening sales offices in multiple locations;
o integrating sales activities;
o investing in customer service;
o expanding its public relations, advertising, and trade show activities; and
o developing on-line training and support programs which will help support an
outside network of resellers and distributors.
Expand Internationally. Digital Lava intends to expand its international
customer base over the next several years by opening international sales
offices, hiring additional employees, developing international distribution and
sales networks, enhancing its software products by adding localized versions and
multi-language support and increasing its expenditures for marketing.
Products and Services
Digital Lava's software products, VideoVisor and vPrism, can link and
integrate video, other desktop applications and data on a personal computer.
Digital Lava also provides various other services designed to promote widespread
usage of its technology. Digital Lava spent $421,087 and $445,162 on research
and development activities in 1996 and 1997, respectively.
vPrism. vPrism is easy-to-use software that assists in compiling digital
video and other information from diverse sources, organizes its content, creates
links to other important data, and then rapidly publishes the information in a
VideoCapsule file. VideoCapsules may be distributed on compact discs and digital
video discs and streamed over intranets and the Internet using technology
provided by RealNetworks, Silicon Graphics, InfoValue Computing, Starlight
Networks, FVC.COM, and Microsoft. Digital Lava provides these tools for
commercial video producers, electronic title companies, training companies,
video content distributors, universities and large corporations. vPrism also
provides a unique and powerful solution for researchers who use video to collect
data. Primary researchers and market researchers, for example, use vPrism for
video archiving, video event logging, analysis and coding.
vPrism provides a video publisher with several key benefits. First, the
system is easy-to-use and does not require proficiency in the use of a
programming, scripting or authoring language. Second, vPrism allows a publisher
to create powerful interactive video programs very rapidly. Depending on the
length of video, a completely interactive, indexed and linked VideoCapsule
program can be produced in a few hours. This is significantly faster than
traditional computer-based editing tools. Third, as a result of the rapid
publishing time, video-based content can be produced at a much lower cost than
with traditional computer-based editing tools.
Prior to December 1998, vPrism was commercially available only on the Apple
Macintosh OS operating system. On December 28, 1998, Digital Lava announced the
availability of a Microsoft Windows95 version of vPrism. vPrism is designed to
manage hundreds of hours of digital video content and is available as a
standalone system or in a workgroup configuration.
VideoVisor. VideoVisor is a personal computer application that is designed
to make users more productive when accessing video. VideoVisor, when used in
conjunction with VideoCapsules, allows users to manage and manipulate video
data, much like word processors manipulate textual data, and
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integrate video with other information on their desktop computers. Users may
search and annotate video, re-arrange and organize video content, subtitle text
and transcripts, access notes, and link to other files, Web sites, images and
applications. VideoVisor is easy-to-use and aimed at users who require instant
access to video and related information and the ability to manipulate and save
that information on their desktop computer.
VideoVisor provides users with several key benefits. First, the software
results in increased user productivity, saving time and enhancing the quality of
the end-user's experience. Second, VideoVisor provides corporations and large
organizations with powerful, low-cost and effective software for deploying video
communications, training, distance learning and other video applications. Third,
VideoVisor is a powerful external communications tool that can be used for
training, advertising, marketing, education and other 'extranet' applications.
VideoVisor is available for the Windows95 and Windows-NT platforms.
VideoVisor supports standard digital video formats and VideoCapsule files
published in a variety of formats, including MPEG-1, MPEG- 2, MPEG-4, QuickTime,
RealVideo, ASF (Netshow), AVI and MOV. VideoVisor conforms to Microsoft Office,
Active-X and DirectShow standards. Digital Lava introduced a new version of the
product, VideoVisor Professional, in November 1998. VideoVisor Professional
replaces the previous version of VideoVisor and contains several new features.
It is being sold at the same price, terms and conditions as the earlier version.
Beginning in December 1998, Digital Lava began shipping VideoVisor Professional
to all customers that ordered VideoVisor software. Digital Lava has recorded
sales of approximately $40,000 for VideoVisor Professional through January 22,
1999.
Consulting, Programming and Other Services. Digital Lava provides a range
of consulting and programming services that principally relate to the creation
and maintenance of video content and applications based on Digital Lava's
technology. Digital Lava provides other general services to support its
customers in the use of its software products.
Customer Service and Support
Digital Lava currently provides free customer support, including defect
correction, telephone and Web-based technical support, for companies and
organizations that license its VideoVisor software. Digital Lava does intend to
charge customers for significant version upgrades of its VideoVisor software.
Customers that license vPrism currently receive 12 months of free post sales
support. After one year, customers may elect to sign an extended maintenance
contract.
Digital Lava maintains a technical support hotline to answer inquiries and
provides technical information on the Web site. Digital Lava's support staff
also responds to e-mail inquiries. Digital Lava tracks support requests and
product defects. Digital Lava uses customer feedback as a source of ideas for
product improvements and enhancements.
Strategic Relationships
Digital Lava has independent software vendor, licensing, development,
distribution, and reseller relationships with a number of software industry
leaders. Digital Lava is a NetShow independent software vendor. NetShow is
Microsoft's proprietary software to view streaming media over the Internet and
intranets. As a NetShow independent software vendor, Digital Lava has the
opportunity to work with Microsoft to:
o raise Digital Lava's visibility through Microsoft press releases and
designation as a NetShow independent software vendor on Microsoft's NetShow
Web site;
o provide Digital Lava with technical assistance with regard to NetShow;
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o assist Digital Lava in its marketing efforts, including invitations to
NetShow demonstrations at conferences and tradeshow exhibits; and
o gain access to mailing lists of Microsoft registered product users.
Digital Lava was selected to participate in the NetShow JumpStart CD
demonstration disc. Digital Lava also licenses Microsoft's Internet Explorer
Administration Kit under a royalty-free license and distribution agreement. This
agreement permits Digital Lava to customize Microsoft's Internet Explorer Web
browser for integration with VideoVisor and distribute the integrated products
to Digital Lava's end-users. The integrated products allow end-users to view
"streamed" video content that is linked with other Web browser content on an
intranet or the Internet.
Digital Lava has entered into a consulting and development agreement with
RealNetworks, Inc., under which RealNetworks has developed custom software to
allow Digital Lava to integrate RealNetworks' RealPlayer software, used for
viewing streaming media over the Internet and intranets, with VideoVisor. Under
a licensing and distribution agreement with RealNetworks, Digital Lava is a
RealMedia Architecture Partner and licenses RealNetworks' RealPlayer client
software for integration with VideoVisor, distributes the integrated products to
end-user clients, and is authorized to resell RealNetworks' server software
products. Under this agreement, Digital Lava also has the opportunity to work
with RealNetworks to:
o raise the visibility of Digital Lava through press releases, promotional
mailings and through RealNetworks' Web site; and
o assist Digital Lava in its marketing efforts by including Digital Lava in
RealNetworks user conferences and potentially at tradeshows and conference
events.
Digital Lava has a worldwide distribution agreement with FVC.COM, which was
formally First Virtual Corporation, a leading manufacturer of high quality
corporate and distance learning video solutions. Under this agreement, FVC.COM
integrates VideoVisor with its video networking and access applications to
create Virtual Classroom(TM), which allows students to access course content and
complementary resources 24 hours a day. FVC.COM distributes its video networking
products through partners such as Ascend Communications, Inc., American Nortel
Communications, Inc., IBM Corporation, Ingram Micro, Inc. and Bay Networks, Inc.
Digital Lava also offers video hosting services to corporate and other
customers under a Web hosting service agreement with VStream, Inc. Under this
agreement, Digital Lava edits and publishes video content in its proprietary or
custom format, and, through VStream, "hosts" the customers' published video
content so that it is available for streaming across the Internet using either
RealNetworks or Microsoft NetShow video servers.
Under an agreement with MicroVideo Learning Systems, Inc., Digital Lava
converts MicroVideo's software video training courseware to Digital Lava's
proprietary format and resells the published content to Digital Lava's
customers. In addition, Digital Lava allows WingsNet, Inc. to publish its video
course content into Digital Lava's proprietary format for resale to end-users.
Sales, Marketing and Distribution
Sales. Digital Lava has focused and will continue to focus its sales and
marketing efforts on the corporate training, communications and distance
learning markets for the next several years. Once Digital Lava has firmly
established itself in these markets, Digital Lava plans to expand into other
business and consumer markets. Digital Lava markets its products and services
through a direct sales force and through resellers. Digital Lava's direct sales
force markets Digital Lava's products and services primarily to corporate
customers worldwide. Digital Lava is in the process of significantly expanding
its direct sales force in North America and plans to increase the number of
direct sales representatives from one to seven by the end of the first quarter
of 1999.
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Marketing. Digital Lava participates in trade shows, conferences and
seminars, provides product information through Digital Lava's Web site, and
promotes Digital Lava and its products to industry analysts and the media.
Digital Lava's marketing programs are aimed at informing potential partners and
prospects about the capabilities and benefits of Digital Lava's products and
services, increasing brand name awareness, and stimulating demand across all
market segments. Digital Lava has an agreement with Schwartz Communications,
Inc., a leading high-tech public relations agency, to provide ongoing public
relations and promotional services to gain access to major media and markets.
Digital Lava currently has two employees in marketing and plans to increase its
marketing staff to four employees following the offering.
Distribution. Digital Lava has entered into various reseller relationships
with systems integrators, video software resellers and training companies,
including :
o Roscor Corporation;
o AE Business Solutions;
o Producers Studio;
o IRM Training Pty. Ltd.;
o VCS Technologies, Inc.;
o WingsNet, Inc.;
o StorNet, Inc.; and
o DocuVideo Productions.
These companies resell Digital Lava's products and services to end-users and
video publishers in the United States, Australia and New Zealand. Digital Lava
also currently distributes its products domestically and internationally through
its direct sales force based in the United States. Digital Lava may establish
international subsidiaries that market and sell Digital Lava's products and
services outside the United States in the future.
Competition
The market for software and services for the Internet and intranets is
relatively new, constantly evolving and intensely competitive. Digital Lava
expects that competition will intensify in the future. Digital Lava's principal
competitors include:
o Eloquent, Inc.;
o Veon, Inc.;
o Vsoft, Inc.;
o VStream, Inc.;
o LiveNote, Inc.;
o Adobe Systems, Inc.; and
o Visionary Information Systems, Inc.
Digital Lava also competes or may compete with computer-based training software
companies including Macromedia, Inc., Asymetrix Corporation, and Allen
Communications, Inc. Digital Lava also competes or may compete with more general
purpose audio and video streaming software companies including:
o Microsoft;
o RealNetworks;
o VDOnet Corporation;
o Xing Technology Corporation;
o Cubic VideoComm, Inc.;
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o Motorola, Inc.;
o Vosaic LLC; and
o Oracle Corporation.
Digital Lava's vPrism and VideoVisor software also competes indirectly with
delivery systems for multimedia content other than audio and video, such as
Flash by Macromedia and Enliven by Narrative Communications Corp. Many of
Digital Lava's competitors have longer operating histories, greater name
recognition and significantly greater financial, technical and marketing
resources than Digital Lava. As a result, these competitors may be able to
develop products comparable or superior to Digital Lava's or adapt more quickly
to new technologies or evolving customer requirements.
Competitive factors in this market include:
o the quality and reliability of software;
o features for creating, editing and publishing video;
o ease of use and interactive user features;
o cost per user; and
o compatibility with the user's existing network components and software
systems.
To expand its user base and further enhance the user experience, Digital Lava
must continue to innovate and improve the performance of its software. Digital
Lava is committed to the continued market penetration of its brand, products and
services. Digital Lava may, as a strategic response to changes in the
competitive environment, implement pricing, licensing, service or marketing
changes designed to extend its current brand and technology franchise. For
example, Digital Lava may elect to reduce the price for select versions of its
software or even make select versions available for download free of charge.
Continued price concessions or the emergence of other pricing or distribution
strategies by competitors may have a material adverse effect on Digital Lava's
business, financial condition and results of operations.
Intellectual Property
Digital Lava's success depends in part on its ability to protect its
proprietary software and other intellectual property. To protect its proprietary
rights, Digital Lava relies generally on patent, copyright, trademark and trade
secret laws, confidentiality agreements with employees and third parties, and
license agreements with consultants, vendors and customers, although Digital
Lava has not signed an agreement in every case. Despite these protections, a
third party could copy or otherwise obtain and use Digital Lava's products or
technology, or develop similar technology independently.
Digital Lava currently has one patent pending in the U.S. relating to its
product architecture and technology. The pending patent application may not be
granted, or, if granted, may not provide any competitive advantage to Digital
Lava. Many of Digital Lava's current and potential competitors dedicate
substantially greater resources to protection and enforcement of intellectual
property rights, especially patents. If a patent has issued or issues in the
future which covers Digital Lava's products, Digital Lava would need to either
obtain a license or design around the patent. Digital Lava may not be able to
obtain a license on acceptable terms, if at all, nor design around the patent.
Digital Lava attempts to avoid infringing known proprietary rights of third
parties in its product development efforts. However, Digital Lava has not
conducted and does not conduct comprehensive patent or trademark searches to
determine whether it infringes patents or other proprietary rights held by third
parties. In addition, it is difficult to proceed with certainty in a rapidly
evolving technological environment in which there may be numerous patent
applications pending, many of which are confidential when filed, with regard to
similar technologies.
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If Digital Lava discovered that its products violated third-party
proprietary rights, there can be no assurance that it would be able to obtain
licenses to continue offering its products without substantial reengineering or
that reengineering would be successful, that a license would be available on
commercially reasonable terms, if at all, or that litigation could be avoided or
settled without substantial expense and damage awards. Any claims against
Digital Lava relating to the infringement of third-party proprietary rights,
even if not meritorious, could result in the expenditure of significant
financial and managerial resources and in injunctions preventing Digital Lava
from distributing certain products.
To license many of its products, Digital Lava relies in part on
"shrinkwrap" and "clickwrap" licenses that are not signed by the end user and,
therefore, may be unenforceable under the laws of certain jurisdictions. As with
other software products, Digital Lava's products are susceptible to unauthorized
copying and uses that may go undetected, and policing unauthorized use is
difficult. In general, Digital Lava's efforts to protect its intellectual
property rights may not be effective to prevent misappropriation of its
technology, or to prevent the development and design by others of products or
technologies similar to or competitive with those developed by Digital Lava.
Digital Lava's failure or inability to protect its proprietary rights could
materially adversely affect Digital Lava's business, financial condition and
results of operations.
Digital Lava also relies on certain technology that it licenses from third
parties, including software that is integrated with internally developed
software and used in Digital Lava's products, to perform key functions. In the
future, third-party technology licenses may not be available to Digital Lava on
commercially reasonable terms. The loss of any of these technologies could have
a material adverse effect on Digital Lava's business, financial condition and
results of operations.
Employees
Digital Lava currently has 14 full-time employees and two part-time
employees, including four in product development, three in customer service,
four in sales and marketing and five in finance and administration. Both of the
part-time employees will become consultants to Digital Lava following the
completion of this offering. All employees except Roger Berman are based at
Digital Lava's executive offices in Los Angeles, California.
Digital Lava has entered into employment agreements with Joshua Sharfman,
Chief Executive Officer, and Thomas Stigler, Vice President, Sales and Business
Strategy, which commence on the closing date of this offering and expire two
years later. Mr. Sharfman will become President of Digital Lava upon completion
of this offering. Messers. Sharfman and Stigler will each receive an annual base
salary of $230,000, 40,000 stock options exercisable at the initial public
offering price per share and a one-time cash bonus of $60,000. Digital Lava
intends to hire additional employees in product development, sales and
marketing. None of Digital Lava's employees is subject to a collective
bargaining agreement, and Digital Lava believes that its relations with its
employees are good.
Facilities
Digital Lava's executive offices are located in west Los Angeles,
California in an office building in which Digital Lava leases an aggregate of
3,585 square feet at a current monthly rental of $6,811.50. The lease agreement
is non-cancelable and terminates on June 2, 2000. Digital Lava has an option to
extend the lease agreement for one additional 3 year term. During the next 12
months, Digital Lava plans to acquire additional space at its current location.
If additional space is not available, however, Digital Lava will sublease its
current space and lease new space at a new location. Digital Lava anticipates
that it will require additional space within the next 12 months, and that
suitable additional space will be available on commercially reasonable terms,
although there can be no assurance in this regard. Digital Lava does not own any
real estate.
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Legal Proceedings
Digital Lava is not currently subject to any material legal proceedings.
Digital Lava may from time to time become a party to various legal proceedings
arising in the ordinary course of its business.
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MANAGEMENT
Directors and Officers
Set forth below are the directors and officers of Digital Lava:
Name Age Position
- ---- --- --------
Dr. James W. Stigler 44 Chairman of the Board
Joshua D.J. Sharfman 41 Chief Executive Officer and Director
Thomas H. Stigler 42 Vice President, Sales and Business
Strategy and Director
Roger Berman 44 Director
Gerald Porter 54 Director
Danny Gampe 44 Chief Financial Officer
Patricia Bodner 36 Vice President of Worldwide Marketing
Michael Goodell 42 Vice President of Consulting and Services
Dr. James W. Stigler has served as Chairman of the Board for Digital Lava
since its inception in July 1995. He is currently a part-time employee of
Digital Lava. Dr. Stigler is a professor, author and researcher in the fields of
education, psychology and video research. Since 1991, Dr. Stigler has served as
a Professor at the University of California, Los Angeles. From 1983 to 1991, Dr.
Stigler served as an Associate Professor at the University of Chicago. Dr.
Stigler holds an A.B. degree from Brown University, a Masters degree from the
University of Pennsylvania and a Ph.D. from the University of Michigan. Dr.
Stigler is the brother of Thomas Stigler.
Joshua D.J. Sharfman has served as Chief Executive Officer and a director
of Digital Lava since May 1996. Upon completion of this offering, Mr. Sharfman
will become President of Digital Lava. From 1994 to 1996, Mr. Sharfman served as
Vice President of Research and Development at ParcPlace-Digitalk, Inc., a
cross-platform object-oriented software firm. From 1993 to 1994, he operated his
own software development consulting firm. From 1984 to 1993, Mr. Sharfman served
as Executive Vice President of Research and Development at Dassault Systemes
USA, a wholly owned subsidiary of Dassault Systemes SARL, and in a variety of
marketing and development management functions at CADAM Inc., both of which are
CAD/CAM software vendors. From 1981 to 1984, Mr. Sharfman served as Section Head
of the Electro-Optical and Data Systems Group at Hughes Aircraft Company. Since
1980, Mr. Sharfman has also served as an Adjunct Professor of Engineering at the
University of Southern California. Mr. Sharfman holds a B.S. degree from the
University of California, Los Angeles and a M.S. degree from the University of
Southern California.
Thomas H. Stigler has served as Vice President, Sales and Business Strategy
and a director of Digital Lava since November 1995. From January to November
1995, Mr. Stigler served as an Account Executive at Sybase, Inc, a database
software company. From January 1993 to January 1995, Mr. Stigler served as
District Manager of the Gulf Coast Region for Hitachi Data Systems Corp. From
December 1980 to January 1993, Mr. Stigler held several sales and management
positions at IBM Corporation including Account Executive and Marketing Manager.
Mr. Stigler holds a B.S. degree in Radio, TV and Film from Northwestern
University. Mr. Stigler is the brother of Dr. James Stigler.
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Roger Berman has served as a director of Digital Lava since its inception
in July 1995. He is currently a part-time employee of Digital Lava. From July
1995 to December 1997, Mr. Berman was the President of Digital Lava. Prior to
joining Digital Lava, Mr. Berman served as President of St. Eve International,
Inc., an apparel company, from May 1992 to July 1995 and Sherne Lingerie, Inc.
from January 1986 to December 1991. Mr. Berman holds a B.A degree from Hamilton
College and an MBA from New York University.
Gerald Porter has served as a director of Digital Lava since January 1996.
Mr. Porter has been a consultant in the software services industry since 1995.
From 1989 to 1995, Mr. Porter served as President of Systems and Computer
Technology Corp., a software development company. Prior to 1989, Mr. Porter held
several senior positions in the banking industry, including Senior Vice
President at Bank of America and Chief Operating Officer at American Security
Bank. Mr. Porter holds a B.A. degree from Edinboro University in Pennsylvania.
Danny Gampe has served as Chief Financial Officer of Digital Lava since
January 1998. From 1997 to January 1998, Mr. Gampe served as Vice President of
Finance and Administration for eShare Technologies, an Internet software
development firm. From 1992 to 1997, Mr. Gampe served as Chief Financial Officer
of Robbins Research International, a seminar development company. From 1991 to
1992, Mr. Gampe served as Manager of Financial Planning & Analysis at Wahlco
Environmental Systems, Inc. Mr. Gampe holds a B.A. degree from the University of
California at Long Beach and an MBA from the University of Redlands. In
addition, Mr. Gampe has been a Certified Management Accountant since 1993.
Patricia Bodner has served as Vice President of Worldwide Marketing for
Digital Lava since May 1997. From September 1995 to December 1996, Ms. Bodner
served as Senior Vice President of Marketing for Inscape, a joint-venture
between Warner Music Group, HBO and Nash New Media. From November 1994 to August
1995, Ms. Bodner served as Vice President of Marketing for BMG Video, a division
of BMG Entertainment of North America. From November 1991 to November 1994, Ms.
Bodner served as Vice President of Marketing at New Line Home Video, a division
of Time Warner Inc. From September 1986 to November 1991, Ms. Bodner served as
National Sales Promotion Manager at Warner Home Video, a division of Time Warner
Inc. Ms. Bodner holds a B.A. degree from the University of Wisconsin-Madison.
Michael Goodell has served as Vice President of Consulting and Services for
Digital Lava since October 1997. From June 1979 to September 1997, Mr. Goodell
held several positions at IBM Corporation, including Principal of Consulting,
Manager of Industry Marketing, Marketing Manager and Senior Sales
Representative. Mr. Goodell holds a B.S. and a M.S. degree from Rice University.
Directors' Compensation
Digital Lava's directors who are not full-time employees of Digital Lava
receive $1,000 for attendance at each meeting of the board of directors or any
committee of the board and will be reimbursed for their out-of-pocket expenses
in connection with their attendance. No directors' fees have been paid to date.
Committees of the Board
Upon completion of this offering, the board of directors will have two
standing committees: the Audit Committee and the Compensation Committee. The
Audit Committee will review with Digital Lava's independent public accountants
the scope and adequacy of the audit to be performed by the independent public
accountants, the accounting practices, procedures and policies of Digital Lava,
and all related party transactions. The Compensation Committee will recommend to
the board the compensation to be paid to
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<PAGE>
officers and directors, administer Digital Lava's stock option plan and approve
the grant of options under the stock option plan. Digital Lava currently has
only one disinterested director on its board of directors. At least two
disinterested directors will be added to the board of directors following the
completion of this offering and both committees will be comprised of at least
two disinterested directors.
Executive Compensation
Summary Compensation. The following table sets forth the total compensation
paid during 1998 to Digital Lava's Chief Executive Officer and the other
executive officers whose 1998 compensation exceeded $100,000.
<TABLE>
<CAPTION>
Annual Compensation Long Term Compensation Awards
------------------------ -----------------------------
Securities
Name and Underlying All Other
Principal Position Salary($) Bonus ($) Options (#) Compensation
- ------------------ --------- --------- ----------- ------------
<S> <C> <C> <C> <C>
Joshua Sharfman
Chief Executive Officer........................ $190,000 -- -- --
Thomas Stigler
Vice President, Sales/Business Strategy........ 177,501 -- -- --
Patricia Bodner
Vice President, Worldwide Marketing............ 132,917 -- -- --
Michael Goodell
Vice President, Consulting/Services............ 105,417 -- -- --
</TABLE>
Option Grants. No options were granted in 1998 to any of the officers named
in the above table.
Option Exercises and Option Values. The table sets forth certain
information with respect to stock options held by the above-named officers on
December 31, 1998. These officers did not exercise any options in 1998. The
value of the options was based on the assumed initial offering price per share
and the exercise price of the options at December 31, 1998. Upon completion of
the offering, all of these options will vest and the exercise price will be
reduced to the initial public offering price per share. Under their employment
agreements, Mr. Sharfman and Mr. Stigler will each receive options to purchase
40,000 shares of common stock at the initial public offering price per share
following the completion of this offering.
<TABLE>
<CAPTION>
Number of Shares
of Stock Underlying Value of Unexercised In-
Unexercised Options the-Money Options
at December 31, 1998 at December 31, 1998 ($)
------------------------------ ----------------------------
Name Exercisable Unexercisable Exercisable Unexercisable
- ---- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Joshua Sharfman ........... -- -- -- --
Thomas Stigler ............ -- -- -- --
Patricia Bodner ........... 3,830 3,830 -- --
Michael Goodell ........... 8,207 8,207 -- --
</TABLE>
Employment and Consulting Agreements
Digital Lava has entered into employment agreements with Joshua Sharfman,
Chief Executive Officer, and President, upon completion of this offering, and
Thomas Stigler, Vice President of Sales and Business Strategy, which will
commence on the closing date of the offering and expire on the second
anniversary of the closing date. Under the terms of their employment agreements,
Mr. Sharfman and Mr. Stigler will each receive an annual base salary of
$230,000, 40,000 stock options exercisable at the initial public offering price
per share, and a one-time cash bonus of $60,000. Mr. Sharfman and Mr. Stigler
will be
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<PAGE>
eligible to receive additional stock options, bonuses and a higher salary at the
discretion of the board of directors.
In addition, the agreements provide that if either Mr. Sharfman or Mr.
Stigler is terminated without cause or required to perform a material portion of
his services at a location more than 25 miles from Digital Lava's current
location in Los Angeles, California, they will receive a severance payment equal
to their annual salary. Mr. Sharfman will receive a severance payment equal to
eight months' pay, or pay through the end of the term if less than eight months,
if he elects to resign after the appointment of an executive officer senior in
position or responsibility to him or designation of another person as the
President or Chief Executive Officer of Digital Lava. Mr. Stigler will receive
an identical severance payment if he elects to resign after the appointment of
an executive officer in charge of sales and marketing or designation of another
person as Vice President of Sales and Business Strategy of Digital Lava. A state
court may determine not to enforce, or only partially enforce, certain
provisions of these agreements.
Digital Lava has entered into a consulting agreement with Roger Berman,
currently a part-time employee and director. The agreement has a term of two
years and begins on the closing date of this offering. Mr. Berman will receive
$60,000 upon the closing of this offering and an annual fee of $60,000. At the
closing of this offering, he will cease to be an employee of Digital Lava.
Digital Lava has entered into a consulting agreement with James Stigler,
currently a part-time employee and Chairman of the Board. The agreement has a
term of two years and begins on the closing date of this offering. Dr. Stigler
will receive $40,000 upon the closing of this offering and an annual fee of
$24,000. At the closing of this offering, he will cease to be an employee of
Digital Lava.
Indemnification of Directors and Officers and Related Matters
The certificate of incorporation of Digital Lava provides that, to the
fullest extent permitted by applicable law, Digital Lava will indemnify any
person who was or is a party or is threatened to be made a party to an action,
suit or proceeding, whether civil, criminal, administrative or investigative, by
reason of the fact that the person is or was director, officer, employee or
agent of Digital Lava or serves or served any other enterprise at the request of
Digital Lava.
In addition, the certificate of incorporation provides that a director of
Digital Lava shall not be personally liable to Digital Lava or its stockholders
for monetary damages for breach of the director's fiduciary duty. However, the
certificate does not eliminate or limit the liability of a director for any of
the following reasons:
o a breach of the director's duty of loyalty to Digital Lava or its
stockholders;
o acts or omissions not in good faith or that involve intentional misconduct
or knowing violation of law;
o a transaction from which the director derived an improper personal benefit;
or
o for unlawful payments of dividends or unlawful stock redemptions or
repurchases.
Digital Lava will purchase and maintain directors' and officers' insurance
as soon as the board of directors determines practicable, in amounts which they
consider appropriate, insuring the directors against any liability arising out
of the director's status as a director of Digital Lava regardless of whether
Digital Lava has the power to indemnify the director against the liability under
applicable law.
Digital Lava has been advised that it is the position of the Commission
that insofar as provisions of the certificate of incorporation may be invoked to
disclaim liability for damages arising under the Securities Act, these
provisions are against public policy as expressed in the Securities Act and are,
therefore,
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<PAGE>
unenforceable.
1996 Incentive and Non-Qualified Stock Option Plan
The board of directors has adopted Digital Lava's 1996 Incentive and
Non-Qualified Stock Option Plan. The plan provides for the grant of incentive
stock options to employees, including employee directors, and non-qualified
stock options to employees, directors and consultants. A total of 250,000 shares
of common stock have been reserved for issuance under the plan.
Upon the completion of this offering, 139,622 options will be outstanding
under the plan at a weighted average exercise price per share of $7.58, assuming
an initial public offering price of $7.50 per share. All of the outstanding
options will be fully vested and exercisable. The plan is administered by the
board of directors and, following the completion of the offering, the
Compensation Committee of the board. Options granted under the plan will vest as
determined by the Compensation Committee, and may accelerate and become fully
vested in the event of an acquisition of Digital Lava. The exercise of options
granted under the plan will be as determined by the Compensation Committee,
although the exercise price of incentive stock options must be at least equal to
the fair market value of the common stock on the date of grant. The board of
directors may amend or modify the plan at any time. The plan will terminate in
2006 unless terminated earlier by the board of directors.
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<PAGE>
CERTAIN TRANSACTIONS
The law firm of Ehrenreich Eilenberg Krause & Zivian LLP has performed
legal services for Digital Lava in connection with this offering and may perform
legal services for Digital Lava following this offering. In 1996 and 1997,
Digital Lava issued to Eilenberg & Zivian, an affiliate of Ehrenreich Eilenberg
Krause & Zivian LLP, warrants to purchase an aggregate of 23,212 shares of
common stock at an exercise price of $6.46. Eilenberg & Zivian is also the owner
of 9,334 shares of common stock which it received from Digital Lava in exchange
for services in 1995. Under an agreement dated as of December 1, 1997, E&Z
Investments, an affiliate of Ehrenreich Eilenberg Krause & Zivian LLP, has
currently exercisable options to purchase an aggregate of 16,420 shares of
common stock at an exercise price of $.91 per share from Messrs. James Stigler
and Berman. E&Z Investments also has currently exercisable options, assigned to
it by Judson Cooper, to purchase an aggregate of 8,207 shares of common stock
from Messrs. James Stigler, Thomas Stigler, Berman and Sharfman at an exercise
price of $.91 per share.
In January 1998, Digital Lava entered into a financial consulting agreement
with Prism Ventures LLC under which Prism is to receive $300,000, payable on the
earlier of the consummation of this offering or December 31, 1998 for financial
and strategic advisory consulting services. In February 1999, Prism and Digital
Lava agreed to terminate this agreement and that no compensation was due to
Prism. In 1997, Prism received $100,000 from Digital Lava for consulting
services. Judson Cooper is a member of Prism.
Under an agreement dated as of January 31, 1997, Judson Cooper was granted
currently exercisable options to purchase an aggregate of 159,522 shares of
common stock from Messrs. James Stigler, Thomas Stigler, Berman and Sharfman at
an exercise price of $0.91. Of these options, Mr. Cooper assigned options to
purchase 8,207 shares to E&Z Investments.
Digital Lava has entered into a consulting agreement with Roger Berman in
which Mr. Berman has agreed to provide Digital Lava with certain financial,
operational and strategic development services, including financing and credit
strategies, cash management and human resources. The agreement has a term of two
years and begins on the closing date of this offering. Mr. Berman will receive
$60,000 upon the closing of this offering and an annual fee of $60,000. Mr.
Berman is currently a part-time employee and a director of Digital Lava. At the
closing of this offering, he will cease to be an employee of Digital Lava.
Digital Lava has entered into a consulting agreement with James Stigler in
which Dr. Stigler has agreed to provide certain consulting services to Digital
Lava, including development, financial and strategic advisory services. The
agreement has a term of two years and begins on the closing date of this
offering. Dr. Stigler will receive $40,000 upon the closing of this offering and
an annual fee of $24,000. Dr. Stigler is currently a part-time employee and
Chairman of the Board of Digital Lava. At the closing of this offering, he will
cease to be an employee of Digital Lava.
Digital Lava issued a $20,000 promissory note to James Stigler in October
1998. The note bears interest at 12% per annum and is payable in October 1999.
In December 1998, Digital Lava issued a $300,000 promissory note to Henry
Stigler, father of James and Thomas Stigler. The note bears interest at 12% per
annum and will be paid at the closing of this offering. Mr. Stigler also
received warrants to purchase 150,000 shares of common stock at 130% of the
initial public offering per share.
Each of the transactions described above were ratified by Digital Lava's
entire board of directors, a majority of whom did not have an interest in the
transactions. Digital Lava believes that the terms of the transactions described
above were no less favorable to Digital Lava than could have been obtained from
unaffiliated third parties. Digital Lava has adopted a policy, effective
following the consummation of this
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<PAGE>
offering, that all future transactions between it and its officers, directors
and affiliates must (1) be approved by a majority of those members of the board
of directors that are not parties, directly or indirectly through affiliates, to
the transaction and (2) be on terms no less favorable to Digital Lava than could
be obtained from unrelated third parties.
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<PAGE>
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information regarding the beneficial
ownership of the common stock, as of December 31, 1998 by (1) each person known
by Digital Lava to be the beneficial owner of more than 5% of the outstanding
shares of common stock, (2) each director and executive officer of Digital Lava
and (3) all executive officers and directors of Digital Lava as a group.
Beneficial ownership has been determined in accordance with the rules of
the Securities and Exchange Commission and includes voting or investment power
with respect to shares. Unless otherwise indicated, the persons named in the
table have sole voting and investment power with respect to the number of shares
indicated as beneficially owned by them. The number of shares of common stock
outstanding used in calculating the percentage ownership for each listed person
includes the shares of common stock underlying options or warrants held by the
person and exercisable within 60 days of December 31, 1998 but excludes shares
of common stock underlying options or warrants held by any other person.
"Shares of Common Stock Beneficially Owned" includes "Shares Subject to
Options Held by Others" and "Shares Issuable Upon Exercise of Options."
Unless otherwise indicated, the address of each beneficial owner is 10850
Wilshire Boulevard, Suite 1260, Los Angeles, CA 90024.
<TABLE>
<CAPTION>
Percentage of Common Stock
Shares of Beneficially Owned Shares Subject Shares
Common Stock -------------------------- to Options Issuable
Name and Address of Beneficial Beneficially Before After Held by Upon Exercise
Owner Owned Offering Offering Others of Options
- ----- ----- -------- -------- ------ ----------
<S> <C> <C> <C> <C> <C>
Dr. James W. Stigler 299,105 15.0% 6.8% 68,030 --
Thomas H. Stigler 239,403 11.8% 5.4% 39,880 40,000
Roger Berman 199,403 10.0% 4.5% 48,091 --
Judson Cooper 151,315 7.6% 3.4% -- 151,315
181 Harbor Drive, Stamford, CT 06902
Joshua D.J. Sharfman 139,702 6.9% 3.1% 19,941 40,000
Gerald Porter 83,330 4.2% 1.9% -- 3,330
Kenneth Mendoza 99,702 5.0% 2.3% -- --
Michael Goodell 16,414 * * -- 16,414
Patricia Bodner 7,660 * * -- 7,660
Danny Gampe 5,472 * * -- 5,472
All executive officers and directors as
a group (8 persons) 990,489 47.0% 22.0% 75,942 12,876
</TABLE>
* less than 1%
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<PAGE>
SELLING STOCKHOLDERS
The registration statement, of which this prospectus forms a part, also
relates to the registration by Digital Lava, for the account of the selling
stockholders, of an aggregate of 880,436 shares of common stock. The shares are
not being underwritten by the representative in connection with this offering.
The selling stockholders have agreed with Digital Lava and the representative
not to directly or indirectly offer, sell, transfer or otherwise encumber or
dispose of any of their common stock for a period of nine months after the date
of this prospectus, with the exception of two selling stockholders owning an
aggregate of 30,000 shares of common stock who have agreed not to sell an
aggregate of 20,000 of their shares for a period of three months and the
remainder of their shares for a period of six months after the date of this
prospectus.
The sale of the shares by the selling stockholders may be effected from
time to time in transactions, which may include block transactions by or for the
account of the selling stockholders, in the over-the-counter market or in
negotiated transactions, or through the writing of options on the shares, a
combination of these methods of sale, or otherwise. Sales may be made at fixed
prices which may be changed, at market prices prevailing at the time of sale, or
at negotiated prices.
The selling stockholders may effect these transactions by selling their
shares directly to purchasers, through broker-dealers acting as agents for the
selling stockholders, or to broker-dealers who may purchase shares as principals
and thereafter sell the shares from time to time in the over-the-counter market,
in negotiated transactions, or otherwise. Broker-dealers, if any, may receive
compensation in the form of discounts, concessions or commissions from the
selling stockholders and/or the purchaser for whom the broker-dealers may act as
agents or to whom they may sell as principals or both, which compensation as to
a particular broker-dealer may be in excess of customary commissions.
The selling stockholders and broker-dealers, if any, acting in connection
with sales, might be deemed to be "underwriters" within the meaning of Section
2(11) of the Securities Act and any commission received by them and any profit
upon the resale of the securities might be deemed to be underwriting discounts
and commissions under the Securities Act.
Sales of any shares of common stock by the selling stockholders may depress
the price of the common stock in any market that may develop for the common
stock.
The following table sets forth certain information known to Digital Lava
regarding beneficial ownership of Digital Lava's common stock by each of the
selling stockholders as of December 31, 1998 and as adjusted to reflect the sale
of shares offered in this prospectus. With the exception of Shahrokh Sedaghat
who has been a consultant to Digital Lava since October 1998, none of the
selling stockholders has had any position with, held any office of, or had any
other material relationship with Digital Lava.
<TABLE>
<CAPTION>
Shares Beneficially Shares Beneficially
Owned Prior to Number of Shares Owned After
Name of Beneficial Owner (1) Offering Being Offered Offering (2)
- ---------------------------- -------- ------------- ------------
<S> <C> <C> <C>
Richard Stone.......................... 161,250 161,250 0
Navida, Inc............................ 127,500 127,500 0
Dolphin Waves, Inc..................... 60,000 60,000 0
Shahrokh Sedaghat...................... 47,875 (3) 45,000 2,875
Shapour and Parvindokht................ 45,000 45,000 0
Sedaghat
Theodore Friedman...................... 33,750 33,750 0
Eli Jacobsen........................... 30,000 30,000 0
David Stone............................ 30,000 30,000 0
Glen Sutton III........................ 30,000 30,000 0
</TABLE>
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<PAGE>
<TABLE>
<S> <C> <C> <C>
Norman Veitzer........................ 30,000 30,000 0
Harold Wrobel......................... 30,000 30,000 0
Broadway Partners..................... 22,500 22,500 0
Christine Walley...................... 22,500 22,500 0
Sheila Sconiers....................... 19,500 19,500 0
Stephanie Rubin....................... 7,500 (4) 7,500 0
John Hancock Global................... 16,667 16,667 0
Technology Fund
Joseph Habert......................... 15,000 15,000 0
Georgia Schley........................ 15,000 15,000 0
Arthur Steinberg IRA.................. 15,000 15,000 0
R. Steinberg Pension Trust............ 15,000 15,000 0
Grace Terry........................... 15,000 15,000 0
Walter Terry.......................... 15,000 15,000 0
Eric Appell........................... 10,975 (5) 8,100 2,875
Ester Dusi............................ 7,500 7,500 0
John Glorieux......................... 7,500 7,500 0
Jerry Heymann......................... 7,500 7,500 0
Andreas Iseli......................... 7,500 7,500 0
Mitchell Steinberg.................... 7,500 7,500 0
Stephan Williams...................... 7,500 7,500 0
Lawrence Manus........................ 5,000 5,000 0
John Musinsky......................... 3,750 3,750 0
Michael Zylberman..................... 3,750 3,750 0
Frank Loccisano....................... 3,334 3,334 0
Christopher Creamer................... 3,000 3,000 0
Chana Sasha Foundation................ 1,667 1,667 0
R. Merrill Hunter..................... 1,667 1,667 0
Marc Roberts.......................... 1,667 1,667 0
Robert Steinberg...................... 1,500 1,500 0
Keith Alliotts........................ 417 417 0
Ryan Schinman......................... 417 417 0
</TABLE>
- ----------
(1) Digital Lava believes the persons named in the table above, based upon
information furnished by these persons, have sole voting and investment
power with respect to the number of shares beneficially owned by them.
(2) Assumes that all shares of common stock being registered will be sold.
(3) Includes 2,875 shares issuable upon the exercise of currently exercisable
warrants.
(4) The Whitestone Group, an entity controlled by Mrs. Rubin's husband,
previously owned warrants to purchase 10,943 shares of common stock. The
Whitestone Group and the Company agreed to the cancellation of these
warrants in February 1999. Ms. Rubin disclaims any beneficial ownership of
any stock owned by the Whitestone Group.
(5) Includes 2,875 shares issuable upon the exercise of currently exercisable
warrants.
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<PAGE>
DESCRIPTION OF SECURITIES
The authorized capital stock of Digital Lava consists of 35,000,000 shares
of common stock, $.0001 par value and 5,000,000 shares of preferred stock,
$.0001 par value. Upon completion of the offering, there will be 4,396,092
shares of common stock issued and outstanding, no shares of preferred stock
outstanding and 1,200,000 warrants issued and outstanding.
Recapitalization
Prior to the sale of securities in this offering, Digital Lava will amend
its certificate of incorporation to effect a 1 for 9.139 reverse stock split and
complete a recapitalization of its authorized, issued and outstanding capital
stock and debt. Prior to the reverse split and the recapitalization, Digital
Lava will have outstanding: 1,201,960 shares of common stock; 809,565 shares of
Series A preferred stock; 50,740 shares of Series B preferred stock; 8,500
shares of Series B-1 preferred stock; and 30,000 shares of Series C preferred
stock. All of the preferred stock automatically converts to common stock upon an
initial public offering of the common stock. In addition, prior to the
recapitalization, Digital Lava will have outstanding an aggregate principal
amount of $5,319,500 of promissory notes. An aggregate principal amount of
$1,750,000 of promissory notes matured on November 20, 1998. All of the holders
of these notes have agreed to extend the maturity date of their notes until the
earlier of February 19, 1999 or the consummation of this offering.
As of January 1, 1999, we were in default on the repayment of an additional
aggregate principal amount of 3,019,500 of promissory notes. In connection with
the recapitalization:
o holders of an aggregate principal amount of $1,532,000 of these notes
agreed to extend the term of their notes to the earlier of the closing date
of this offering or February 19, 1999 and convert one-half of the
outstanding principal of their notes, the accrued interest on the notes and
the warrants received in connection with the issuance of the notes into an
aggregate of 456,600 shares of common stock; the remaining one-half of the
principal amount of the notes will be paid at the closing of this offering;
o holders of an aggregate principal amount of $187,500 of these notes agreed
to extend the term of their notes to June 30, 1999; however, because the
closing of this offering did not occur by December 31, 1998, the entire
principal amount of their notes became due and payable; the holders have
agreed to waive the default and in consideration Digital Lava has agreed to
pay the entire principal amount of their notes, and accrued interest, at
the closing of this offering;
o holders of an aggregate principal amount of $1,300,000 of these notes
agreed to extend the term of their notes to the earlier of the closing date
of this offering or February 19, 1999 and convert one-half of the
outstanding principal of their notes, the accrued interest on the notes and
the warrants received in connection with the issuance of the notes into an
aggregate of 390,000 shares of common stock; the remaining one-half of the
principal amount of the notes, and a success fee, will be paid at the
closing of this offering;
o 11,030 shares of common stock and an aggregate of 8,824 shares of Series A
preferred stock held by certain officers and directors and an employee of
Digital Lava will be canceled;
o holders of outstanding warrants to acquire 107,689 shares of common stock
agreed to convert their warrants into 30,836 shares of common stock;
o holders of an aggregate of 3,000 shares of Series B-1 preferred stock
agreed to exchange their shares for an aggregate of 3,600 shares of Series
B preferred stock; and
o Digital Lava will amend its certificate of incorporation to increase the
conversion ratios of the Series B and C preferred stock from 10:1 to
20.3099:1 and 19.3702:1, respectively. As a result of the change in
conversion ratios, Digital Lava will record a dividend of $690,469 to the
holders of the Series B and C preferred stock.
All information set forth below gives effect to the certificate of incorporation
to be filed prior to the sale of
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<PAGE>
securities in this offering.
Common Stock
Holders of common stock are entitled to one vote for each share held on all
matters submitted to a vote of stockholders and do not have cumulative voting
rights. Accordingly, holders of a majority of the shares of common stock
entitled to vote in any election of directors may elect all of the directors
standing for election. Holders of common stock are entitled to receive ratably
dividends, if any, as may be declared by the board of directors out of funds
legally available therefor, subject to any preferential dividend rights of any
outstanding preferred stock. Upon the liquidation, dissolution or winding up of
Digital Lava, the holders of common stock are entitled to receive ratably the
net assets of Digital Lava available after the payment of all debts and other
liabilities and subject to the prior rights of any outstanding preferred stock.
Holders of common stock have no preemptive, subscription, redemption or
conversion rights. The outstanding shares of common stock are, and the shares
offered by Digital Lava in this offering will be, when issued and paid for,
fully paid and nonassessable. The rights, preferences and privileges of holders
of common stock are subject to, and may be adversely affected by, the rights of
the holders of shares of any series of preferred stock which Digital Lava may
designate and issue in the future.
Preferred Stock
Upon the closing of this offering, the board of directors will have the
authority, without further action by the stockholders, to issue up to 5,000,000
shares of preferred stock in one or more series and to fix the right,
preferences, privileges and restrictions of the preferred stock, including:
o dividend rights;
o dividend rates;
o conversion rights;
o voting rights, which may be greater or lessor than the voting rights of the
common stock;
o rights and terms of redemption;
o liquidation preferences;
o sinking fund terms; and
o the number of shares constituting any series or the designation of a series
without any further vote or action by the stockholders.
The issuance of shares of preferred stock could adversely affect the voting
power of holders of common stock and the likelihood that these holders will
receive dividend payments and payments upon liquidation and could have the
effect of delaying, deferring or preventing a change in control of Digital Lava.
Digital Lava has no present plans to issue any additional shares of preferred
stock.
Outstanding Warrants
Prior to the sale of securities in this offering, warrants to purchase an
aggregate of 628,109 shares of common stock at a weighted average exercise price
of $8.896 per share will be outstanding. Of these warrants, warrants to purchase
333,109 will be exercisable.
Registration Rights
Holders of warrants to purchase an aggregate of 614,978 of common stock
have certain registration rights with regard to the resale of the shares
issuable upon exercise of their warrants. Additionally, holders of options to
purchase an aggregate of 175,936 shares of common stock from certain of Digital
Lava's founders have certain registration rights with regard to the resale of
the shares underlying their options. Following the completion of this offering,
these holders could require Digital Lava to register for
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<PAGE>
resale the shares issuable upon exercise of the warrants and the shares
underlying the options and the shares would then be freely tradeable, subject to
the lock-up agreements the holders have entered into with Digital Lava and the
representative.
Description of Warrants
Exercise Price and Terms. Each warrant entitles the registered holder to
purchase, at any time commencing 12 months after date of this prospectus until
60 months after the date of this prospectus, one share of common stock at a
price equal to 120% of the initial public offering price of the common stock per
share. Commencing 18 months after the date of this prospectus, the warrants will
be subject to redemption by Digital Lava, in whole but not in part, at $.10 per
warrant on 30 days' prior written notice. The warrants may only be redeemed if
the average closing sale price of the common stock as reported on the American
Stock Exchange equals or exceeds 266% of the initial public offering price per
share of the common stock for any 20 trading days within a period of 30
consecutive trading days ending on the fifth trading day prior to the date of
notice of redemption.
The holder of any warrant may exercise their warrant by surrendering the
certificate representing the warrant to the warrant agent, with the subscription
form properly completed and executed, together with payment of the exercise
price. No fractional shares will be issued upon the exercise of the warrants.
The exercise price of the warrants bears no relationship to any objective
criteria of value and should in no event be regarded as an indication of any
future market price of the securities offered in this offering.
Adjustments. The exercise price of the warrants and the number of shares of
common stock issuable upon the exercise of the warrants are subject to
adjustment in certain events, including stock dividends, stock splits,
combinations or reclassifications of the common stock.
Transfer, Exchange and Exercise. The warrants are in registered form and
may be presented to the warrant agent for transfer, exchange or exercise at any
time on or prior to their expiration date sixty (60) months after the date of
this prospectus, at which time the warrants will become wholly void and of no
value. The warrants may not be exercised until 12 months after the date of this
prospectus. If a market for the warrants develops, the holder may sell the
warrants instead of exercising them. There can be no assurance, however, that a
market for the warrants will develop or, if developed, will continue.
Modification of Warrants. Digital Lava and the warrant agent may make
modifications to the warrants as they deem necessary and desirable that do not
adversely affect the interests of the warrantholders.
Certain Charter and By-Law Provisions
Certain provisions of Digital Lava's certificate of incorporation and
bylaws may have the effect of making it more difficult for a third party to
acquire, or of discouraging a third party from attempting to acquire, control of
Digital Lava. These provisions could limit the price certain investors might be
willing to pay in the future for shares of Digital Lava's common stock. Certain
of these provisions allow Digital Lava to issue preferred stock without
stockholder approval and provide that special meetings of stockholders of
Digital Lava may be called only by the President of Digital Lava, the board of
directors or holders of not less than a majority of the votes entitled to be
cast at the special meeting. These provisions may make it more difficult for
stockholders to take certain corporate actions and could have the effect of
-42-
<PAGE>
delaying or preventing a change in control of Digital Lava.
Transfer Agent And Registrar
The transfer agent and registrar for the common stock and the warrant agent
for the warrants is American Stock Transfer & Trust Company, New York, New York.
-43-
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Prior to this offering, there has been no public market for Digital Lava's
common stock. Future sales of substantial amounts of common stock in the public
market or the availability of shares for sale, could adversely affect the
prevailing market price and the ability of Digital Lava to raise equity capital
in the future.
Upon completion of this offering, Digital Lava will have 4,396,092 shares
of common stock outstanding, assuming no exercise of outstanding options and
warrants or the underwriters' over-allotment option. After the offering,
3,280,436 of the 4,396,092 shares of common stock will be freely tradeable
without restriction under the Securities Act, except for any shares purchased by
an "affiliate" of Digital Lava, as that term is defined under the rules and
regulations of the Securities Act, which will be subject to the resale
limitations of Rule 144 under the Securities Act.
The remaining 1,115,656 shares of common stock were issued by Digital Lava
in private transactions in reliance upon one or more exemptions contained in the
Securities Act, will be deemed "restricted securities" within the meaning of
Rule 144 promulgated under the Securities Act and may be publicly sold only if
registered under the Securities Act or sold under exemptions from the Securities
Act. Because all of these restricted shares will have been held for more than
one year as of the date of this prospectus, all of the shares will be eligible
for public sale beginning 90 days after the effective date of this prospectus in
accordance with the requirements of Rule 144, subject to the lock-up agreements
described below.
In general, under Rule 144(e), as currently in effect, a stockholder, or
stockholders whose shares are aggregated, including an affiliate, who has
beneficially owned for at least one year shares of common stock that are treated
as "restricted securities," would be entitled to sell publicly, within any
three-month period, up to the greater of 1% of the then outstanding shares of
common stock, 43,538 shares immediately after the completion of this offering,
or the average weekly reported trading volume in the common stock during the
four calendar weeks preceding the date on which notice of sale is given,
provided certain requirements are satisfied. In addition, affiliates of Digital
Lava must comply with additional requirements of Rule 144 in order to sell
shares of common stock, including shares acquired by affiliates in this
offering. Under Rule 144, a stockholder deemed not to have been an affiliate of
Digital Lava at any time during the 90 days preceding a sale by him, and who has
beneficially owned for at least two years shares of common stock that are
treated as "restricted securities," would be entitled to sell those shares
without regard to the Rule 144 requirements.
Holders of warrants to purchase an aggregate of 653,277 shares of common
stock have certain registration rights with regard to the resale of the shares
issuable upon exercise of their warrants. Additionally, holders of options to
purchase an aggregate of 175,936 shares of common stock from certain of Digital
Lava's founders have certain registration rights with regard to the resale of
the shares underlying their options. Following the completion of this offering,
these holders could require Digital Lava to register for resale the shares
issuable upon exercise of the warrants and the shares underlying the options and
the shares would then be freely tradeable, subject to the lock-up agreements
described below.
Except as noted below, each of Digital Lava's officers and directors, all
other holders of shares of common stock, and all holders of options and warrants
to acquire shares of common stock have agreed not to, directly or indirectly,
offer, sell, transfer, pledge, assign, hypothecate or otherwise encumber or
dispose of any of Digital Lava's securities, whether or not presently owned, for
a period of 12 months after the date of this prospectus without the prior
written consent of Digital Lava and the representative. The holder of an option
to purchase 151,315 shares of common stock from certain officers and directors
has entered into a similar agreement with Digital Lava and the representative
for a three month period with respect to 400,877 of these shares and for a six
month period with respect to the remainder of these shares. The selling
stockholders, with the exception of two selling stockholders owning an aggregate
of 30,000 shares of common stock who have agreed not to sell an aggregate of
20,000 of their shares for a period of three months and the remainder of their
shares for a period of six months after the date of this prospectus, have
entered into nine month lock-up agreements with Digital Lava and the
representative. The holders of warrants to purchase 275,000 shares of common
stock issued in connection with our December 1998 bridge financing have entered
into six month lock-up agreements.
-44-
<PAGE>
UNDERWRITING
The underwriters named below, for whom Dirks & Company, Inc. is acting as
representative, have severally agreed, subject to the terms and conditions
contained in the underwriting agreement to purchase from Digital Lava, and
Digital Lava has agreed to sell to the underwriters the respective number of
units opposite their names.
Underwriters Number of Units
------------ ---------------
Dirks & Company, Inc.
---------
Total.............................. 1,200,000
=========
Digital Lava has agreed to sell the units to the underwriters on a "firm
commitment" basis. Termination may only be based on events that result in a
material impairment of the agreement to offer the securities for sale.
Digital Lava has been advised by the representative that it initially
proposes to offer the units at the public offering price set forth on the cover
page of this prospectus. The representative may allow certain dealers who are
members of the National Association of Securities Dealers, Inc. concessions not
in excess of $_______ per unit, of which amount a sum not in excess of
$__________ per unit may in turn be reallowed by these dealers to other dealers.
After the initial distribution of the units, the public offering price,
concessions and reallowances may be changed. The representative has informed
Digital Lava that it does not expect sales to discretionary accounts by the
underwriters to exceed five percent of the units offered by Digital Lava.
Digital Lava has granted to the underwriters an option, exercisable within
45 days of the date of this prospectus, to purchase from Digital Lava at the
offering price, less underwriting discounts and the non-accountable expense
allowance, all or part of an additional 180,000 units on the same terms and
conditions of the offering for the sole purpose of covering over-allotments, if
any.
Digital Lava has agreed to indemnify the underwriters against certain
liabilities, including liabilities under the Securities Act. Digital Lava has
agreed to pay to the representative a non-accountable expense allowance equal to
three percent of the gross proceeds derived from the units underwritten, $50,000
of which has been paid to date.
If at any time commencing 180 days after the date of this prospectus, the
closing sale or bid price of the common stock is greater than 150% of the
initial public offering price of the common stock for a period of five (5)
consecutive trading days, the representative will, upon request, release any
securities subject to a lock-up agreement described in "Shares Eligible For
Future Sale." An appropriate legend shall be marked on the face of certificates
representing all the securities. In addition, Digital Lava has agreed not to
sell or offer for sale any of its securities for a period of six (6) months from
the date of this prospectus without the consent of the representative, except in
connection with strategic transactions or mergers and acquisitions for which no
consent is required.
In connection with the offering, Digital Lava has agreed to issue and sell
to the representative and/or its designees, at the closing of the proposed
underwriting, for nominal consideration, five year representative's warrants to
purchase 240,000 shares of common stock and/or 120,000 redeemable common stock
purchase warrants. The representative's warrants are exercisable at any time
during a period of four years commencing at the beginning of the second year
after their issuance and sale at a price of 165% of the initial public offering
price per share of common stock and 165% of the initial public offering price
per redeemable common stock purchase warrant. The shares of common stock,
warrants and shares of common stock underlying the warrants issuable upon
exercise of the representative's warrants are identical to those offered to the
public. The representative's warrants contain anti-dilution provisions providing
for adjustment of the number of securities issuable upon the exercise of the
warrants under certain circumstances. The representative's warrants grant to the
holders and to the holders of the underlying common stock and warrants certain
rights of registration of the common stock and warrants underlying the
representative's warrants.
Digital Lava has also agreed to provide for a finder's fee to the
representative if Digital Lava completes a merger, acquisition, joint venture or
any other capital business transaction in which the representative introduces
Digital
-45-
<PAGE>
Lava to the other party or parties, for a period of five years following the
effective date of the registration statement. The finder's fee is equal to 5% of
the first $3,000,000 of consideration involved in a transaction, 4% of the next
$3,000,000 of consideration, 3% of the next $2,000,000 of consideration, 2% of
the next $2,000,000 of consideration and 1% of the excess, if any, over
$10,000,000 of consideration.
Digital Lava has agreed that for five (5) years from the effective date of
the registration statement, the representative may designate one person for
election to Digital Lava's board of directors. In the event that the
representative elects not to exercise its designation right, then it may
designate one person to attend all meetings of Digital Lava's board of directors
for a period of three years. Digital Lava has agreed to reimburse the
representative's designee for all out-of-pocket expenses incurred in connection
with the designee's attendance at meetings of the board of directors.
In connection with this offering, certain underwriters and selling group
members and their respective affiliates may engage in transactions that
stabilize, maintain or otherwise affect the market prices of the common stock
and warrants. These transactions may include stabilization transactions effected
in accordance with Rule 104 of Regulation M, under which persons may bid for or
purchase the common stock and/or warrants for the purpose of stabilizing their
respective market prices.
The underwriters also may create a short position for the account of the
underwriters by selling more units in connection with the offering than they are
committed to purchase from Digital Lava, and in this case may purchase common
stock and warrants in the open market following completion of the offering to
cover all or a portion of a short position. The underwriters may also cover all
or a portion of a short position by exercising the over-allotment option
referred to above. In addition, the representative may impose "penalty bids"
under contractual arrangements with the underwriters and may reclaim from an
underwriter, or dealer participating in the offering, for the account of other
underwriters, the selling concession with respect to the common stock and
warrants that are distributed in the offering but subsequently purchased for the
account of the underwriters in the open market. Any of the transactions
described in this paragraph and the preceding paragraph may result in the
maintenance of the prices of the common stock and warrants at a level above that
which might otherwise prevail in the open market. None of the transactions
described in either paragraph is required, and, if they are undertaken, they may
be discontinued at any time.
Prior to this offering, there has been no public market for the units.
Accordingly, the initial public offering price of the units and the terms of the
redeemable common stock purchase warrants were determined by negotiation between
Digital Lava and the representative. Among the factors considered in determining
the prices and terms, in addition to the prevailing market conditions, were the
history of and the prospects for the industry in which Digital Lava competes, an
assessment of Digital Lava's management, the prospects of Digital Lava, its
capital structure and other factors that were deemed relevant. The offering
price does not necessarily bear any relationship to the assets, results of
operations or net worth of Digital Lava.
The expenses of the offering, other than underwriting discounts and
commissions, are set forth below:
SEC Registration Fee $ 11,867
American Stock Exchange Listing Fee $ 32,500
NASD Filing Fee $ 4,768
Accounting Fees and Expenses* $250,000
Printing and Engraving* $100,000
Legal Fees and Expenses* $350,000
Blue Sky Fees and Expenses* $ 20,000
Transfer Agent and Registrar Fees* $ 5,000
Miscellaneous Expenses* $ 25,865
--------
Total $800,000
========
- ----------
* Estimated.
Digital Lava will pay all expenses of the offering, including the expenses
of registering the selling stockholders' shares.
Dirks & Company, Inc., the representative of the underwriters, commenced
operations in July 1997. Dirks &
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<PAGE>
Company has co-managed only two public offerings of securities and participated
as an underwriter in only three public offerings of securities. Accordingly, the
representative has limited experience as a co-manager or underwriter of public
offerings of securities. In addition, the representative is a relatively small
firm and no assurance can be given that the representative will be able to
participate as a market maker in the common stock or warrants. No assurance can
be given that any broker-dealer will be a market maker in either of the common
stock or the warrants.
LEGAL MATTERS
The validity of the securities being offered by this prospectus will be
passed upon for Digital Lava by Ehrenreich Eilenberg Krause & Zivian LLP , New
York, New York. This firm beneficially owns of 57,273 shares of common stock.
Orrick, Herrington & Sutcliffe LLP, New York, New York, has acted as counsel to
the underwriters in connection with this offering.
EXPERTS
The financial statements of Digital Lava Inc. as of December 31, 1997 and
for the years ended December 31, 1997 and 1996 included in this prospectus have
been so included in reliance on the report, which contains an explanatory
paragraph relating to Digital Lava's ability to continue as a going concern as
described in note 2 to the financial statements, of PricewaterhouseCoopers LLP,
independent accountants, given on the authority of this firm as experts in
auditing and accounting.
ADDITIONAL INFORMATION
Digital Lava has filed with the Securities and Exchange Commission a
registration statement on Form SB-2 under the Securities Act with respect to the
securities offered in this offering. This prospectus, which forms a part of the
registration statement, does not contain all the information set forth in the
registration statement, as permitted by the rules and regulations of the
Commission. For further information with respect to Digital Lava and the
securities offered in this offering, reference is made to the registration
statement. Statements contained in this prospectus as to the contents of any
contract or other document that has been filed as an exhibit to the registration
statement are qualified in their entirety by reference to the exhibits for a
complete statement of their terms and conditions. The registration statement and
other information may be read and copied at the Commission's Public Reference
Room at 450 Fifth Street N.W., Washington, D.C. 20549. The public may obtain
information on the operation of the Public Reference Room by calling the
Commission at 1-800-SEC-0330. The Commission maintains a Web site at
http://www.sec.gov that contains reports, proxy and information statements, and
other information regarding issuers that file electronically with the
Commission. Digital Lava's Web site can be accessed at www.digitallava.com.
Upon effectiveness of the registration statement, Digital Lava will be
subject to the reporting and other requirements of the Exchange Act and intends
to furnish its shareholders annual reports containing financial statements
audited by its independent auditors and to make available quarterly reports
containing unaudited financial statements for each of the first three quarters
of each year.
-47-
<PAGE>
DIGITAL LAVA INC.
Index to Financial Statements
Page
----
Report of Independent Accountants...................................... F-2
Balance Sheet.......................................................... F-3
Statement of Operations................................................ F-4
Statement of Stockholders' Deficit..................................... F-5
Statement of Cash Flows................................................ F-6
Notes to Financial Statements.......................................... F-7
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Stockholders of Digital Lava Inc.
The reverse stock split described in Note 12 to the financial statements has not
been consummated at February 5, 1999. When it has been consummated, we will be
in a position to furnish the following report:
"In our opinion, the accompanying balance sheet and related statements of
operations, of stockholders' deficit and of cash flows present fairly, in
all material respects, the financial position of Digital Lava Inc. at
December 31, 1997, and the results of its operations and its cash flows for
the years ended December 31, 1996 and 1997 in conformity with generally
accepted accounting principles. 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 of these statements in accordance with generally
accepted auditing standards which require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant
estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable
basis for the opinion expressed above.
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 suffered recurring losses and
negative cash flows from operations, has deficits in working capital and
stockholders' equity, and expects to incur future losses. These factors
raise substantial doubt about the Company's ability to continue as a going
concern. Management's plans in regard to these matters are also described
in Note 2. The accompanying financial statements do not include any
adjustments that might result from the outcome of this uncertainty."
PricewaterhouseCoopers LLP
New York, New York
July 31, 1998 except
as to Note 12 which is as of
January 12, 1999
F-2
<PAGE>
DIGITAL LAVA INC.
Balance Sheet
<TABLE>
<CAPTION>
Pro Forma
September 30,
December 31, September 30, 1998
1997 1998 (Note 13)
------------ ------------ ------------
(Unaudited)
<S> <C> <C> <C>
Assets
Current Assets:
Cash and cash equivalents .................................. $ 173,262 $ 11,786 $ 11,786
Accounts receivable ........................................ 167,112 183,952 183,952
Other current assets ....................................... 89,202 26,472 26,472
Deferred offering costs .................................... -- 289,112 289,112
------------ ------------ ------------
Total current assets ................................... 429,576 511,322 511,322
Fixed assets, net .......................................... 94,137 75,075 75,075
Other assets ............................................... 1,965 16,969 16,969
------------ ------------ ------------
$ 525,678 $ 603,366 $ 603,366
============ ============ ============
Liabilities and Stockholders' Deficit
Current liabilities:
Accounts payable ........................................... $ 391,245 $ 424,496 $ 424,496
Accrued interest ........................................... 239,439 874,176 468,472
Accrued expenses ........................................... 60,151 511,328 511,328
Notes payable, net of debt discount ........................ 3,452,088 4,632,749 3,269,095
Deferred revenue ........................................... -- 186,254 186,254
------------ ------------ ------------
Total current liabilities .............................. 4,142,923 6,629,003 4,859,645
------------ ------------ ------------
Commitments and contingencies (Notes 11 and 12)
Stockholders' deficit:
Convertible preferred stock - Series A, B, B-1
and C, $.0001 par value; 5,000,000 shares authorized;
98,349 shares issued and outstanding at
December 31, 1997 and September 30, 1998, respectively;
none issued and outstanding pro forma (liquidation
preference of $1,626,965) .............................. 9 9 --
Common stock, $0.0001 par value; 35,000,000 shares
authorized; 131,524 shares issued and outstanding at
December 31, 1997 and September 30, 1998, respectively;
1,996,092 issued and outstanding pro forma ............. 13 13 199
Additional paid-in capital ................................. 3,351,031 4,203,859 10,227,303
Accumulated deficit ........................................ (6,968,298) (10,229,518) (14,483,781)
------------ ------------ ------------
Total stockholders' deficit ............................ (3,617,245) (6,025,637) (4,256,279)
------------ ------------ ------------
$ 525,678 $ 603,366 $ 603,366
============ ============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE>
DIGITAL LAVA INC.
Statement of Operations
<TABLE>
<CAPTION>
Nine Months Ended
Year Ended December 31, September 30,
-------------------------- --------------------------
1996 1997 1997 1998
----------- ----------- ----------- -----------
(Unaudited)
<S> <C> <C> <C> <C>
Revenues:
Software licenses .................. $ -- $ 273,989 $ 131,804 $ 832,090
Consulting and services ............ -- 290,583 244,664 315,542
----------- ----------- ----------- -----------
Total revenues ................. -- 564,572 376,468 1,147,632
----------- ----------- ----------- -----------
Cost of revenues:
Cost of software licenses .......... -- 1,968 1,059 7,708
Cost of consulting and services .... -- 121,008 100,561 236,631
----------- ----------- ----------- -----------
Total cost of revenues ......... -- 122,976 101,620 244,339
----------- ----------- ----------- -----------
Gross profit ................... -- 441,596 274,848 903,293
----------- ----------- ----------- -----------
Operating costs and expenses:
Selling, general and administrative 1,522,757 3,316,961 2,337,115 2,773,240
Research and development ........... 421,087 445,162 322,385 334,142
----------- ----------- ----------- -----------
Total operating costs and
expenses ..................... 1,943,844 3,762,123 2,659,500 3,107,382
----------- ----------- ----------- -----------
Loss from operations ........... (1,943,844) (3,320,527) (2,384,652) (2,204,089)
----------- ----------- ----------- -----------
Other income and expenses:
Interest expense ................... (450,563) (924,842) (762,517) (1,057,131)
Other income ....................... 9,750 -- -- --
----------- ----------- ----------- -----------
Total other income
and expenses ................. (440,813) (924,842) (762,517) (1,057,131)
----------- ----------- ----------- -----------
Net loss ....................... $(2,384,657) $(4,245,369) $(3,147,169) $(3,261,220)
=========== =========== =========== ===========
Basic and diluted loss per
share (Note 2) ..................... $ (93.00) $ (31.14) $ (23.75) $ (22.05)
=========== =========== =========== ===========
Weighed average common shares
used in basic and diluted loss per
share (Note 2) .................... 25,641 136,353 132,492 147,933
=========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE>
DIGITAL LAVA INC.
Statement of Stockholders' Deficit
<TABLE>
<CAPTION>
Series A Series B Series B-1 Series C
Convertible Convertible Convertible Convertible
Preferred Stock Preferred Stock Preferred Stock Preferred Stock
--------------- --------------- ------------------ ----------------
Shares Amount Shares Amount Shares Amount Shares Amount
------ ------ ------ ------ ------ -------- ------ -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1995 .............................. 88,584 $ 9 1,772 $ -- 602 $ -- -- $ --
Issuance of convertible preferred stock for cash ...... -- -- 2,471 -- 328 -- 2,462 --
Issuance of convertible preferred stock warrants
in conjunction with notes payable ................... -- -- -- -- -- -- -- --
Issuance of convertible preferred stock warrants
for services ........................................ -- -- -- -- -- -- -- --
Modification of outstanding convertible
preferred stock warrants ............................ -- -- -- -- -- -- -- --
Issuance of convertible preferred stock for services .. -- -- 383 -- -- -- 821 --
Issuance of convertible preferred stock in exchange for
elimination of anti-dilution rights ................. -- -- 926 -- -- -- -- --
Issuance of common stock warrants in
conjunction with notes payable ...................... -- -- -- -- -- -- -- --
Issuance of common stock for services ................. -- -- -- -- -- -- -- --
Net loss .............................................. -- -- -- -- -- -- -- --
------ ------ ------ ------ ------ -------- ------ -------
Balance, December 31, 1996 .............................. 88,584 9 5,552 -- 930 -- 3,283 --
Issuance of common stock warrants in
conjunction with notes payable ...................... -- -- -- -- -- -- -- --
Issuance of common stock warrants for services ........ -- -- -- -- -- -- --
Modification of outstanding convertible
preferred stock warrants ............................ -- -- -- -- -- -- -- --
Modification of outstanding common stock warrants ..... -- -- -- -- -- -- --
Issuance of common stock for services ................. -- -- -- -- -- -- -- --
Options issued by management and principal
stockholders for services performed
by consultants ...................................... -- -- -- -- -- -- -- --
Issuance of common stock for elimination of
anti-dilution rights ................................ -- -- -- -- -- -- -- --
Net loss .............................................. -- -- -- -- -- -- -- --
------ ------ ------ ------ ------ -------- ------ -------
Balance, December 31, 1997 .............................. 88,584 9 5,552 -- 930 -- 3,283 --
Unaudited:
Modification of outstanding convertible
preferred stock warrants ............................ -- -- -- -- -- -- -- --
Modification of outstanding common stock warrants ..... -- -- -- -- -- -- --
Issuance of common stock warrants for services ........ -- -- -- -- -- -- --
Issuance of common stock warrants in
conjunction with notes payable ...................... -- -- -- -- -- -- -- --
Modification of options issued by management
and principal stockholders for services
performed by consultants ............................ -- -- -- -- -- -- -- --
Net loss
------ ------ ------ ------ ------ -------- ------ -------
Balance, September 30, 1998 (unaudited) ................. 88,584 $ 9 5,552 $ -- 930 $ -- 3,283 $ --
====== ====== ====== ====== ====== ======== ====== =======
<CAPTION>
Common Stock Additional
--------------------------- Paid-In Accumulated
Shares Amount Capital Deficit Total
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1995 ........................... -- $ -- $ 216,991 $ (338,272) $ (121,272)
Issuance of convertible preferred stock for cash ... -- -- 469,680 -- 469,680
Issuance of convertible preferred stock warrants
in conjunction with notes payable ................ -- -- 803,170 -- 803,170
Issuance of convertible preferred stock warrants
for services ..................................... -- -- 50,800 -- 50,800
Modification of outstanding convertible preferred
stock warrants ................................... -- -- 35,000 -- 35,000
Issuance of convertible preferred stock for services -- -- 110,000 -- 110,000
Issuance of convertible preferred stock in exchange
for elimination of anti-dilution rights .......... -- -- 1 -- 1
Issuance of common stock warrants in
conjunction with notes payable ................... -- -- 2,500 -- 2,500
Issuance of common stock for services .............. 110,732 11 101,185 -- 101,196
Net loss ........................................... -- -- -- (2,384,657) (2,384,657)
------------ ------------ ------------ ------------ ------------
Balance, December 31, 1996 ........................... 110,732 11 1,789,327 (2,722,929) (933,582)
Issuance of common stock warrants in
conjunction with notes payable ................... -- -- 501,319 -- 501,319
Issuance of common stock warrants for services ..... -- -- 5,100 -- 5,100
Modification of outstanding convertible preferred
stock warrants ................................... -- -- 153,535 -- 153,535
Modification of outstanding common
stock warrants ................................... -- -- 59,663 -- 59,663
Issuance of common stock for services .............. 4,378 -- 10,000 -- 10,000
Options issued by management and principal
stockholders for services performed
by consultants .................................. -- -- 832,089 -- 832,089
Issuance of common stock for elimination of
anti-dilution rights ............................. 16,414 2 (2) -- --
Net loss ........................................... -- -- -- (4,245,369) (4,245,369)
------------ ------------ ------------ ------------ ------------
Balance, December 31, 1997 ........................... 131,524 13 3,351,031 (6,968,298) (3,617,245)
Unaudited:
Modification of outstanding convertible preferred
stock warrants ................................... -- -- 30,978 -- 30,978
Modification of outstanding common
stock warrants ................................... -- -- 10,050 -- 10,050
Issuance of common stock warrants for services ..... -- -- 49,981 -- 49,981
Issuance of common stock warrants in
conjunction with notes payable ................... -- -- 415,419 -- 415,419
Modification of options issued by management
and principal stockholders for services
performed by consultants ........................ -- -- 346,400 -- 346,400
Net loss ........................................... -- -- -- (3,261,220) (3,261,220)
------------ ------------ ------------ ------------ ------------
Balance, September 30, 1998 (unaudited) .............. 131,524 $ 13 $ 4,203,859 $(10,229,518) $ (6,025,637)
============ ============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE>
DIGITAL LAVA INC.
Statement of Cash Flows
<TABLE>
<CAPTION>
Nine Months
Year Ended December 31, Ended September 30,
------------------------------ ------------------------------
1996 1997 1997 1998
----------- ----------- ----------- -----------
(Unaudited)
<S> <C> <C> <C> <C>
Cash flows from operating activities:
Net loss ............................................. $(2,384,657) $(4,245,369) $(3,147,169) $(3,261,220)
Adjustments to reconcile net income
to net cash provided by (used in)
operating activities:
Deferred revenues ................................ -- -- -- 186,254
Depreciation and amortization .................... 31,891 104,890 48,453 147,526
Amortization of debt discount .................... 396,368 716,433 617,608 544,905
Compensation from grant of
non-employee stock options
and warrants .................................. 261,996 866,589 789,055 396,381
Changes in assets and liabilities
affecting operating cash flows:
Accounts receivable ............................ -- (167,112) (72,426) (16,840)
Other assets ................................... -- (3,406) -- (14,543)
Accounts payable ............................... 12,006 334,601 79,254 33,251
Accrued interest ............................... 57,279 15,411 118,638 634,737
Accrued expenses ............................... (39,845) 182,160 (16,823) 451,177
----------- ----------- ----------- -----------
Net cash used in operating activities .................. (1,664,962) (2,195,803) (1,583,410) (898,372)
----------- ----------- ----------- -----------
Cash flows used in investing activities:
Acquisition of fixed assets .......................... (105,519) (55,620) (54,185) (23,992)
Deferred offering costs .............................. -- -- -- (289,112)
----------- ----------- ----------- -----------
Net cash used in investing activities .................. (105,519) (55,620) (54,185) (313,104)
----------- ----------- ----------- -----------
Cash flows from financing activities:
Proceeds from notes payable .......................... 1,300,000 2,869,500 2,169,500 1,050,000
Repayment of notes payable ........................... -- (450,000) (450,000) --
Proceeds from issuance of preferred stock ............ 469,680 -- -- --
----------- ----------- ----------- -----------
Net cash provided by financing activities .............. 1,769,680 2,419,500 1,719,500 1,050,000
----------- ----------- ----------- -----------
Net increase (decrease) in cash and cash
equivalents .......................................... (801) 168,077 81,905 (161,476)
Cash and cash equivalents at beginning of
period ............................................... 5,986 5,185 5,185 173,262
----------- ----------- ----------- -----------
Cash and cash equivalents at end of period ............. $ 5,185 $ 173,262 $ 87,090 $ 11,786
=========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE>
DIGITAL LAVA INC.
Notes to Financial Statements
1. Nature of Business and Reorganization
Nature of Business
Digital Lava Inc. (the "Company") develops and markets video publishing
software applications for corporate training, communications, distance learning,
research and other applications. The Company's technology allows users to
organize and manage video content, link video to other types of files and
publish video with all of the linked information on CD-ROM or DVD, corporate
intranets or the public Internet.
Reorganization
The Company originally operated as LAVA L.L.C., a New Jersey limited
liability company (the "LLC") which was formed in July 1995. Pursuant to a
Merger Agreement dated November 26, 1996 by and among Digital Lava Inc., a
Delaware Corporation formed in June 1996 specifically for the purpose of this
merger, and the LLC, the ownership interests in the LLC were exchanged for
shares of series A, B, B-1 and C convertible preferred stock of Digital Lava
Inc. (hereinafter all references to the Company refer to Digital Lava Inc. and
its predecessor, the LLC). The accompanying financial statements and footnotes
reflect the reorganization for all periods presented.
2. Summary of Significant Accounting Policies
Basis of presentation
The accompanying financial statements have been prepared assuming the
Company will continue as a going concern. Since inception, the Company has
suffered recurring losses and negative cash flows from operations, has deficits
in working capital and stockholders' equity, and expects to incur future losses.
These conditions raise substantial doubt about the Company's ability to continue
as a going concern. The Company's ability to continue as a going concern is
dependent upon its ability to generate sufficient cash flow to meet its
obligations as they come due. In this regard, management has implemented a plan
to raise additional equity financing through an initial public offering of its
common stock ("IPO") and believes that such financing, together with existing
cash balances and other sources of liquidity (i.e., debt, equity, etc), will be
sufficient to meet its cash needs for at least the next 12 months. The
accompanying financial statements do not include any adjustments relating to the
recoverability of the carrying amount of recorded assets or the amount of
liabilities that might result from the outcome of these uncertainties.
Unaudited interim information
The information presented as of September 30, 1998, and for the nine month
periods ended September 30, 1997 and 1998, has not been audited. In the opinion
of management, the unaudited interim financial statements include all
adjustments, consisting only of normal recurring adjustments, necessary to
present fairly the Company's financial position as of September 30, 1998, and
the results of its operations and its cash flows for the nine months ended
September 30, 1997 and 1998, and the stockholders deficit for the nine months
ended September 30, 1998.
Use of estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires the management of the Company to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
F-7
<PAGE>
DIGITAL LAVA INC.
Notes to Financial Statements
Cash equivalents
The Company considers all highly liquid investments purchased with an
initial maturity of 90 days or less to be cash equivalents and investments with
original maturities of greater than 90 days to be short-term investments.
Fair value of financial instruments
All current assets and liabilities are carried at cost, which approximates
fair value because of the short maturity of those instruments.
Concentration of risk
Financial instruments which potentially subject the Company to
concentration of credit risk consists primarily of accounts receivable. The
company maintains an allowance for uncollectible accounts receivable based upon
expected collectibility and generally does not require collateral. At December
31, 1997, no allowance for uncollectible accounts was deemed necessary by
management. For the year ended December 31, 1997, one customer accounted for
approximately 43% of the Company's total net revenues.
Property and equipment
Property and equipment comprised of computer and office equipment and is
stated at cost, less accumulated depreciation of $67,002 at December 31, 1997.
Depreciation is calculated using the straight-line method over the estimated
useful lives of the assets, generally 3 to 7 years. Maintenance and repair
expenses are charged to operations as incurred.
Deferred offering costs
In connection with the Company's proposed IPO, the Company has incurred
certain costs which have been deferred. In the event the proposed IPO is not
consummated, the deferred offering costs will be expensed.
Revenue recognition
Revenues from the licensing of the Company's software products are
recognized upon shipment to the customer, pursuant to an executed software
licensing agreement when no significant vendor obligations exist and collection
is probable. If acceptance by the customer is required, revenue is recognized
upon customer acceptance. Consulting and service revenues consist of short-term
professional service contracts, such as system development, consulting and video
encoding and capsule creation, are deferred until significant contractual
obligations have been fulfilled. Costs associated with professional service
contracts, such as salaries and materials, are deferred until the related
revenue is recognized.
Software development costs
Development costs incurred in the research and development of new software
products and enhancements to existing software products are expensed as incurred
until technological feasibility has been established. After technological
feasibility is established, any additional costs would be capitalized. Through
December 31, 1997, software development has been substantially completed
concurrently with the establishment of technological feasibility and,
accordingly, no costs have been capitalized.
F-8
<PAGE>
DIGITAL LAVA INC.
Notes to Financial Statements
Income taxes
Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date. A valuation allowance is provided if it
is more likely than not that some or all of the deferred tax asset will not be
realized.
Prior to November 1996, the Company operated as a limited liability company
that was treated as a partnership for federal and state income tax purposes. As
a result, all federal and state tax matters for the Company prior to November
1996 are the responsibility of the members. There are no pro forma income taxes
presented for the period from January 1, 1996 to November 1996 as the Company
incurred losses for both book and tax purposes.
Stock based compensation
As permitted by SFAS No. 123, "Accounting for Stock-Based Compensation,"
the Company accounts for its stock-based compensation arrangements pursuant to
APB Opinion No. 25, "Accounting for Stock Issued to Employees." In accordance
with the provisions of SFAS No. 123, the Company discloses the pro forma effects
of accounting for these arrangements using the minimum value method to determine
fair value.
Loss per share
Basic earnings per share ("Basic EPS") is computed by dividing net loss
available to common stockholders by the weighted average number of common shares
outstanding during the period. Diluted earnings per share ("Diluted EPS") gives
effect to all dilutive potential common shares outstanding during a period. In
computing Diluted EPS, the treasury stock method is used in determining the
number of shares assumed to be purchased from the conversion of common stock
equivalents. Pursuant to Securities and Exchange Commission Staff Accounting
Bulletin No. 98, common stock and convertible preferred stock issued for nominal
consideration prior to the anticipated effective date of the initial public
offering ("IPO"), are included in the calculation of basic and diluted net loss
per share as if they were outstanding for all periods presented.
Net loss per share for the years ended December 31, 1996 and 1997 does not
include the effect of 98,349 (983,490 on an as-if converted basis) shares of
convertible preferred stock outstanding, 5,471 and 42,237, respectively, of
stock options outstanding with a weighted average exercise price of $9.14 per
share, 17,125 (171,250 on an as-if converted basis) warrants to purchase
outstanding shares of a series A convertible preferred stock with exercise
prices ranging from $38.84 to $182.78 per share, or 27,356 and 446,254
respectively, of warrants to purchase common stock with exercise prices ranging
from $3.88 to $11.42 per share, because their effects are anti-dilutive.
New accounting pronouncements
Effective January 1, 1998, the Company adopted the provisions of SFAS No.
130, "Reporting Comprehensive Income" ("SFAS 130"). SFAS No. 130 establishes
standards for reporting comprehensive income, defined as all changes in equity
from nonowner sources. Adoption of SFAS No. 130 did not have a material effect
on the Company's financial position or results of operations.
F-9
<PAGE>
DIGITAL LAVA INC.
Notes to Financial Statements
Effective January 1, 1998, the Company adopted the provisions of SFAS No.
131, "Disclosures about Segments of an Enterprise and Related Information." SFAS
No. 131 establishes standards for the way public enterprises report information
about operating segments in annual financial statements and requires those
enterprises to report selected information about operating segments in interim
financial reports issued to stockholders. Adoption of SFAS No. 131 did not have
a material effect on the Company's financial position or results of operations.
Effective January 1, 1998, the Company adopted American Institute of
Certified Public Accountants Statement of Position 97-2, "Software Revenue
Recognition ("SOP 97-2"). SOP 97-2 generally requires revenue earned on software
arrangements involving multiple elements such as software products, upgrades,
enhancements, post-contract customer support, installation and training to be
allocated to each element based on the relative fair values of the elements. The
adoption of SOP 97-2 did not have an effect on the Company's financial position
or results of operations.
3. Accrued Expenses
Accrued expenses comprised the following:
December 31, September 30,
1997 1998
-------- --------
Accrued payroll ........................ $ 46,097 $131,315
Other accrued liabilities .............. 14,054 380,013
-------- --------
$ 60,151 $511,328
======== ========
4. Related Party Transactions
In January 1997, certain members of management and principal stockholders
of the Company granted a consultant options to acquire up to 13,958 of their
shares of series A convertible preferred stock and 19,941 of their shares of
common stock in exchange for services provided to the Company. The options have
an exercise price of $45.70 per share of series A convertible preferred stock
and $4.57 per share of common stock. The Company has recorded the fair value of
the options, in the amount of $754,554 as a contribution of capital by the
stockholders and as general and administrative expense. As discussed in Note 12,
these options were amended in May 1998.
In December 1997, certain members of management and principal stockholders
of the Company granted options to acquire 1,642 of their shares of series A
convertible preferred stock to a consultant in exchange for certain legal and
advisory services provided to the Company. The options have an exercise price of
$45.70 per share. The Company has recorded the fair value of the options, in the
amount of $77,535, as a contribution of capital by the stockholders and as
general and administrative expense. As discussed in Note 12, these options were
amended in May 1998.
Since inception, the Company has received ongoing consulting and legal
services from stockholders. Services rendered for years ended December 31, 1996
and 1997, amounted to $244,316 and $235,669, respectively, of which $153,475 is
included in accounts payable at December 31, 1997.
F-10
<PAGE>
DIGITAL LAVA INC.
Notes to Financial Statements
5. Notes Payable
December 31, September 30,
1997 1998
----------- -----------
Notes payable:
Notes payable ...................... $ 2,117,500 $ 2,117,500
Convertible notes payable .......... 902,000 902,000
Secured convertible notes payable .. 700,000 1,750,000
----------- -----------
3,719,500 4,769,500
Less: debt discount ................ (267,412) (136,751)
----------- -----------
$ 3,452,088 $ 4,632,749
=========== ===========
Notes payable
From March 1996 to July 1996, the Company issued an aggregate of $750,000
in unsecured promissory notes. The notes, as amended, bear interest at rates
ranging from 9% to 12% per annum and are due and payable on the earlier of
December 31, 1998 or upon the date the Company obtains financing in which gross
proceeds exceed $3.5 million. In conjunction with the issuance of the notes, the
holders were granted warrants to purchase 10,669 shares of series A convertible
preferred stock at exercise prices ranging from $68.54 to $182.78 per share. The
value of the warrants at the time of issuance of $535,400 was determined using
the Black-Scholes model and amortized as interest expense over the initial term
of the notes. In July 1996 and February and August 1997, in exchange for waiving
the acceleration of the maturity date caused by the Company raising additional
financing in excess of a specified amount and extending the maturity date of the
notes until December 31, 1998, the exercise price of the warrants were reduced
to prices ranging from $45.70 to $68.54. The total incremental difference
between the value of the warrants before and after the modification of the
terms, as determined using the Black-Scholes model, was $35,000 and $140,535 for
the years ended December 31, 1996 and December 31, 1997, respectively, and is
being amortized as interest expense over the remaining life of the debt. The
warrants are exercisable at any time prior to dates ranging from March 2006 to
July 2006. None of the warrants have been exercised as of September 30, 1998.
In February and March 1997, the Company issued an aggregate of $200,000 in
unsecured promissory notes. The notes, as amended, bear interest at 12% per
annum and are due and payable on the earlier of December 31, 1998 or upon the
date the Company obtains financing in which gross proceeds exceed $3.5 million.
In conjunction with the issuance of the notes, the holders of the notes were
granted warrants to purchase 23,101 shares of common stock at an exercise price
of $6.85. The value of the warrants at the time of issuance of $18,156 was
determined using the Black-Scholes model and was amortized as interest expense
over the initial term of the notes. In August 1997, in exchange for waiving the
acceleration of the maturity date of the notes caused by the Company raising
additional financing in excess of a specified amount until December 31, 1998,
the exercise price of the warrants was reduced to $4.57. The total incremental
difference between the value of the warrants before and after the modification
of the warrant terms, as determined using the Black-Scholes model, was $8,444
and is being amortized as interest expense over the remaining life of the notes.
The warrants are exercisable at any time prior to March 2007. None of the
warrants have been exercised as of September 30, 1998.
In September 1996, the Company completed a private placement of 9 units to
new investors, each consisting of a $50,000 senior promissory note which bears
interest at 12% per annum and was due and payable on the earlier of April 3,
1997 or upon the date the Company obtains financing in which gross proceeds
exceed $1.5 million.
F-11
<PAGE>
DIGITAL LAVA INC.
Notes to Financial Statements
In addition, each unit included warrants to purchase 548 shares of series A
convertible preferred stock at an exercise price of $114.24 per share. Proceeds
received from the offering of $450,000 were repaid in April 1997. The value of
the 4,932 warrants at the time of issuance of $258,970 was determined using the
Black-Scholes model and was amortized as interest expense over the period the
notes were outstanding. The warrants are exercisable at any time prior to
September 2006. None of the warrants have been exercised as of September 30,
1998.
During the period from December 1996 to February 1997, the Company
completed a private placement of 7 units to existing investors, each consisting
of a $50,000 senior promissory note which bears interest at 12% per annum and,
through various amendments, is payable on the earlier of December 31, 1998 or
upon the date the Company obtains financing in which gross proceeds exceed $2.0
million. In addition, each unit included warrants to purchase 5,472 shares of
common stock at an exercise price of $11.42 per share. Proceeds from the
offering totaled $350,000. The total value of the 38,304 warrants at the time of
issuance of $8,500 was determined using the Black-Scholes model and was
amortized as interest expense over the initial term of the notes. In August
1997, in exchange for the waiving the acceleration of the maturity date of the
notes caused by the Company raising additional financing in excess of a
specified amount until December 31, 1998, the exercise price of the warrants was
reduced to $6.85. The incremental difference between the value of the warrants
before and after the modification of the terms, as determined using the
Black-Scholes model, was $16,800 and is being amortized as interest expense over
the remaining life of the debt. The warrants are exercisable at any time prior
to February 2007. None of the warrants have been exercised as of September 30,
1998.
During the period from April 1997 to May 1997, the Company completed a
private placement of 32.7 units to new investors, each consisting of a $25,000
senior promissory note, which bears interest at 6% per annum and, as amended, is
due and payable on the earlier of (i) dates ranging from April 15 1998 to May
30, 1998 or (ii) upon the closing of an initial public offering. In addition,
each unit included warrants to purchase 2,736 shares of common stock at an
exercise price of $9.14 per share. Proceeds from the offering totaled $817,500.
The value of the 89,467 warrants at the time of issuance of $58,043 was
determined using the Black-Scholes model and was amortized as interest expense
over the initial term of the notes. In October and November 1997, in exchange
for extending the maturity date of the notes until May 1998, the exercise price
of the warrants was reduced to $8.23 per share. The incremental difference
between the value of the warrants before and after the modification of the terms
of the warrants, as determined using the Black-Scholes model, was $8,175 and was
amortized as interest expense over the remaining life of the debt. The warrants
are exercisable at any time prior to dates ranging from April 2003 to May 2005.
None of the warrants have been exercised as of September 30, 1998. As of May 30,
1998, the Company was in default of the repayment terms of these notes. As
described in Note 12, the Company renegotiated the terms for promissory notes
with an aggregate principle amount of $630,000 and amended the notes for the
remaining $187,500.
Convertible notes payable
During the period from June 1997 to July 1997, the Company completed a
private placement of 36.08 units to new investors, each consisting of a $25,000
convertible promissory note which bears interest at 6% per annum and were due
and payable on the earlier of (i) dates ranging from June 25, 1998 to July 28,
1998 or (ii) upon the closing of an initial public offering. In addition, each
unit included warrants to purchase 2,736 shares of common stock at an exercise
price of $8.86 per share. Proceeds from the offering totaled $902,000.
Outstanding principal and accrued interest is mandatorily convertible upon the
date the Company obtains financing in which gross proceeds exceed $3.5 million
at a price equal to the price obtained in the equity offering. The value of the
98,715 warrants at the time of issuance of $114,554 was determined using the
Black-Scholes model and was amortized as interest expense over the original
maturity of the notes. In December 1997, in exchange for extending the
F-12
<PAGE>
DIGITAL LAVA INC.
Notes to Financial Statements
maturity date of the notes, the exercise price of the warrants was reduced to
$7.40 per share. The incremental difference between the value of the warrants
before and after the modification of the terms of the warrants, as determined
using the Black-Scholes model, was $19,844 and is being amortized as interest
expense over the remaining life of the debt. The warrants are exercisable at any
time prior to dates ranging from June to July 2005. None of the warrants have
been exercised as of September 30, 1998. As of July 28, 1998, the Company was in
default of the repayment terms of the notes and as such they are no longer
convertible. As described in Note 12, the Company renegotiated the terms of the
promissory notes.
Secured convertible notes payable
In November and December 1997, the Company completed a bridge financing of
70 units (the "Bridge Units") to investors, each consisting of a $10,000 secured
convertible promissory note (the "Bridge Notes") which bears interest at 12% per
annum plus a one time fee of 10% of the principal amount loaned ("10% Success
Fee") payable upon the payment of the note which is due and payable on the
earlier of (i) November 20, 1998, (ii) upon the closing of an initial public
offering or (iii) upon the date the Company obtains financing in which gross
proceeds exceed $5.0 million. In addition, each unit included warrants to
purchase 1,164 shares of common stock at an exercise price of $8.68 per share.
Proceeds from the offering totaled $700,000 as of December 31, 1997. Outstanding
principal, accrued interest and the 10% Success Fee is convertible at each
holder's option based on a $15 million valuation of the Company or at a price
equal to the price obtained in a private placement of equity securities. The 10%
Success Fee and the value of the 81,480 warrants granted at the time of issuance
of $168,812 are being amortized as interest expense over the period the notes
are outstanding. The warrants are exercisable at any time prior to February
2003. None of the warrants have been exercised as of September 30, 1998. As of
November 20, 1998, the Company was in default on the repayment terms of the
Bridge Notes. As described in Note 12, the Company entered into agreements with
the holders of the Bridge Notes to extend the due dates of their Bridge Notes.
Finder warrants
In September 1996, in connection with the September 1996 issuance of
promissory notes, the Company issued warrants to purchase 438 shares of series A
convertible preferred stock at exercise prices ranging from $114.24 to $182.78
per share as a finders fee. The value of the warrants granted of $8,800 was
determined using the Black-Scholes model and was amortized as debt issuance
costs over the period the notes were outstanding. The warrants are exercisable
at any time prior to September 30, 2006. None of the warrants have been
exercised as of September 30, 1998.
In connection with the April 1997 to July 1997 private placements of
promissory notes, the Company issued warrants to purchase 60,513 shares of
common stock at exercise prices ranging form $8.86 to $11.42 per share as a
finders fee. The value of the warrants granted of $79,005 was determined using
the Black-Scholes model and was amortized as debt issuance costs over the
original maturity date of the related notes. The warrants are exercisable at any
time prior to dates ranging from February 2003 to July 2008. None of the
warrants have been exercised as of September 30, 1998.
In connection with the November and December 1997 bridge financing, the
Company issued warrants to purchase 27,356 shares of common stock at an exercise
price of $8.68 per share as a finders fee. The value of the warrants granted of
$56,750 was determined using the Black-Scholes model and was amortized as debt
issuance costs over the original maturity date of the related notes. The
warrants are exercisable at any time prior to February 2003. None of the
warrants have been exercised as of September 30, 1998. As described in Note 12,
the Company and the finder agreed to the cancellation of these warrants in
February 1999.
F-13
<PAGE>
DIGITAL LAVA INC.
Notes to Financial Statements
Amortization of debt issue costs for the year ended December 31, 1996 and
1997 was $9,910 and $59,889, respectively, of which $91,167 of unamortized costs
is included in other current assets at December 31, 1997.
6. Convertible Preferred Stock
Convertible preferred stock, $.0001 par value, consists of the following:
Shares Issued Liquidation
and Outstanding Preference
Shares December 31, December 31,
Series: Authorized 1997 1997
---------- ---------- ----------
A 966,065 88,584 $ 809,565
B 50,740 5,552 507,400
B-1 8,500 930 85,000
C 30,000 3,283 225,000
Undesignated 3,944,695 -- --
---------- ---------- ----------
5,000,000 98,349 $1,626,965
========== ========== ==========
The Company has reserved 17,125 shares of series A preferred stock for the
exercise of series A warrants issued.
From August 1995 to June 1996, the Company sold 4,243, 930 and 2,462 shares
of series B, B-1 and C convertible preferred stock, respectively, in a private
placement raising gross proceeds of $686,599.
During the year ended December 31, 1996, the Company issued 383 and 821
shares of series B and C convertible preferred stock, respectively, for
services. The fair market value of the stock issued of $110,000 was recognized
as general and administrative expense.
Conversion and voting rights
Each issued share of convertible preferred stock is convertible, in full
and not in part, into ten shares of common stock, subject to certain
adjustments, at the option of the holder and automatically converts upon the
completion of an underwritten public offering. A total of 983,490 shares of
common stock have been reserved for issuance in the event of the conversion of
convertible preferred stock. Each share of preferred stock has a number of votes
equal to the number of shares of common stock into which it is convertible.
Dividends
Each series of preferred stock issued is entitled to receive dividends when
and if declared by the Board. The dividends are noncumulative and payable in
preference to any dividends on common stock. As of December 31, 1997, the
Company had not declared any dividends.
Liquidation
In the event of liquidation, the series C preferred shareholders are
entitled to receive, prior to any distribution to any other shareholders,
approximately $68.54 per share plus all declared and unpaid dividends. The
series B and B-1 preferred shareholders are entitled to receive, after
distribution to series C preferred shareholders and prior
F-14
<PAGE>
DIGITAL LAVA INC.
Notes to Financial Statements
to any distribution to any other shareholders, approximately $91.39 per share
plus all declared and unpaid dividends. The series A preferred shareholders are
entitled to receive, after distribution to series C, B and B-1 preferred
shareholders and prior to any distribution to any other shareholders,
approximately $9.14 per share plus all declared and unpaid dividends. In
addition, the series A preferred shareholders are entitled to share ratably with
the holders of common stock in any remaining distribution.
Anti-dilution
Holders of series B, B-1 and C convertible preferred stock conversion
prices are subject to anti-dilution protection for issuances by the Company of
additional equity shares. In November 1996, in exchange for the issuance of 926
additional shares of series B convertible preferred stock, holders of the series
B convertible preferred stock agreed to cancel their anti-dilution protection
provision. Also, in August 1997, in exchange for the issuance of 16,414 shares
of common stock and warrants to purchase 16,414 shares of common stock at an
exercise price of $9.14 per share, the holder of the series C convertible
preferred stock agreed to cancel the anti-dilution protection provision
contained in the original agreement.
7. Common Stock
In November 1996, the Company issued 110,732 shares of common stock to an
officer of the Company. The fair market value of common stock issued, based upon
management's estimate, of $101,196 was recognized as compensation expense.
In January and March 1997, the Company issued an aggregate of 4,378 shares
of common stock in exchange for consulting services. The fair market value of
the common stock at the time of issuance, based upon management's estimate, of
$10,000 was recognized as general and administrative expense.
8. Warrants
In November 1996, in exchange for legal services provided, the Company
issued warrants to purchase 1,095 shares of series A convertible preferred stock
at an exercise price of $137.09 per share. The value of the warrants granted of
$50,800 was determined using the Black-Scholes model and was recognized as
general and administrative expense. In August 1997, in consideration for
additional legal services performed, the strike price of the warrants were
reduced to $68.54 per share. The incremental difference between the value of the
warrants before and after the modification of $13,000 was recognized as general
and administrative expense. The warrants are exercisable at any time prior to
November 2006. None of the warrants have been exercised as of September 30,
1998.
In January 1997, in exchange for legal services provided, the Company
issued warrants to purchase 10,943 shares of common stock at an exercise price
of $13.71 per share. The value of the warrants granted of $5,100 was determined
using the Black-Scholes model and was recognized as general and administrative
expense. In August 1997, in consideration for additional legal services
performed, the strike price of the warrants were reduced to $6.85 per share. The
incremental difference between the value of the warrants before and after the
modification of $6,400 was recognized as general and administrative expense. The
warrants are exercisable at any time prior to dates ranging from June to
December 2003. None of the warrants have been exercised as of September 30,
1998.
F-15
<PAGE>
DIGITAL LAVA INC.
Notes to Financial Statements
A number of the warrants granted to consultants and in connection with the debt
offerings during 1996 and 1997 contain anti-dilution provisions requiring
adjustment, if at a later date, securities are issued at prices below the
respective warrants exercise price. The following table is a summary of the
shares issuable upon exercise of warrants outstanding as of December 31, 1997 as
adjusted for events which have triggered anti-dilution provisions contained in
the respective warrant agreements:
Common Exercise
Shares Price
Issuable Per
Expiration Upon Common
Issuance Date Date Exercise Share
-------------- ------- --------
March 1996 March 2006 54,712 $ 4.5695
July 1996 July 2006 51,975 4.5695
September 1996 September 2006 64,445 10.0282
September 1996 September 2006 2,971 14.8088
November 1996 November 2006 11,503 6.5198
December 1996 February 2007 21,884 6.8543
January 1997 January 2007 11,503 6.5198
February 1997 February 2007 16,413 6.8543
February 1997 March 2007 11,550 6.8543
March 1997 March 2007 11,550 6.8543
April 1997 April 2003 56,352 8.2251
May 1997 May 2003 33,100 8.2251
May 1997 May 2003 45,711 11.4238
June 1997 June 2005 43,890 7.4730
July 1997 July 2005 76,872 7.4730
August 1997 February 2003 16,413 9.1390
November 1997 February 2003 56,417 8.6172
December 1997 February 2003 52,311 8.6172
------- --------
Total shares and average exercise
price 639,572 $ 7.8098
======= ========
9. Employee Benefits
1996 stock option plan
The Company's 1996 Stock Option Plan (the "1996 Option Plan") permits the
grant of both "incentive stock options" designed to qualify under the Internal
Revenue Code Section 422 and non-qualified stock options. Incentive stock
options may only be granted to employees of the Company whereas non-qualified
stock options may be granted to non-employees, directors and consultants. A
total of 164,132 shares of Common Stock have been reserved for issuance under
the 1996 Option Plan. Each option, once vested, allows the optionee the right to
purchase one share of the Company's Common Stock. The Board of Directors
determines the exercise price of the options; options granted to date generally
vest ratably over four years and expire ten years from the date of grant.
Compensation expense equal to the difference between the assumed fair value of
the Company's Common Stock at the grant date and the exercise price of the
options, if any, is recognized ratably over the vesting period.
F-16
<PAGE>
DIGITAL LAVA INC.
Notes to Financial Statements
Stock option activity can be summarized as follows:
Options Outstanding
--------------------------
Options Weighted Average
Available Shares Exercise Price
--------- -------- ---------------
Balance at December 31, 1995
Authorized 164,132
Granted (6,347) 6,347 $9.14
Canceled 876 (876) $9.14
-------- -------
Balance at December 31, 1996 158,661 5,471 $9.14
Granted (41,690) 41,690 $9.14
Canceled 4,924 (4,924) $9.14
-------- -------
Balance at December 31, 1997 121,895 42,237 $9.14
======== =======
At December 31, 1997, options to purchase 42,237 shares were exercisable of
which 15,785 shares were vested. Options outstanding at December 31, 1997 have a
weighted average remaining contractual life of 9.5 years and weighted average
exercise price of $9.14. Options granted through December 31, 1997 were granted
at exercise prices in excess of fair market value at grant date. The weighted
average grant-date fair value of such options granted during the years ended
December 31, 1996 and 1997 under the minimum value method was less than $.01 per
share.
In October 1997, the Company accelerated the vesting of options to purchase
2,462 shares of common stock, which were granted in March 1997, and granted
additional options to purchase 2,189 shares of common stock which were
immediately vested to a former employee in lieu of severance pay. The assumed
fair value of such options was less than $1,000 based on the Black Scholes
model.
The fair value of each option grant is estimated on the date of grant using
the minimum value method as prescribed in SFAS 123. Assumptions used for options
granted during the years ended December 31, 1996 and 1997 were as follows:
1996 1997
----- ------
Risk free interest rate 6.194% 6.183%
Expected lives (years) 5 5
Expected dividends -- --
Pro forma information regarding net income or loss is required by SFAS 123.
For purposes of pro forma disclosure, the estimated fair value of the options
are amortized to expense over the options' vesting period. Had compensation cost
for these options been determined consistent with the minimum value method
pursuant to SFAS No. 123, the difference between the Company's net income as
reported and as adjusted for the compensation costs for the years ended December
31, 1996 and 1997 would not have been material.
The minimum value method requires input of highly subjective assumptions in
which changes in those assumptions could materially effect the fair value
estimate. In addition, the minimum value method is only allowed for non-public
entities, as public entities are required to include an expected volatility
factor in addition to factors described above. As such, the effects on pro forma
disclosures of applying SFAS 123 are not likely to be representative of the
effects on pro forma disclosures of future years.
F-17
<PAGE>
DIGITAL LAVA INC.
Notes to Financial Statements
10. Income Taxes
There are no income tax assets, liabilities or income tax expense included
in the financial statements. The Company has incurred losses since inception for
both book and tax purposes and as of December 31, 1997, the Company has net
operating loss carryforwards for federal and state purposes of approximately
$2,800,000. Federal and state net operating loss carryforwards begin expiring in
the years 2011 and 2005, respectively. These losses may be subject to limitation
on future year's utilization should certain ownership changes occur.
Temporary differences between the financial statement and tax bases of
assets and liabilities are primarily attributable to net operating loss
carryforwards and capitalized costs. A full valuation allowance has been
provided for the entire amount of the deferred tax assets arising from these
differences as a result of management's current belief that it is more likely
than not that the benefits related to such temporary differences will not be
realized.
11. Commitments and Contingencies
Operating leases
The Company leases its facility under a non-cancelable operating lease
which expires in June 2000. The Company may extend the term of the lease for an
additional three-year period at the then current fair market value. Rent expense
under this lease was $23,582 and $51,169 for the years ended December 31, 1996
and 1997. Future minimum lease payments required under the non-cancelable
operating lease are $81,738, $81,738, and $34,058 for the years ending December
31, 1998, 1999 and 2000, respectively.
In March 1997, the Company entered into a development and two-year software
licensing agreement for the development and license of software to be included
and distributed with one of the Company's software products. Under the terms of
the agreement, royalties are payable on a per unit basis in relation to sales
volume and sales price, and include a one time payment and guaranteed minimum
annual commitment. At December 31, 1997, the Company is committed to payments of
$20,000 in respect of future minimum royalty obligations over the remainder of
this agreement.
12. Subsequent Events
In January and February 1998, the Company issued 105 additional Bridge
Units to investors, raising gross proceeds of $1,050,000. The 10% Success Fee
and the value of the 122,220 warrants granted at the time of issuance of
$253,217 are being amortized as interest expense over the period the notes are
outstanding. In connection with this offering, the Company also issued
additional warrants to acquire 20,368 shares of its common stock as a finder's
fee. The value of such warrants at the time of issuance of $42,203 was recorded
as debt issuance costs is being amortized over the life of the notes. The
warrants are exercisable at any time prior to February 2003. None of the
warrants have been exercised as of September 30, 1998. As of November 20, 1998,
the Company was in default of the repayment terms of the Bridge Notes. In
December 1998 and January 1999, the Company entered into agreements with the
holders of the Bridge Notes to extend the maturity date of their notes until the
earlier of January 31, 1999 or the consummation of the Company's proposed IPO.
In January and February 1999, the Company entered into agreements with the
holders of the Bridge Notes to extend the maturity date of their notes until the
earlier of February 19, 1999 or the consummation of the Company's proposed IPO.
Effective January 1, 1998, the Company entered into a financial consulting
agreement expiring on December 31, 1998 with Prism Ventures LLC ("Prism"). Under
the terms of the agreement, Prism was to receive $300,000, payable on the
earlier of (i) the consummation of an initial public offering of the Company's
common stock, or (ii) December 31, 1998, for financial and strategic advisory
consulting services. In February 1999, the Company and Prism agreed to terminate
this agreement and that no compensation was due to Prism. A stockholder of the
Company is a
F-18
<PAGE>
DIGITAL LAVA INC.
Notes to Financial Statements
member of Prism.
In March 1998, in exchange for waiving the acceleration of the maturity
date caused by the Company raising additional financing in excess of a specified
amount and extending the maturity date of the promissory notes issued during the
period from March to July 1996 until December 31, 1998, the exercise price of
the warrants issued in connection with such promissory notes were reduced to
$38.84 per share of series A convertible preferred stock. The total incremental
difference between the value of the warrants before and after the modification
of the warrant terms, as determined using the Black-Scholes model, was $30,978
and is being amortized as interest expense over the remaining life of the debt.
In March 1998, in exchange for waiving the acceleration of the maturity
date caused by the Company raising additional financing in excess of a specified
amount and extending the maturity date of the promissory notes issued during the
period from October 1996 to March 1997 until December 31, 1998, the exercise
price of the warrants issued in connection with such promissory notes was
reduced to exercise prices ranging from $3.88 to $5.71 per share of common
stock. The total incremental difference between the value of the warrants before
and after the modification of the warrant terms, as determined using the
Black-Scholes model, was $10,050 and is being amortized as interest expense over
the remaining life of the debt.
In May 1998, the Company entered into a consulting agreement with the
Whitestone Group LLC ("Whitestone") for corporate finance, financial and
strategic advisory matters. Under the terms of the agreement, the Company issued
Whitestone warrants to acquire 10,943 shares of its common stock at an exercise
price of $4.57 per share. The value of the warrants granted of $38,100 was
determined using the Black-Scholes model and was recognized as general and
administrative expense. The warrants were exercisable at any time prior to May
2004. None of the warrants have been exercised as of September 30, 1998. In
February 1999, the Company and Whitestone agreed to terminate the consulting
agreement and cancel the Warrants. A stockholder of the Company is an affiliate
of Whitestone.
Effective May 1998, certain members of management and principal
stockholders of the Company (the "Founders") amended the option grant made to a
consultant of the Company in January 1997 (see Note 4). Under the revised terms
and in exchange for additional consulting services provided to the Company, the
strike price of the options were reduced to $9.14 per share of series A
convertible preferred and $.91 per share of common stock. The total incremental
difference between the value of the warrants before and after the modification
of the warrant terms, as determined using the Black-Scholes model, in the amount
of $321,470, was recorded as a contribution of capital by the stockholders and
general and administrative expense. The options are exercisable for a period of
ten years.
Effective May 1998, the Founders amended the option grant made to a
consultant of the Company in December 1997 (see Note 4). Under the revised terms
and in exchange for additional consulting and legal services provided to the
Company, the strike price of the options were reduced to $9.14 per share of
series A convertible preferred stock. The total incremental difference between
the value of the warrants before and after the modification of the warrant
terms, as determined using the Black-Scholes model, in the amount of $24,930,
was recorded as a contribution of capital by the stockholders and general and
administrative expense.
In September 1998, the Company and two members of management entered into
two-year consulting agreements for financial, operational and strategic
development services, effective upon the closing of the IPO. Under the terms of
the agreements, the Company is required to pay bonuses of $100,000 upon the
closing of the IPO and aggregate annual consulting fees of $84,000.
F-19
<PAGE>
DIGITAL LAVA INC.
Notes to Financial Statements
In October 1998, the Company entered into a financial consulting agreement
with a noteholder. Under the terms of the agreement, the Company will issue the
consultant warrants to acquire 20,000 shares of common stock at an exercise
price equal to 90% of the price obtained in the IPO.
In September 1998, the Company entered into two-year employement
agreements, effective upon consummation of the IPO, with its Chief Executive
Officer and its Vice President of Sales. Pursuant to the agreements, upon
consummation of the IPO, the Company is required to pay an aggregate of $120,000
in bonuses and issue options to purchase an aggregate of 80,000 shares of common
stock at an exercise price equal to the IPO price. In addition, the Company is
required to pay annual aggregate salaries of $460,000.
In September 1998, the Board of Directors increased the number of shares
reserved for issuance under the 1996 Stock Option Plan to 250,000 shares.
In September 1998, the Company entered into an agreement to settle an
outstanding dispute regarding finders fees on one of the Company's note
issuances. Under the terms of the agreement, the Company granted warrants to
acquire 21,884 shares of Common Stock at an exercise price of $4.11 per share
and pay $62,500 in cash. The fair value of the warrants, in the amount of
approximately $120,000, was recorded as an expense.
In October 1998, the Company issued at $20,000 note payable to a principal
stockholder. The note bears interest at 12% per annum and is payable in October
1999.
In December 1998, the Company entered into a one-year consulting agreement
with an investor relations firm. Under the terms of the consulting agreement,
the investor relations firm is to receive warrants to acquire 13,131 shares of
common stock at an exercise price of $9.14 per share. The fair value of the
warrants, in the amount of approximately $55,000, will be recorded as an
expense.
In November and December 1998, the Company completed a bridge financing of
5.5 units (the "1998 Bridge Units") to investors, each unit consisting of a
$100,000 subordinated promissory note, which bears interest at 12% per annum.
The notes are due and payable on the earlier of (i) dates ranging from May to
June 1999 or (ii) the closing of an initial public offering of the Company's
common stock. In addition, each unit included warrants to purchase 50,000 shares
of common stock at an exercise price equal to 130% of the initial public
offering price. In the event that Company does not close an initial public
offering prior to the due dates of the Notes, the exercise price of the warrants
will be $9.14 per share. The fair value of the warrants, in the amount of
approximately $380,000, will be recorded as a debt discount and amortized over
the life of the notes. A family member of two officers and principle
stockholders of the Company purchased 3 of the 1998 Bridge Units.
In December 1998, the Company issued warrants to acquire 6,000 shares of
common stock to certain noteholders in settlement of an outstanding dispute. The
warrants have an exercise price of $7.38 per share. The fair value of the
warrants, in the amount of approximately $27,000, will be recorded as an
expense.
In February 1999, the Company and a finder who received warrants to
purchase 27,356 shares of common stock at an exercise price of $8.68 per share
as a finders fee in connection with the November and December 1997 bridge
financing agreed to the cancellation of these warrants.
Proposed public offering
In June 1998, the Company entered into an agreement with an underwriter
(the "Underwriter"), whereby the Underwriter has agreed in principle to sell
shares of the Company's common stock and redeemable warrants in an IPO.
F-20
<PAGE>
DIGITAL LAVA INC.
Notes to Financial Statements
Stock options
In August 1998, Board of Directors declared that upon the consummation of
an initial public offering, the Company will cancel certain outstanding stock
options of employees and consultants and reissue fully vested stock options at
an exercise price equal to the IPO price. The number of shares granted will be
based on the number of stock options such employee or consultant held divided by
the 1 for 9.139 reverse split.
Recapitalization
In August, September and December 1998, effective upon consummation of the
IPO, the Company renegotiated the terms of an aggregate of $2,832,000 of
outstanding promissory notes originally issued from March 1996 through July
1997, with the note holders. Under the revised terms, and in exchange for
extending the maturity date of such notes until December 31, 1998, the Company
will re-pay one-half of the face value of the notes and any 10% Success Fee in
cash upon the closing of the IPO. The remaining one-half of the face value of
the notes, accrued but unpaid interest and the outstanding warrants issued in
connection with the financings will convert into common stock equal to 225% of
the original principal amount of the notes based upon the IPO price per share
(849,600 shares based upon an assumed initial offering price of $7.50 per share)
(the "Note Conversions"). In January 1999, the Company entered into agreements
with the holders of an aggregate principal amount of $2,819,500 of such notes to
extend the maturity date of their notes until the earlier of January 31, 1999 or
completion of the IPO. In January and February 1999, the Company entered into
agreements with the holders of an aggregate principal amount of $2,832,000 of
such notes to extend the maturity date of their notes until the earlier of
February 19, 1999 or the completion of the IPO.
In August and September 1998, the Company entered into agreements,
effective upon consummation of the IPO, to convert outstanding warrants to
acquire 107,687 shares of common stock issued in connection with the Bridge
Units in exchange for 30,836 shares of common stock (the "Warrant Conversions").
In August and September 1998, the Company renegotiated the terms of an
aggregate of $187,500 in outstanding notes payable with the note holders. Under
the revised terms, the Company was required to re-pay one-half of the face value
of the notes and accrued interest in cash upon the closing of the IPO. The
remaining one-half of the face value of the notes would bear interest at 12% per
annum and would become due and payable on June 30, 1999; however because the
closing of the IPO did not occur by December 31, 1998, the entire principal
amount of the notes became immediately due and payable on such date. In January
1999, the note holders agreed to waive such default and in consideration the
Company has agreed to pay the entire principal amount of such notes, and accrued
interest, at the closing of the IPO.
In September 1998, the Company's stockholders authorized the Company to
amend its Certificate of Incorporation to effect a 1 for 9.139 reverse stock
split applicable to all issued and outstanding shares of the Company's common
and preferred stock. The Company intends to effect the amendment to its
Certificate of Incorporation immediately prior to the completion of its IPO. All
common and preferred shares, stock options, warrants and related per share data
reflected in the accompanying financial statements and notes thereto have been
adjusted to give retroactive effect to the stock split.
In September 1998, the Company's shareholders authorized the Company to
amend its Certificate of Incorporation to change the conversion rate of the
series B and C convertible preferred stock to 20.3099 to 1 and 19.3702 to 1,
respectively. In addition, the holder of the series C convertible preferred
stock agreed to cancel warrants to acquire 16,413 shares of common stock issued
in August 1997 in connection with the waiver of the anti-dilution protection
provision on the series C convertible preferred stock. The Company intends to
effect the amendment to its certificate of incorporation immediately prior to
the completion of its IPO.
F-21
<PAGE>
DIGITAL LAVA INC.
Notes to Financial Statements
In September 1998, effective upon completion of the IPO, officers of the
Company have agreed to return 11,028 shares of common stock and 8,822 shares of
series A convertible preferred stock to the Company. The Company will cancel the
returned shares.
13. Unaudited Pro Forma Information
Upon completion of the Company's IPO, all shares of the Company's
convertible preferred stock and certain debt, accrued interest and warrants will
convert into Common Stock of the Company. The unaudited pro forma balance sheet
has been presented assuming such conversions had occurred on September 30, 1998
and reflects the following items:
Return of shares by officers of the Company
As described in Note 12, certain officers of the Company have agreed to
return 8,824 and 11,030 shares of Common Stock and series A preferred stock,
respectively, to the Company. The pro forma balance sheet reflects the return
and cancellation of such shares as if it had occurred on September 30, 1998.
Conversion of series A convertible preferred stock
Each share of the Company's series A convertible preferred stock will
automatically convert into ten shares of Common Stock upon completion of the
IPO. The pro forma balance sheet presented reflects the conversion of the 79,760
shares of series A convertible preferred stock outstanding on a pro forma basis
at September 30, 1998 into 797,600 shares of Common Stock.
Conversion of series B-1 convertible preferred stock
Each share of the Company's series B-1 convertible preferred stock was
initially convertible into ten shares of Common Stock. As discussed in Note 6,
the conversion price of the series B-1 stock is subject to anti-dilution
protection for issuances of additional equity shares by the Company, and as of
September 30, 1998, each share of series B-1 stock will automatically convert
into 21.9335 shares of Common Stock upon completion of the IPO. The pro forma
balance sheet presented reflects the conversion of the 930 shares of series B-1
convertible preferred stock outstanding at September 30, 1998 into 20,411 shares
of Common Stock.
Conversion of series B & C convertible preferred stock
Each share of the Company's series B and C convertible preferred stock was
initially convertible into ten shares of Common Stock. As discussed under
"Recapitalization" in Note 12, the Company's shareholders authorized the Company
to change the conversion rate on the series B and C convertible preferred stock
to 20.3099 to 1 and 19.3702 to 1, respectively. The pro forma balance sheet
reflects the conversion of the 5,552 and 3,283 shares series B and C convertible
preferred stock outstanding at September 30, 1998, respectively, into 177,151
shares of Common Stock. In addition, the pro forma balance sheet reflects the
fair value of the incremental number of 92,062 additional common shares issued
to the holders of the series B and C convertible preferred stock resulting from
the change in conversion rates as a dividend.
Conversion of certain debt, accrued interest and warrants
As more fully described under "Recapitalization" in Note 12, the Company
renegotiated the terms of certain outstanding promissory notes. The pro forma
balance sheet presented reflects the conversion of $1,416,000 in principal
amount of such notes, $405,704 of accrued interest and warrants to acquire
approximately 335,716 shares of Common Stock at a weighted average exercise
price of approximately $6.01 per share into 849,600 shares of Common Stock. The
pro forma balance sheet also reflects the recording of an extraordinary loss in
the amount of $3,563,794 based upon the difference between the fair value of the
(a)
F-22
<PAGE>
DIGITAL LAVA INC.
Notes to Financial Statements
notes, accrued interest and warrants returned to the Company, and (b) the
common stock issued in exchange.
Conversion of outstanding warrants
As described in Note 12, the Company has entered into agreements to convert
outstanding warrants to acquire 107,687 shares of Common Stock into 30,836
shares of common stock. The pro forma balance sheet reflects the conversion of
such warrants as if it had occurred on September 30, 1998.
For the periods ended December 31, 1997 and June 30, 1998, the pro forma
basic and diluted loss per share reflecting the recapitalization would have been
$(4.01) and $(1.50), respectively. The pro forma weighted average shares
outstanding at December 31, 1997 and September 30, 1998 would have been
1,848,586 and 2,094,866, respectively.
F-23
<PAGE>
[Back cover page]
We have not authorized any dealer, salesperson or other person to give any
information or represent anything not contained in this Prospectus. You must not
rely on any unauthorized information. This Prospectus does not offer to sell or
buy any shares in any jurisdiction where it is unlawful. The information in this
Prospectus is current only as of the date of this Prospectus.
LOGO
DIGITAL LAVA INC.
1,200,000 Units, each unit consisting of
two shares of common stock and one
redeemable common stock
purchase warrant.
DIRKS & COMPANY, INC.
___________, 1999.
Until ____________, 1999 (25 days after the date of this Prospectus) all dealers
that buy, sell or trade these securities, whether or not participating in this
offering, may be required to deliver a Prospectus. This is in addition to the
dealers' obligation to deliver a Prospectus when acting as underwriters and with
respect to their unsold allotments or subscriptions.
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 24. Indemnification of Directors and Officers.
Section 145 of the Delaware General Corporation Law provides that a
corporation may indemnify directors and officers as well as other employees and
individuals against expenses (including attorneys' fees), judgements, fines and
amounts paid in settlement actually and reasonably incurred by such person in
connection with any threatened, pending or completed actions, suits or
proceedings in which such person is made a party by reason of such person being
or having been a director, officer, employee or agent to the Registrant. The
Delaware General Corporation Law provides that Section 145 is not exclusive of
other rights to which those seeking indemnification may be entitled under any
bylaw, agreement, vote of stockholders or disinterested directors or otherwise.
Article __ of the Registrant's Bylaws provides for indemnification by the
Registrant of its directors, officers and employees to the fullest extent
permitted by the Delaware General Corporation Law.
Section 102(b)(7) of the Delaware General Corporation Law permits a
corporation to provide in its certificate of incorporation that a director of
the corporation shall not be personally liable to the corporation or its
stockholders for monetary damages for breach of fiduciary duty as a director,
except for liability (i) for any breach of the director's duty of loyalty to the
corporation or its stockholders, (ii) for acts or omissions not in good faith or
which involve intentional misconduct or a knowing violation of law, (iii) for
unlawful payments of dividends or unlawful stock repurchases, redemptions or
other distributions, or (iv) for any transaction from which the director derived
an improper personal benefit. The Registrant's Certificate of Incorporation
provides for such limitation of liability.
The Registrant intends to obtain directors, and officers, insurance
providing indemnification for certain of the Registrant's directors, officers
and employees for certain liabilities.
Reference is also made to the Underwriting Agreement to be filed as Exhibit
1.1 to the registration Statement for information concerning the Underwriters'
obligation to indemnify the registrant and its officers and directors in ceratin
circumstances.
Item 25. Other Expenses of Issuance and Distribution.
SEC Registration Fee $ 11,867
American Stock Exchange Listing Fee $ 32,500
NASD Filing Fee $ 4,768
Accounting Fees and Expenses* $250,000
Printing and Engraving* $100,000
Legal Fees and Expenses* $350,000
Blue Sky Fees and Expenses* $ 20,000
Transfer Agent and Registrar Fees* $ 5,000
Miscellaneous Expenses* $ 25,865
--------
Total $800,000
========
- --------
* Estimated.
II-1
<PAGE>
Item 26. Recent Sales of Unregistered Securities.
The following discussion gives retroactive effect to the one for 9.139
reverse stock split and the recapitalization to be effected immediately prior to
the completion of this offering. Since its organization in July 1995, the
Company, and in several instances members of management and principal
stockholders, has sold and issued the following unregistered securities in
transactions which were exempt from registration under the Securities Act of
1933, as amended, pursuant to Section 4(2) of the Securities Act, as they were
transactions not involving a public offering. The Company believes that all such
purchasers either were "accredited investors" and/or had access to and had an
opportunity to review all relevant information concerning the Company and
sufficient knowledge and experience in business and financial matters to
evaluate the merits and risks of such an investment. The Company believes that
all of the investors were "sophisticated investors."
The Company relied on several factors in concluding that its investors had
the requisite financial status and sophistication to invest in the Company's
securities. The Company's founders or its counsel were personally familiar with
all of its original equity investors and many of the subsequent bridge loan
investors and had direct knowledge of their financial status and prior
investment activities. In addition, the Company relied on detailed investor
questionnaires which required potential investors to confirm their salaries and
net worth. For those bridge loan transactions in which the Company used finders,
the Company had an opportunity to meet many of the potential investors prior to
their investments in the Company's securities. Through discussions with such
potential investors or with the finders who introduced such investors, the
Company was able to learn about the financial status and sophistication of its
investors and their previous investments in bridge loans and similar types of
transactions.
For those investors not personally known by the Company or with whom the
Company did not have an opportunity to meet, the Company relied on the detailed
questionnaires completed by such investors and on personal knowledge of such
investors by the Company's finders and placement agents.
In July 1995, the Company issued an aggregate of 809,565 shares of Common
Stock to Roger Berman, James Stigler, Thomas Stigler and Kenneth Mendoza for
nominal consideration in connection with the formation of the Company.
From August 1995 to June 1996, the Company sold an aggregate of 200,826
shares of Common Stock to 26 individuals, 19 of whom were accredited investors
and 7 of whom were non-accredited investors for $686,599 in cash. Each of the
investors received an offering memorandum which contained appropriate risk
factors and a detailed description of the Company's business. Each of the
investors completed a questionnaire regarding their financial status and
investment history.
From March to June 1996, the Company issued an aggregate of 29,334 shares
of Common Stock to a consultant and its legal counsel, Eilenberg & Zivian, in
consideration for services performed for the Company.
In September 1996, in connection with a $450,000 bridge financing completed
in such month, the Company issued warrants to purchase an aggregate of 70,265
shares of Common Stock to two accredited investors, one of which received a
portion of its warrants as a finder. Each of the investors received an offering
memorandum which contained appropriate risk factors and a detailed description
of the Company's business. Each of the investors completed a questionnaire
regarding their financial status and investment history.
In November 1996, the Company issued 110,732 shares of Common Stock to
Joshua Sharfman, Chief Executive Officer of the Company, in consideration for
services performed for the Company.
In November 1996 and January 1997, the Company issued warrants to purchase
an aggregate of 23,212 shares of Common Stock to Eilenberg & Zivian in
consideration for services performed for the Company.
In January 1997, certain members of management and principal stockholders
of the Company granted to Judson Cooper options to acquire 13,958 of their
shares of series A convertible preferred stock and 19,941 of their shares of
common stock in exchange for services provided to the Company.
In January and March 1997, the Company issued 4,377 shares of common stock
to two consultants for services performed for the Company.
In May 1997, in connection with the issuance of an aggregate principal
amount of $187,500 of promissory notes, the Company issued warrants to purchase
an aggregate of 20,520 shares of Common Stock to five accredited investors. Each
of the investors received an offering memorandum which contained appropriate
risk factors and a detailed description of the Company's business. Each of the
investors completed a questionnaire regarding their financial status and
investment history.
In May 1997, in connection with a $817,500 bridge financing completed in
April and May 1997, the Company issued warrants to purchase an aggregate of
45,712 shares of Common Stock to three individuals who acted as finders in
connection with such financing. Each of the investors who participated in the
financing received an offering memorandum which contained appropriate risk
factors and a detailed description of the Company's business. Each of the
investors completed a questionnaire regarding their
II-2
<PAGE>
financial status and investment history.
In July 1997, in connection with a $902,000 bridge financing completed in
June and July 1997, the Company issued warrants to purchase an aggregate of
15,957 shares of Common Stock to three individuals who acted as finders in
connection with such financing. Each of the investors who participated in the
financing received an offering memorandum which contained appropriate risk
factors and a detailed description of the Company's business. Each of the
investors completed a questionnaire regarding their financial status and
investment history.
In December 1997, certain members of management and principal stockholders
of the Company granted to Eilenberg & Zivian Investments options to acquire
1,642 of their shares of series A convertible preferred stock in exchange for
certain legal and advisory services provided to the Company.
In February 1998, in connection with the issuance of an aggregate principal
amount of $775,000 of promissory notes, the Company issued warrants to purchase
an aggregate of 96,233 shares of Common Stock to ten accredited investors. Each
of the investors received an offering memorandum which contained appropriate
risk factors and a detailed description of the Company's business. Each of the
investors completed a questionnaire regarding their financial status and
investment history.
In February 1998, in connection with a $1,750,000 bridge financing
completed from December 1997 to February 1998, the Company issued warrants to
purchase an aggregate of 47,730 shares of Common Stock to two finders. Each of
the investors in the financing received an offering memorandum which contained
appropriate risk factors and a detailed description of the Company's business.
Each of the investors completed a questionnaire regarding their financial status
and investment history.
In May 1998, the Company issued warrants to purchase an aggregate of 10,943
shares of Common Stock to the Whitestone Group, in consideration for services
performed for the Company.
In September 1998, the Company issued warrants to purchase an aggregate of
21,885 shares of Common Stock to a finder in consideration for such finder's
release of any claims against the Company under the finder's agreement with the
Company.
In October 1998, the Company issued warrants to purchase an aggregate of
20,000 shares of Common Stock to Shahrokh Sedaghat in consideration for services
performed for the Company.
In December 1998, the Company issued warrants to purchase an aggregate of
13,131 shares of Common Stock to Schwartz Communications in consideration for
services performed for the Company.
In December 1998, the Company issued warrants to purchase an aggregate of
6,000 shares of Common Stock to four investors in consideration for such
investors' release of any claims against the Company.
In December 1998, in connection with the issuance of an aggregate principal
amount of $550,000 of subordinated promissory notes, the Company issued warrants
to purchase an aggregate of 275,000 shares of Common Stock to ten accredited
investors. Each of the investors received an offering memorandum which contained
appropriate risk factors and a detailed description of the Company's business.
Each of the investors completed a questionnaire regarding their financial status
and investment history.
In connection with the recapitalization to be completed immediately prior
to the completion of the offering, the Company will issue an aggregate of
846,600 shares of Common Stock to holders of an aggregate principal amount of
$2,832,000 of promissory notes in exchange for one-half of the outstanding
II-3
<PAGE>
principal of their notes, the accrued interest on such notes and the warrants
received in connection with the issuance of such notes. All of such holders
received their notes and warrants in connection with bridge financings completed
from March 1996 through July 1997. In connection with such financings, each
holder received an offering memorandum which contained appropriate risk factors
and a detailed description of the Company's business. Each holder completed a
questionnaire regarding their financial status and investment history.
In connection with the recapitalization to be completed immediately prior
to the completion of the offering, the Company will issue an aggregate of 30,836
shares of Common Stock to holders of an aggregate principal amount of $925,000
of promissory notes in exchange for outstanding warrants to acquire 107,689
shares of Common Stock received in connection with the issuance of such notes.
All of such holders received their notes and warrants in connection a bridge
financing completed from December 1997 to February 1998. In connection with such
financing, each holder received an offering memorandum which contained
appropriate risk factors and a detailed description of the Company's business.
Each holder completed a questionnaire regarding their financial status and
investment history.
Item 27. Exhibits.
Exhibit
Number Description of Exhibits
- ------- --------------------
1(a)****** Form of Underwriting Agreement
1(b)** Form of Financial Advisory Agreement
3(a)** Amended and Restated Certificate of Incorporation, in effect
as of the date hereof
3(b)** Form of Amendment to Amended and Restated Certificate of
Incorporation
3(c)** Form of Amended and Restated Certificate of Incorporation
3(d)* Bylaws of the Company, in effect as of the date hereof
3(e)*** Form of Amended and Restated Bylaws of the Company
4(a)* Form of Common Stock Certificate
4(b)** Form of Warrant Agreement
4(c)** Form of Representative's Warrant Agreement
4(d)* 1996 Incentive and Non-Qualified Stock Option Plan (1)
4(e)* Warrant Agreement dated as of September 30, 1996 between the
Company and Millenium Capital Management (2)
4(f)* Warrant Agreement dated as of September 30, 1996 between the
Company and Miracle Investments Co. (2)
II-4
<PAGE>
4(g)* Registration Rights Agreement between the Company, Miracle
Investments Co. and Millenium Capital Management
4(h)* Warrant Agreement dated November 1, 1996 between the Company
and Eilenberg & Zivian(2)(3)
4(i)* Warrant Agreement dated January 27, 1997 between the Company
and Eilenberg & Zivian (2)(3)
4(j)* Warrant Agreement dated May 30, 1997 between the Company and
certain investors and finders(2)
4(k)* Registration Rights Agreement dated May 30, 1997 between the
Company and certain investors and finders
4(l)* Letter Agreement dated October 6, 1998 between the Company
and certain investors
4(m)* Warrant Agreement dated July 11, 1997 between the Company
and certain investors and finders(2)
4(n)* Registration Rights Agreement dated July 11, 1997 between
the Company and certain investors and finders
4(o)** Warrant Agreement between the Company and Schwartz
Communications
4(p)* Warrant Agreement dated February 19, 1998 between the
Company and certain investors and finders (2)
4(q)* Registration Rights Agreement dated February 19, 1998
between the Company and certain investors and finders
4(r)* Form of Promissory Note dated February 19, 1998 between the
Company and certain investors
4(s)* Warrant Agreement dated May 1, 1998 between the Company and
The Whitestone Group (2)
4(t)* Registration Rights Agreement dated May 1, 1998 between the
Company and The Whitestone Group
4(u)* Letter Agreement between the Company and certain investors
and finders dated July 15, 1998
4(v)* Letter Agreement between the Company and certain investors
and finders dated July 16, 1998
4(w)* Letter Agreement between the Company and certain investors
and finders dated July 29, 1998
4(x)* Warrant Agreement dated as of October 7, 1998 between the
Company and certain consultants
II-5
<PAGE>
4(y)* Registration Rights Agreement dated as of October 7, 1998
between the Company and certain consultants
4(z)* Letter Agreement as of October 7, 1998 between the Company
and certain investors
4(aa)* Amended and Restated Option Agreement dated as of May 1,
1998 between the Company, Judson Cooper and certain founders
of the Company (2)
4(ab)* Amended and Restated Option Agreement dated as of May 1,
1998 between the Company, E&Z Investments and certain
founders of the Company (2)
4(ac)*** Warrant Agreement between the Company and United Resources
Partners dated September 18, 1998
4(ad)** Warrant Agreement dated January 7, 1999 between the Company
and certain investors
4(ae)** Warrant Agreement between the Company and certain investors
dated December 7, 1998
4(af)** Registration Rights Agreemnt between the Company and certain
investors dated between December 7, 1998
4(ag)*** Registration Rights Agreement between the Company and United
Resources Partners dated September 18, 1998
5(a)**** Opinion of Ehrenreich Eilenberg Krause & Zivian LLP
10(a)* Employment Agreement dated September 1, 1998 between the
Company and Thomas Stigler
10(b)* Employment Agreement dated September 1, 1998 between the
Company and Joshua D.J. Sharfman
10(c)* Consulting Agreement dated September 1, 1998 between the
Company and Roger Berman
10(d)* Consulting Agreement dated September 1, 1998 between the
Company and Dr. James Stigler
10(e)* Consulting Agreement dated September 1, 1998 between the
Company and Prism Ventures LLC
10(f)** Consulting Agreement dated May 1, 1998 between the Company
and the Whitestone Group
10(g)** Consulting Agreement dated October 7, 1998 between the
Company and Shahrokh "Shawn" Sedaghat
10(h)***** Agreement dated January 8, 1998 between the Company and
RealNetworks, Inc.(4)
10(i)***** Agreement dated April 1, 1998 between the Company and
RealNetworks, Inc.(4)
10(j)***** Software License Agreement dated March 31, 1997 between the
Company and Cinax Designs, Inc.(4)
10(k)** Agreement dated August 8, 1998 between the Company and
Lesson Lab
23(a)**** Consent of Ehrenreich Eilenberg Krause & Zivian LLP
(included in opinion filed as Exhibit 5(a))
II-6
<PAGE>
23(b)******* Consent of PricewaterhouseCoopers LLP
24(a)* Power of Attorney (included in Part II of the Registration
Statement under the caption Signatures")
27(a)** Financial Data Schedule
- ----------
* Filed with original SB-2 Registration Statement filed on October 23,
1998.
** Filed with Amendment No. 1 to SB-2 Registration Statement filed on
January 12, 1999.
*** Filed with Amendment No. 2 to SB-2 Registration Statement.
**** Filed with Amendment No. 3 to SB-2 Registration Statement.
***** Filed with Amendment No. 5 to SB-2 Registration Statement.
****** Filed with Amendment No. 6 to SB-2 Registration Statement.
******* Filed with this Amendment No. 7 to SB-2 Registration Statement.
(1) Does not reflect increase in number of shares issuable under the Plan
pursuant to resolution of Board of Directors.
(2) These agreements were entered into prior to the reverse split of the
Company's Common Stock and, therefore, do not reflect such reverse split.
(3) These warrant agreements do not reflect exercise price changes made
pursuant to resolutions of the Board of Directors.
(4) Confidential information is omitted and identified by a * and filed
separately with the SEC pursuant to a request for Confidential Treatment.
Item 28. Undertakings.
(a) Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers and controlling persons of
the small business issuer pursuant to the foregoing provisions, or otherwise,
the undersigned Registrant has been advised that in the opinion of the
Securities and Exchange Commission such indemnification is against public policy
as expressed in the Act and is, therefore, unenforceable. In the event that a
claim for indemnification against such liabilities (other than the payment by
the undersigned Registrant of expenses incurred or paid by a director, officer
or controlling person of the undersigned Registrant in the successful defense of
any action, suit or proceeding) is asserted by such director, officer or
controlling person in connection with the securities being registered, the
undersigned Registrant will, unless in the opinion of its counsel the matter has
been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Act and will be governed by the final adjudication of
such issue.
(b) The undersigned Registrant in all instances will provide to the
Underwriter at the closing specified in the underwriting agreement certificates
in such denominations and registered in such names as required by the
underwriter to permit prompt delivery to each purchaser.
(c) The undersigned Registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities
Act of 1933, the information omitted from the form of prospectus
filed as part of a registration statement in reliance upon Rule
430A and contained in the form of prospectus filed by the
undersigned Registrant pursuant to Rule 424(b)(1) or (4) or
497(h) under the Securities Act of 1933 shall be deemed to be
part of the registration statement as of the time it was declared
effective; and
(2) For the purpose of determining any liability under the Securities
Act of 1933, each post-effective amendment that contains a form
of prospectus shall be deemed to be a new registration statement
relating to the securities offered therein, and the offering of
such securities at that time shall be deemed to be the initial
bona fide offering thereof.
II-7
<PAGE>
(d) The undersigned Registrant hereby undertakes that it will:
(1) File, during any period in which it offers or sells securities, a
post-effective amendment to this registration statement to:
(i) Include any prospectus required by Section 10(a)(3) of the
Securities Act;
(ii) Reflect in the prospectus any facts or events which,
individually or together, represent a fundamental change in
the information in the registration statement.
Notwithstanding the foregoing, any increase or decrease in
volume of securities offered (if the total dollar value of
securities offered would not exceed that which was
registered) and any deviation from the low or high end of
the estimated maximum offering range may be reflected in the
form of prospectus filed with the Commission pursuant to
Rule 424(b) if, in the aggregate, the changes in volume and
price represent no more than a 20% change in the maximum
aggregate offering price set forth in the "Calculation of
Registration Fee" table in the effective registration
statement; and
(iii) Include any additional or changed material information on
the plan of distribution.
(2) For determining liability under the Securities Act, treat each
post-effective amendment as a new registration statement of the
securities offered, and the offering of the securities at that
time to be the initial bona fide offering.
(3) File a post-effective amendment to remove from registration any
of the securities that remain unsold at the end of the offering.
II-8
<PAGE>
SIGNATURES
In accordance with the requirements of the Securities Act of 1933, the
undersigned Registrant certifies that it has reasonable grounds to believe that
it meets all of the requirements for filing on Form SB-2 and authorized this
Registration Statement to be signed on its behalf by the undersigned, thereunto
duly authorized, in the City of Los Angeles, State of California, on the 16th
day of February, 1999.
DIGITAL LAVA INC.
By: /s/ Joshua D.J. Sharfman
----------------------------
Joshua D.J. Sharfman
Chief Executive Officer
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in their
respective capacities and on the respective dates set forth opposite their
names.
Signatures Title Date
- ---------- ----- ----
*
- ---------------------------
James Stigler Chairman and Director February 16, 1999
/s/ Danny Gampe
- ---------------------------
Danny Gampe Chief Financial Officer February 16, 1999
(Principal Financial and
Accounting Officer)
*
- ---------------------------
Roger Berman Director February 16, 1999
*
- ---------------------------
Thomas Stigler Director February 16, 1999
*
- ---------------------------
Gerald Porter Director February 16, 1999
/s/ Joshua D.J. Sharfman
- ---------------------------
Joshua D.J. Sharfman Chief Executive Officer February 16, 1999
and Director (Principal
Executive Officer)
*By: /s/ Joshua D.J. Sharfman
---------------------------
Joshua D.J. Sharfman
Attorney-in-fact
II-9
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the use in the Prospectus constituting part of the
Registration Statement on Form SB-2 of our report dated July 31, 1998, except as
to Note 12 which is as of January 12, 1999, relating to the financial statements
of Digital Lava Inc., which appears in such Prospectus. We also consent to the
reference to us under the heading "Experts" in such Prospectus.
PricewaterhouseCoopers LLP
February 16, 1999
