<PAGE> 1
FILED PURSUANT TO RULE 424(b)(1)
REGISTRATION NO. 333-80849
PROSPECTUS
1,400,000 Shares
[SUNHAWK.COM CORPORTION(TM) LOGO]
Common Stock
-------------------------
This is an initial public offering of 1,400,000 shares of common stock of
Sunhawk.com Corporation.
No public market currently exists for our shares. The shares will be listed
for trading on the NASDAQ SmallCap(R) Market and Tier II of the Pacific Stock
Exchange.
SEE "RISK FACTORS" BEGINNING ON PAGE 5 FOR A DISCUSSION OF FACTORS THAT YOU
SHOULD CONSIDER BEFORE BUYING SHARES OF OUR COMMON STOCK.
-------------------------
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS
PROSPECTUS IS ACCURATE OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
-------------------------
<TABLE>
<CAPTION>
PER SHARE TOTAL
--------- -----------
<S> <C> <C>
Public offering price....................................... $12.00 $16,800,000
Underwriting discounts and commissions...................... $ 0.90 $ 1,260,000
Proceeds, before expenses, to Sunhawk.com................... $11.10 $15,540,000
</TABLE>
The underwriter may, for 30 days after the date of this prospectus,
purchase up to an additional 210,000 shares of common stock from us at the
initial public offering price less the underwriting discount.
-------------------------
The underwriting agreement provides that the shares are being offered on a
firm-commitment basis, such that the underwriter will purchase all of the
1,400,000 shares if any of the shares are purchased. The underwriter expects to
deliver the shares against payment in New York, New York on February 24, 2000.
-------------------------
Offers and sales of the common stock to investors pursuant to this
prospectus are restricted to individuals who meet suitability standards of not
less than annual gross income of $65,000 and a minimum net worth of $65,000,
exclusive of automobile, home and home furnishings, or a minimum net worth of
$150,000, exclusive of automobile, home and home furnishings. In addition,
investors who are residents of Virginia must be accredited investors as defined
in Rule 501 of Regulation D promulgated under Section 4(2) of the Securities Act
of 1933, as amended.
-------------------------
JOSEPH GUNNAR & CO., LLC
February 14, 2000
<PAGE> 2
[Inside Cover Page]
Fore front: Sound waves emanating from music notes centered on page. Various
blocks with arrows pointing to aspects of Company's business.
Background: Digital screen depicting digital codes and squares.
Text: - Get Digital
- Internet based digital rights management distribution system
for the secure publishing, enhancing and preparing of digital
content
- Direct Digital Distribution
- Sheet music, books, games, audio, video, images, theater, plays,
musicals, lectures
- Protection, Encryption
- "tech solutions for secure content distribution"
- Enhancement, preparation and delivery
- Education and entertainment
- Worldwide delivery
[Inside Back Cover]
Fore front: Various images of people involved in business, entertainment and
educational situations.
Background: Circular presentation creating larger images as one moves away
from the center
Text: www.sunhawk.com
digital solutions
<PAGE> 3
PROSPECTUS SUMMARY
You should read the following summary together with the more detailed
information regarding our company and the common stock being sold in this
offering and our financial statements and notes to those statements appearing
elsewhere in this prospectus.
Sunhawk.com Corporation has developed and is operating an Internet based
digital rights management system that secures, enhances, prepares and publishes
copyrighted digital content and other proprietary digital products for
distribution over the Internet. We currently sell digital sheet music, audio
music in the MP3 format and other proprietary digital products.
Our principal executive offices are located at 223 Taylor Avenue North,
Suite 200, Seattle, Washington 98109, and our telephone and fax numbers are
(206) 728-6063 and (206) 728-6416, respectively. Our e-mail address is
[email protected], and our web site address is www.sunhawk.com. Information
accessed on or through our web site does not constitute a part of this
prospectus.
THE OFFERING
<TABLE>
<S> <C>
Common stock offered by us.............. 1,400,000 shares
Common stock outstanding immediately
prior to the date of this offering.... 1,399,380 shares
Common stock to be outstanding after
this offering......................... 2,799,380 shares
Over-allotment option................... 210,000 shares
Use of proceeds......................... We anticipate that the net proceeds from this offering will
be used for:
- sales, marketing, brand building and website enhancement
activities;
- working capital for general business purposes;
- production of proprietary digital products;
- acquisition of licenses for production of proprietary
digital products;
- research and development of additional features of our
distribution system;
- repayment of bridge financing loans; and
- upgrading existing facilities and acquisition of
equipment, including leasehold improvements.
Proposed Nasdaq SmallCap(R) Market
Symbol................................ "SNHK"
Proposed Pacific Stock Exchange
Symbol................................ "SHA"
</TABLE>
Except as otherwise indicated, all information in this prospectus assumes
that the underwriter does not exercise the option granted by Sunhawk.com to
purchase additional shares in this offering.
3
<PAGE> 4
SUMMARY FINANCIAL INFORMATION
The following table summarizes the financial data of our business and
should be read in conjunction with "Management's discussion and analysis of
financial condition and results of operations."
<TABLE>
<CAPTION>
FISCAL YEAR
ENDED SEPTEMBER 30,
-------------------------------------
1999 1998 1997
----------- ----------- ---------
<S> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Sales................................................ $ 100,575 $ 27,263 $ 15,066
Gross profit (loss).................................. (71,150) 4,746 10,052
Loss from operations................................. (2,732,083) (1,349,125) (844,406)
Net loss............................................. (2,834,337) (1,475,579) (910,983)
Net loss per share --
basic and diluted.................................. $ (2.46) $ (1.66) $ (1.04)
Weighted average common shares for net loss per share
computations -- basic and diluted.................. 1,154,214 887,689 875,424
</TABLE>
The following table provides a summary of our balance sheet as of September
30, 1999. The "as adjusted" column reflects the sale of 1,400,000 shares of
common stock in this offering at an assumed initial public offering price of
$12.00 per share after deducting the estimated underwriting discounts,
commissions and estimated offering expenses payable by us.
<TABLE>
<CAPTION>
AT SEPTEMBER 30, 1999
-------------------------
ACTUAL AS ADJUSTED
----------- -----------
<S> <C> <C>
BALANCE SHEET DATA:
Working capital............................................. $(1,337,009) $13,845,086
Total assets................................................ 3,130,128 17,249,128
Total shareholders' equity.................................. 1,745,510 15,864,510
</TABLE>
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
SEPTEMBER 30,
---------------------- TOTALS AS OF
1999 1998 1997 SEPTEMBER 30, 1999
------ ----- ----- ------------------
<S> <C> <C> <C> <C>
SUMMARY OPERATING DATA:
Solero(R) song titles published................... 4,959 1,516 538 7,013
Solero(R) pages published......................... 27,146 5,778 2,429 35,353
Total online digital products sold................ 16,931 3,404 125 20,460
</TABLE>
4
<PAGE> 5
RISK FACTORS
WE CURRENTLY HAVE AN UNSOUND FINANCIAL CONDITION WHICH ADVERSELY AFFECTS OUR
OPERATIONS.
Presently, we are operating at a loss and are financing our operations with
borrowed funds. This situation has limited the growth of our business,
substantially increased our debt and resulted in a going concern qualification
report from our independent auditors. We will be unable to continue our business
as presently conducted unless we obtain the proceeds of this offering.
WE HAVE INCURRED LOSSES SINCE INCEPTION IN CONNECTION WITH THE DEVELOPMENT OF
OUR DIGITAL RIGHTS MANAGEMENT AND ENCRYPTION TECHNOLOGY AND E-COMMERCE
OPERATIONS, AND MAY INCUR FUTURE LOSSES AND AS A RESULT, OUR OPERATIONS MAY
SUFFER.
To date, we have had limited revenues and have incurred losses from
operations. We incurred net losses of $2,834,337, $1,475,579, and $910,983 for
the years ended 1999, 1998, and 1997, respectively. The aggregate amount of our
accumulated deficit as of September 30, 1999 was $1,599,709 after adjustment for
the change in tax status from an "S" Corporation to a "C" Corporation. We expect
to continue to devote substantial resources to the production of Solero(R)
digital sheet music and Sunhawk Audio files, sales and marketing activities and
the acquisition of rights to additional sheet music, recorded music and other
digital content. As we expand our technology to address electronic distribution
of other types of content we expect to incur additional significant increases in
research and development costs as well as in sales and marketing. Accordingly,
we expect to incur significantly larger losses in the next 12 months. We may
find that these efforts are more expensive than we currently anticipate, which
would further increase our losses. As a result, we will need to generate
significant revenues to achieve and maintain profitability. Our business
strategy may not be successful, and we cannot predict when, or if, we will
become profitable. If we achieve profitability, we may not be able to sustain
it.
WE WILL NEED ADDITIONAL FINANCING AND IF WE CANNOT SECURE SUCH FINANCING, THERE
WOULD BE SUBSTANTIAL DOUBT AS TO OUR ABILITY TO CONTINUE AS A GOING CONCERN.
Our capital requirements have been and will continue to be significant. In
the past, we have been substantially dependent upon loans and contributions from
our shareholders. The proceeds of this offering together with existing funds are
expected to be sufficient to meet our cash requirements for the next 12 months.
Beyond that period, we will require additional funds in order to meet our
strategic business objectives and remain competitive. This capital may not be
available on acceptable terms, if at all. If we raise additional funds by
issuing equity or convertible debt securities, the percentage ownership of our
shareholders will be reduced, and these securities may have rights, preferences
or privileges senior to those of our shareholders. If we cannot obtain
sufficient funds, we may not be able to grow our operations, make technological
developments or compete effectively and there would be a substantial doubt as to
our ability to continue as a going concern.
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<PAGE> 6
OUR DIGITAL RIGHTS MANAGEMENT AND ENCRYPTION, CONTENT ENHANCEMENT AND ELECTRONIC
COMMERCE BUSINESSES ARE DIFFICULT TO EVALUATE BECAUSE WE HAVE A LIMITED
OPERATING HISTORY AND, CONSEQUENTLY, OUR OPERATING RESULTS MAY BE UNCERTAIN.
We were incorporated in August 1992 but did not go online with our web site
until February 1997 and did not make our first sale online until March 1997.
Accordingly, we have a limited operating history upon which you can evaluate our
business and prospects, which makes it difficult to forecast our future
operating results. The new and evolving nature of using e-commerce for the
distribution of proprietary digital products increases these uncertainties. You
must consider our business in light of the risks, uncertainties and problems
frequently encountered by companies with limited operating histories.
THERE IS AN EXISTING EFFORT TO ESTABLISH A STANDARD FOR THE DISTRIBUTION OF
DIGITAL MUSIC THROUGH A CONSORTIUM KNOWN AS THE SECURE DIGITAL MUSIC INITIATIVE,
AND IF A STANDARD, EXCLUDING SUNHAWK.COM, IS ADOPTED, OUR BUSINESS WOULD BE
HARMED.
There is an existing effort to establish a standard for the distribution of
digital music through the Secure Digital Music Initiative. The Secure Digital
Music Initiative seeks to create the industry standard for the distribution of
music and, potentially, other proprietary digital products. We cannot assure you
that our Solero(R) format will be a successful format for the creation, storage
and distribution of digital music and other interactive proprietary digital
products, or that it will be adopted by customers in sufficient numbers for us
to be successful. Further, if another format for the creation, storage and
delivery of interactive digital sheet music and other proprietary digital
products is chosen, we cannot assure you that we will be able to obtain a
license to such technology on favorable terms or at all, or that it will be
possible to convert our digital sheet music and other proprietary digital
products into that alternate format.
WE MAY BE EXPOSED TO LIABILITY FOR MUSIC AND OTHER CONTENT ON OUR WEB SITE AND
ELSEWHERE THAT, IF FOUND TO BE DEFAMATORY OR IN VIOLATION OF A THIRD PARTY'S
COPYRIGHT, TRADEMARK OR OTHER RIGHTS COULD HARM OUR BUSINESS.
We may be subject to claims for copyright or trademark infringement,
negligence, defamation, obscenity or on other grounds related to the music and
information available for download or use on our web site and distributed on
CD-ROMS, enhanced CDs and elsewhere. The area of law relating to the digital
distribution of music and other materials over the Internet is unsettled, and we
face risks associated with, for example, content appearing on sites to which we
link, content appearing on sites created by members of our associates program,
and a failure by us to obtain all necessary rights to distribute our music
products. Any liability incurred as a result of such claims or from the loss of
the rights to distribute our music products could harm our business.
OUR PRINCIPAL SUBCONTRACTORS ARE LOCATED IN RUSSIA AND THEIR UNAVAILABILITY AS A
RESULT OF POLITICAL INSTABILITY COULD DISRUPT OR INCREASE THE COST OF OUR
DIGITAL SHEET MUSIC PRODUCTION AND HARM OUR BUSINESS.
While our encryption, quality control and Internet operations are located
at our offices in Seattle, Washington, substantially all of our "raw" digital
sheet music is produced by third-party contractors overseas. These relationships
may be affected by political or economic uncertainties, termination of our
existing agreements or personnel shortages. Because of distance and different
legal systems, we would have difficulty enforcing our agreements with these
contractors. Although domestic third-party providers of these
6
<PAGE> 7
services are available, we believe that such services are more costly. If the
supply of music converted into our Solero(R) format from foreign third-party
subcontractors is disrupted for any reason, our ability to produce additional
Solero(R) music titles will be disrupted until other service providers are
contracted with, and our business could be harmed.
WE HAVE NO WRITTEN AGREEMENT WITH OUR DISTRIBUTORS OF PRINTED SHEET MUSIC AND
OUR FAILURE TO FULFILL ORDERS FOR TRADITIONAL PRINTED SHEET MUSIC COULD PREVENT
US FROM SATISFYING CUSTOMER ORDERS AND RESULT IN THE LOSS OF EXISTING OR
POTENTIAL CUSTOMERS AND THUS HARM OUR BUSINESS.
Although we have accounts with several distributors, we obtain
substantially all of our traditional printed sheet music directly from an
unaffiliated third-party distributor with whom we do not have a written
agreement. There can be no assurance that if our distributor relationship were
terminated, we would be able to find an alternative, comparable supplier capable
of providing printed sheet music on terms that we would find satisfactory. To
the extent our distributor does not have sufficient capacity or is otherwise
unable to fulfill orders on a timely basis, such capacity constraints could harm
our business. We also rely on third-party carriers for traditional printed sheet
music shipments and are therefore subject to the risks, including employee
strikes and inclement weather, associated with these carriers' ability to
provide delivery services to meet our shipping needs. If we fail to adequately
address these and other order fulfillment risks, our business would be harmed.
ALTHOUGH WE HAVE NOT EXPERIENCED ANY YEAR 2000 PROBLEMS, THE OCCURRENCE OF ANY
YEAR 2000 PROBLEMS COULD HARM OUR BUSINESS.
Our software, products and information systems were developed using a
four-digit year code. As a result, we believe that our software, products and
information systems will function properly with respect to dates in the Year
2000 and thereafter. While we have not experienced any Year 2000 problems to
date, we cannot assure you that we will not encounter latent issues that will
require upgrades, modifications or replacements. Any resulting system failures
or significant upgrades or modifications could harm our business. We have
established contingency plans. The failure by us to successfully implement our
contingency plans to address future problems relative to Year 2000 matters could
harm our business.
ANY FAILURE BY THIRD-PARTIES THAT PROVIDE PRODUCTS AND SERVICES ON WHICH WE RELY
TO ADDRESS POTENTIAL YEAR 2000 RISKS COULD HARM OUR BUSINESS.
There can be no assurance that the products, software and systems of other
companies on which our products, software, systems and operations rely will
function properly with respect to dates in the Year 2000 and thereafter. We have
identified our critical vendors and are monitoring their Year 2000 compliance
programs. The failure of any of our critical vendors to adequately address the
Year 2000 problem could harm our business.
OUR OFFICERS AND DIRECTORS WILL CONTINUE TO HAVE SUBSTANTIAL CONTROL OVER
SUNHAWK.COM AFTER THIS OFFERING, WHICH WILL ENABLE THEM TO EXERCISE SIGNIFICANT
INFLUENCE OVER ALL MATTERS REQUIRING SHAREHOLDERS APPROVAL.
Immediately after the closing of this offering, the Eller and McConney 1995
Family Living Trust, of which Mr. Eller, our chairman of the board, chief
executive officer and president, and Mary McConney, our treasurer, serve as the
trustees, will own 1,024,284 shares of our outstanding common stock, which will
represent 36.6% of our
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<PAGE> 8
outstanding common stock or 34.0% if the underwriters' over-allotment option is
exercised in full. Accordingly, the Eller and McConney 1995 Family Living Trust
will have significant influence over the election of directors and other matters
submitted to a vote of our shareholders. Moreover, our executive officers,
directors and entities affiliated with them will, in the aggregate, beneficially
own 40.2% of our outstanding common stock, or 37.3% if the underwriters'
over-allotment option is exercised in full, upon the completion of this
offering. As a result, these shareholders will possess significant influence
over us, with the ability to significantly influence all matters requiring
approval by our shareholders.
FORWARD-LOOKING STATEMENTS
This prospectus contains forward-looking statements. These forward-looking
statements include statements about our plans, objectives, expectations and
intentions and other statements that are not historical facts. When we use the
words "expects," "anticipates," "intends," "plans," "believes," "seeks,"
"estimates" and similar expressions, we are generally identifying
forward-looking statements. Because these forward-looking statements involve
risks and uncertainties, there are many factors that could cause actual results
to differ materially from those expressed or implied by these forward-looking
statements, including the factors discussed above.
8
<PAGE> 9
USE OF PROCEEDS
The estimated net proceeds to us of this offering, at the initial public
offering price of $12.00 per share and after deducting estimated underwriting
discounts and commissions and estimated offering expenses payable by us, will be
approximately $14,119,000. We currently expect to apply the estimated net
proceeds as follows:
<TABLE>
<CAPTION>
USE AMOUNT PERCENTAGE
- ------------------------------------------------------ ----------- ----------
<S> <C> <C>
Sales and Marketing, including sales force
enhancement; brand building program development and
implementation; marketing and advertising programs
and upgrading and maintaining our digital rights
management technology and website................... $ 8,000,000 57%
Working capital for general business purposes
including utilities, telephone, rent, office
supplies and computer repair........................ 1,541,000 11%
Production of proprietary digital products including
Solero(R) digital sheet music and Sunhawk Audio
Music files......................................... 1,078,000 7%
Research and development of additional features for
our digital rights management distribution system... 1,000,000 7%
Acquisition of additional licenses for the production
of proprietary digital products..................... 1,000,000 7%
Repayment of bridge financing loans which bear
interest at a rate of 8.5% per annum and is due at
the earlier of the closing of this offering or
September 26, 2000.................................. 1,000,000 7%
Acquisition and upgrade of equipment for our digital
rights management distribution system............... 250,000 2%
Reconfiguration of headquarters facilities............ 250,000 2%
----------- ---
Total....................................... $14,119,000 100%
=========== ===
</TABLE>
We cannot assure you that the above dollar amounts will be specifically
allocated as set forth in the foregoing table. Nonetheless, our management will
only have discretion to apply proceeds from this offering in a manner other than
as set forth above in extraordinary circumstances. Allocation of net proceeds is
further subject to future events including general economic conditions, changes
in our strategy and response to competitive pressures and consumer preferences
associated with the music industry and Internet commerce. Pending ultimate
application, the net proceeds will be invested in interest-bearing securities
guaranteed by the U.S. government or its agencies.
9
<PAGE> 10
CAPITALIZATION
The following table sets forth our capitalization as of September 30, 1999:
- on an actual basis; and
- on an "as adjusted" basis to reflect the receipt by us of the
estimated net proceeds from this offering;
You should read this information together with our financial statements and
the notes to those statements included elsewhere in this prospectus.
<TABLE>
<CAPTION>
AT SEPTEMBER 30, 1999
-------------------------
ACTUAL AS ADJUSTED
----------- -----------
<S> <C> <C>
Shareholders' equity:
Preferred stock, no par value; 10,000,000 shares
authorized; none issued and outstanding.............. -- --
Common stock, no par value; 30,000,000 shares
authorized; 1,399,380 shares issued and outstanding,
actual; 2,799,380 shares issued and outstanding, as
adjusted............................................. $ 3,345,219 $17,464,219
Accumulated deficit....................................... (1,599,709) (1,599,709)
----------- -----------
Total shareholders' equity........................... 1,745,510 15,864,510
----------- -----------
Total capitalization............................ $ 1,745,510 $15,864,510
=========== ===========
</TABLE>
The foregoing table assumes no exercise of any outstanding stock options or
warrants. In addition to the shares of common stock to be outstanding after this
offering, we may issue additional shares of common stock under the following
plans and arrangements:
- 17,932 shares of common stock subject to options outstanding under our
1996 Stock Option Plan and 266,210 shares available for future issuance
under the plan as of September 30, 1999;
- 140,000 shares of common stock reserved for issuance upon exercise of the
underwriter's warrants; and
- 41,680 shares of common stock reserved for issuance upon exercise of the
warrants as part of the bridge financing loan agreements.
10
<PAGE> 11
DILUTION
Our net tangible book value (deficiency) at September 30, 1999 was
$(659,781), or $(.47) per share. Net tangible book value per share represents
the amount of our total tangible assets less our total liabilities divided by
the number of shares of common stock outstanding as of September 30, 1999. After
giving effect to the sale of the 1,400,000 shares of common stock offered in
this prospectus at an assumed initial public offering price of $12.00 per share,
after deducting estimated underwriting discounts and commissions and estimated
offering expenses payable by us, our as adjusted net tangible book value at
September 30, 1999 would have been $14,522,314, or $5.19 per share. This
represents an immediate increase in net tangible book value of $5.66 per share
to existing shareholders and an immediate dilution of $6.81 per share, or 56.8%
of the assumed initial public offering price of $12.00, to new investors
purchasing shares of common stock in this offering. The following table
illustrates the per share dilution:
<TABLE>
<S> <C> <C>
Assumed initial public offering price....................... $12.00
Net tangible book value (deficiency) per share at
September 30, 1999..................................... $(.47)
Increase per share attributable to new investors.......... 5.66
-----
As adjusted net tangible book value per share after this
offering.................................................. 5.19
------
Dilution per share to new investors......................... $ 6.81
======
</TABLE>
The table below sets forth on an adjusted basis at September 30, 1999,
after giving effect to the sale of the 1,400,000 shares of common stock offered
in this prospectus at an assumed initial public offering price of $12.00 per
share, the following information both for our existing shareholders and for
investors purchasing shares of common stock in this offering:
- the number of shares of common stock purchased from us;
- the total consideration paid to us; and
- the average price paid per share.
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION
------------------- --------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
--------- ------- ----------- ------- -------------
<S> <C> <C> <C> <C> <C>
Existing shareholders..... 1,399,380 50% $ 5,883,497 25.9% $ 4.20
New investors............. 1,400,000 50% 16,800,000 74.1% 12.00
--------- ----- ----------- -----
Total........... 2,799,380 100.0% $22,683,497 100.0%
========= ===== =========== =====
</TABLE>
The foregoing table assumes no exercise of any outstanding stock options or
warrants. As of September 30, 1999, there were outstanding options to purchase
17,932 shares of common stock under the 1996 Stock Option Plan, at a weighted
average exercise price of $10.77 per share. To the extent that outstanding
options or warrants are exercised, there will be further dilution to new
investors.
DIVIDEND POLICY
We have never declared or paid any cash dividends on our common stock, and
we do not anticipate paying cash dividends in the foreseeable future. Any future
determination with regard to the payment of dividends will be at the sole
discretion of our board of directors.
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<PAGE> 12
SELECTED FINANCIAL DATA
The following selected financial data for the years ended September 30,
1999, 1998, and 1997 are derived from our financial statements, which have been
audited by Ernst & Young LLP, independent auditors. The financial statements
include all adjustments, consisting of normal recurring adjustments, which we
consider necessary for a fair presentation of our financial position and results
of operations for these periods. When you read the selected financial data
below, it is important that you also read the historical financial statements
and related notes to those statements appearing elsewhere in this prospectus, as
well as the section of this prospectus entitled "Management's discussion and
analysis of financial condition and results of operations." The historical
results and the results for the year ended September 30, 1999 are not
necessarily indicative of the results that may be expected of future results.
<TABLE>
<CAPTION>
FOR THE FISCAL YEAR ENDED
SEPTEMBER 30,
---------------------------------------
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA:
Sales................................... $ 100,575 $ 27,263 $ 15,066
Cost of goods sold...................... 171,725 22,517 5,014
----------- ----------- -----------
Gross profit (loss)..................... (71,150) 4,746 10,052
Selling, general and administrative
expenses............................. 2,660,933 1,353,871 854,458
----------- ----------- -----------
Loss from operations.................... (2,732,083) (1,349,125) (844,406)
Interest income......................... 13,140 -- --
Interest expense on notes payable to
shareholders......................... (115,394) (126,454) (66,577)
----------- ----------- -----------
Net loss................................ $(2,834,337) $(1,475,579) $ (910,983)
=========== =========== ===========
Net loss per share -- basic and
diluted.............................. $ (2.46) $ (1.66) $ (1.04)
=========== =========== ===========
Weighted average common shares for net
loss per share computations -- basic
and diluted.......................... 1,154,214 887,689 875,424
</TABLE>
<TABLE>
<CAPTION>
AT SEPTEMBER 30,
---------------------------------------
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
BALANCE SHEET DATA:
Working capital (deficit)................. $(1,337,009) $(3,213,584) $(1,602,704)
Total assets.............................. 3,130,128 508,516 212,831
Total shareholders' equity (deficit)...... 1,745,510 (2,807,902) (1,432,323)
</TABLE>
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<PAGE> 13
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of our financial condition and results of
operations should be read in conjunction with the financial statements and the
notes to those statements and other financial information included elsewhere in
this prospectus.
OVERVIEW
We were incorporated in August 1992 and began distributing and selling
digital sheet music over the Internet in March 1997. From the date of
incorporation until March 1997, our operating activities consisted principally
of the following:
- creating our digital sheet music catalog;
- developing and patenting our technology;
- establishing international operations for the production of digital sheet
music;
- negotiating for the rights to distribute and sell sheet music;
- developing a corporate infrastructure for the management of data;
- producing digital sheet music;
- creating and distributing CD-ROM collections; and
- developing the Sunhawk.com web site.
In September 1996, we began selling CD-ROMs of the complete works of Scott
Joplin, and in July 1997, we began selling CD-ROMs of Handel's Messiah, both
containing digital sheet music in our Solero(R) format. We launched our web site
in February 1997 and made our first sale of digital sheet music in March 1997.
In 1998, we established our strategic alliances and entered into contracts with
Warner Bros. Publications U.S. Inc. and EMI Christian Music Publishing for the
right to sell and distribute selected portions of their sheet music catalogs.
From March 1997 through September 30, 1999, we sold approximately 20,500 digital
sheet music products and approximately 1,400 traditional printed sheet music
products and CD-ROMs. Through September 30, 1999, substantially all of our sales
have been derived from the sale of digital or printed sheet music and CD-ROMs
through our web site and from special promotions and services for our strategic
partners.
Sales are primarily derived from digital and printed sheet music offered
over the Internet and either downloaded directly from our web site or ordered
from our web site and delivered via regular mail or overnight courier. Sales are
net of any applicable discounts, and sales of traditional printed sheet music
include shipping and handling charges. A customer's account is settled by
directly charging his credit card. For digital sheet music downloaded over the
Internet, revenues are recognized upon execution of the order. Revenues from
sales of traditional printed sheet music are recognized upon shipment of the
printed sheet music from our offices in Seattle, Washington.
Cost of goods sold consists principally of the costs associated with
royalty payments, materials, amortization of the cost of producing digital
masters, shipping costs and credit card processing fees. In order to expand our
digital sheet music catalog, we entered into contracts with Warner Bros.
Publications U.S. Inc. and EMI Christian Music Publishing for initial terms of
ten and five years, respectively, from the date of execution. These contracts
provide us with access to selected portions of the music catalogs of Warner
Bros.
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Publications U.S. Inc. and EMI Christian Music Publishing. Upon the sale of any
digital title licensed from Warner Bros. Publications U.S. Inc. or EMI Christian
Music Publishing, we are required to remit the appropriate royalty to the
respective publisher. Royalty payments range from 10% to 70% and are based on
actual sales, less credit card processing fees and shipping costs, if any.
Inventory consists of CD-ROMs and the cost of the printed sheet music books.
Amortization of the cost of producing digital masters relates to the digital
sheet music and is based on the shorter of estimated useful lives or the term of
the distribution contracts for the digital masters. Shipping costs and credit
card processing fees include costs related to the shipping of traditional
printed sheet music and the processing of credit card payments for printed and
digital sheet music. We expect that our cost of goods sold will increase
significantly as we accelerate our production of digital sheet music and enter
into additional strategic partnerships to further develop and expand our catalog
of digital sheet music and recorded music. Furthermore, amortization of the
music catalog distribution rights began in the quarter ended June 30, 1999,
resulting in an increase in cost of goods sold. The amortization of music
catalog distribution rights is approximately $38,000 per quarter through the
remaining term of the Warner Bros. Publications U.S. Inc. contract, which ends
December 31, 2007.
Selling expenses consist primarily of promotional and advertising
expenditures, including payroll and payroll-related expenses. We have incurred
minimal advertising expenditures to date as we have focused our efforts on
creating our digital sheet music catalog and securing strategic alliances and
the rights to digitize sheet music. We expense all advertising costs as
incurred, and we expect selling expenses to increase significantly as we seek to
increase the number of Solero(R) Viewers downloaded from our web site or
distributed on CD-ROMs and enhanced CDs, drive customer traffic to our web site,
enhance our brand name awareness and otherwise promote the sale of our products.
General and administrative expenses consist primarily of management salaries and
expenses, insurance premiums, rent, telephone costs, travel expenses for general
business, legal and professional fees, staff salaries, other payroll expenses
and other related expenses for general corporate functions.
To date we have incurred and expect to continue to incur substantial costs
in order to:
- expand our sheet music catalog;
- produce, distribute and sell digital and printed sheet music;
- develop our technologies;
- acquire patents and other intellectual property rights;
- acquire the rights to sheet music;
- secure and maintain relationships with Warner Bros. Publications U.S.
Inc. and EMI Christian Music Publishing;
- further develop our operational infrastructure and web site;
- distribute and sell certain recorded music;
- increase the size of our staff;
- expand our sales and marketing efforts; and
- upgrade our software and hardware.
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RESULTS OF OPERATIONS FOR THE YEAR ENDED SEPTEMBER 30, 1999 COMPARED TO THE YEAR
ENDED SEPTEMBER 30, 1998
Sales
Sales for the year ended September 30, 1999, were $100,575 compared to
$27,263 for the year ended September 30, 1998. This increase in sales resulted
from entering into strategic alliances with Warner Bros. Publications U.S. Inc.
and EMI Christian Music Publishing, offering printed sheet music on our web site
and providing a wider selection of music titles in our Solero(R) format. We also
benefitted from the overall increase in Internet shopping. In addition, in order
to increase customer traffic to our web site, we offered a variety of
promotional features on our web site and provided special services for our
strategic partners.
Cost of goods sold
Cost of goods sold for the year ended September 30, 1999 were $171,725
compared to $22,517 for the year ended September 30, 1998. The increase in cost
of goods sold was primarily due to commencement of the amortization of the music
catalog distribution rights during the third quarter of fiscal year 1999. The
increase was also due to an increase during the year ended September 30, 1999 in
the proportion of royalty-bearing sales to sales of public domain titles which
do not bear royalties. Additionally, amortization of digital sheet music masters
during the year ended September 30, 1999 increased as the number of digital
sheet music titles produced during that period increased. For the year ended
September 30, 1999, royalty payments accounted for $38,159, or 38% of sales.
Costs associated with the amortization of digital sheet music masters accounted
for $20,946, or 21% of sales and costs associated with the amortization of music
catalog distribution rights were $75,378, or 75% of sales. For the year ended
September 30, 1998, royalty payments accounted for $4,183, or 15% of sales, and
costs associated with the amortization of digital sheet music masters accounted
for $8,347, or 31% of sales.
Selling, general and administrative expenses
Selling expenses for the year ended September 30, 1999, were $547,694,
including advertising costs of $218,403, compared to $82,915, with advertising
costs of $36,005, for the year ended September 30, 1998. Selling expenses for
both periods consisted primarily of expenditures incurred in connection with
advertising, attending trade shows, establishing and maintaining our strategic
alliances with Warner Bros. Publications U.S. Inc. and EMI Christian Music
Publishing, expansion of our web site and payroll-related expenses. In the third
quarter of 1999, we initiated our strategic marketing plan. As part of this
plan, we experienced a significant increase in advertising costs as part of the
new strategic marketing plan. General and administrative expenses for the year
ended September 30, 1999 were $2,113,239 compared to $1,270,956 for the year
ended September 30, 1998. The increase was primarily due to the expansion of our
production capabilities to grow our digital sheet music catalog, hiring key
management personnel, increases in corporate facility expenses necessary to
operate the business, and the relocation of our office.
Interest expense on notes payable to shareholder
Interest expense for the year ended September 30, 1999, was $115,394
compared to $126,454 for the year ended September 30, 1998. On October 1, 1999,
the accrued interest amount of $113,928 was converted to a note payable to
shareholder and began accruing
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interest. The interest expense was attributable to loans made to us by the Eller
and McConney 1995 Family Living Trust, which loans were converted into common
stock on March 31, 1999.
RESULTS OF OPERATIONS FOR THE YEAR ENDED SEPTEMBER 30, 1998 COMPARED TO THE YEAR
ENDED SEPTEMBER 30, 1997
Sales
Sales for the year ended September 30, 1998 were $27,263 compared to
$15,066 for the year ended September 30, 1997. Sales for the year ended
September 30, 1997 consisted of sales over the Internet of sheet music converted
into Solero(R) format and CD-ROMs. The increase in sales was principally due to
the expansion of our music catalog and customer base, which resulted from the
inclusion of song titles from the Warner Bros. Publications U.S. Inc. and EMI
Christian Music Publishing catalogs and the addition of traditional printed
sheet music on our web site.
Cost of goods sold
Cost of goods sold for the year ended September 30, 1998 was $22,517
compared to $5,014 for the year ended September 30, 1997. The increase in cost
of goods sold was due to an increase in the proportion of royalty-bearing sales
to sales of public domain titles which do not bear royalties and an increase in
the amortization of digital sheet music masters due to the increase in the
number of digital sheet music titles from $1,804, or 12% of the sales for the
year ended September 30, 1997, to $8,347, or 31% of sales for the year ended
September 30, 1998.
Selling, general and administrative expenses
Selling expenses for the year ended September 30, 1998 were $82,915
compared to $65,021 for the year ended September 30, 1997. This increase was due
primarily to our attendance at more trade shows and general advertising. General
and administrative expenses for the year ended September 30, 1998 were
$1,270,956 compared to $789,437 for the year ended September 30, 1997. This
increase was primarily due to the expenses associated with operating a larger
office, improvements and upgrades to our facilities and software and hardware,
increases in the number of personnel necessary to support the growth of our
business and operations, and costs incurred in connection with adding production
and programming functions and enhancing the features and functionality of our
web site and related technology.
Interest expense on notes payable to shareholder
Interest expense for the year ended September 30, 1998 was $126,454
compared to $66,577 for the year ended September 30, 1997. This increase was due
to the additional debt we incurred in order to satisfy our operating costs and
expenses.
LIQUIDITY AND CAPITAL RESOURCES
We have financed our operations since inception primarily with funds
received from the sale of equity to and loans from the Eller and McConney 1995
Family Living Trust. As of September 30, 1999, we had cash of $18,300 and a
working capital deficiency of
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$1,337,009. We are currently financing our daily operations primarily through a
line of credit with a financial institution. As of the date of this prospectus,
$1,000,000 has been drawn on this line of credit.
On January 12, 2000, we entered into an Agency Agreement with Joseph Gunnar
& Co., LLC, which is also the underwriter of this offering, to obtain from third
parties bridge financing loans totaling $1,000,000. The loans bear interest at a
rate of 8.5% per annum and will be due at the earlier of the closing of this
offering or September 26, 2000. The loans hold a first security on Sunhawk.com's
assets as collateral. The loans have a 50% warrant coverage, which equates to
1,042 warrants per $25,000 of loan proceeds for a total of 41,680 warrants at
the initial public offering price, which is assumed to be $12.00 per share. The
warrants may be adjusted for stock splits, recapitalization, or reorganization
of Sunhawk.com. The warrants are exercisable commencing six months following the
closing date of this offering. Upon closing, payments to Joseph Gunnar & Co.,
LLC will include
- a commission equal to 7% of the aggregate loan amount;
- a structuring fee equal to 3% of the aggregate loan amount;
- reimbursement of out-of-pocket expenses; and
- reimbursement of reasonable fees and disbursement of counsel to Joseph
Gunnar & Co., LLC.
The loans closed on January 26, 2000.
In connection with securing the bridge financing loans, there may have been
a violation of Section 5 of the Securities Act of 1933 and Sunhawk.com may be
subject to liability, which may require us to repay the funds loaned to us in
connection with the bridge financing. Under the terms of the bridge financing
loans, the loans are to be repaid from the proceeds of this offering.
Net cash used in operating activities totaled $1,711,433 for the year ended
September 30, 1999 compared to $1,210,904 for the year ended September 30, 1998.
The increase for the year ended September 30, 1998, as compared to the prior
year, was primarily attributable to increases in advertising and production
staff.
Net cash used in investing activities was $511,490 for the year ended
September 30, 1999 compared to $267,533 for the year ended September 30, 1998.
The increase in cash used in investing activities for the year ended September
30, 1998, as compared to the prior year, was primarily for the acquisition of
property, equipment, digital sheet music masters, patents and trademarks.
Net cash provided by financing activities was $2,182,130 for the year ended
September 30, 1999 compared to $1,513,902 for the year ended September 30, 1998.
The increase in net cash for financing activities for the year ended September
30, 1999 was primarily derived from proceeds from the sale of common stock to
the Eller and McConney 1995 Family Living Trust in the aggregate amount of
$1,500,000 and proceeds from notes payable in the aggregate amount of $1,645,000
issued to the Eller and McConney 1995 Family Living Trust which, along with
other notes payable to the Eller and McConney 1995 Family Living Trust, were
converted into common stock at a conversion price of $13.31 per share on March
31, 1999. This was offset by an increase of $1,063,095 in deferred offering
costs in the year ended September 30, 1999 compared to the prior year. Net cash
provided by financing activities for the year ended September 30, 1998 was
primarily derived from proceeds from notes payable issued to the Eller and
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McConney 1995 Family Living Trust in the aggregate amount of $1,413,902, which,
along with other loans by the Eller and McConney 1995 Family Living Trust, were
converted into common stock at $13.31 per share on March 31, 1999.
We believe that the net proceeds from our prior financing, the debt to
equity conversion by the Eller and McConney 1995 Family Living Trust, and this
offering will provide us with the necessary cash proceeds to allow Sunhawk.com
to continue operations and meet our material commitments, such as our annual
lease payments, through at least January, 2001. We have no current arrangements
with respect to, or potential sources of, additional financing. If we seek to
raise additional capital, we cannot assure you that any future financing will be
available to us if needed, on commercially reasonable terms, or at all. Any
inability to obtain additional financing if needed may cause us to be unable to
continue as a going concern and it would be necessary to consider other
alternatives such as substantially curtailing our operations.
YEAR 2000 COMPLIANCE
Although we have not experienced any Year 2000 problems, it is possible
that Year 2000-related issues may cause problems or disruptions. While we
believe that all of our systems are Year 2000 compliant, we cannot assure you
that we will not discover a problem during 2000 that needs to be upgraded,
modified or replaced. In addition, we depend on a number of third-party vendors
to provide both information and non-information technology systems and services.
While we believe that our material third-party systems and services are Year
2000 compliant, we cannot be sure that we will not experience any problems
during 2000. We also cannot provide any assurance that governmental agencies,
utility companies, Internet access companies and others outside of our control
will not experience any future Year 2000 problems.
We believe that the Year 2000 issue will not have a material adverse effect
on our business, financial condition or operating results. However, despite all
of our efforts to-date towards insuring Year 2000 compliance, latent issues may
still surface in the future that require upgrades, modifications or replacement,
all of which could be time-consuming and expensive. In addition, there can be no
assurance that utility companies, Internet access companies and our third-party
vendors will be Year 2000 compliant. The failure by such entities to be Year
2000 compliant could result in a systemic failure such as a prolonged Internet,
telecommunications or electrical failure.
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BUSINESS
OVERVIEW
We are an Internet based digital rights management and digital publishing
company. We provide digital rights management technology, proprietary digital
products preparation and enhancement and a digital distribution infrastructure
for the secure digital delivery of proprietary digital products over the
Internet. Our digital rights management technology enables us to securely
distribute licensed copyright-protected digital content on behalf of our
strategic partners and, ultimately, on behalf of any owner of such material.
Anything that can be copyrighted can also be digitized and distributed over
the Internet, including text, audio, video, photographic images, film, sheet
music, literature, and software. While most information available on the
Internet is intended to be free, proprietary digital products are expected to be
sold or licensed, and new systems are required to allow these transactions to
take place securely over the Internet, to account for them, and to restrict
copying.
Our digital rights management distribution system is based upon proprietary
software that encrypts proprietary digital products so that they can be viewed
and heard, if applicable, only by the customer. We distribute our Solero(R)
viewer via the Internet, which identifies the customer and allows the
proprietary digital products which are downloaded to the customer to be viewed,
heard, if applicable, and printed out, after payment. For two years we have been
efficiently conducting secure international distribution of certain proprietary
digital products on behalf of our business partners, as either a principal or
service provider, and will market our digital rights management technology to
others for their use, as appropriate.
In addition to our ability to securely distribute proprietary digital
products, we are, with patented technology, enhancing copyrighted materials to
add significant value to them. We have applied such technology initially for
digitally enhancing sheet music, and these enhanced products have been sold
since 1997. Sheet music is digitized and enhanced by us to animate the notes
played while hearing them, allowing for variations in tempo, allowing the user
to add or subtract instruments and showing notes being played on a keyboard or
other instrument being scored, all in a real-time interactive manner. Our
business partners in the digitized sheet music activities to date, with whom we
have long term licenses, include Warner Bros. Publications U.S. Inc., which also
owns 7% of Sunhawk.com, EMI Christian Music Publishing a division of EMI
Christian Music Group, and Mel Bay Publications, Inc.
We also securely distribute music in the MP3 compressed format using our
digital rights management distribution system for our partners. Additionally,
discussions are underway with book publishers and other owners of content to
digitize and distribute these proprietary digital products. We also intend to
act as a publisher of proprietary digital products of which we will own the
rights.
Our digital rights management technology, digital content preparation and
enhancement and digital distribution infrastructure provide the foundation for
our operations. This structure enables us to provide a full spectrum of value
added services to copyright owners and other publishers of proprietary digital
products for sale over the Internet.
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LIMITATIONS OF THE TRADITIONAL PHYSICAL METHOD OF SALE AND DISTRIBUTION OF
PROPRIETARY DIGITAL PRODUCTS
Proprietary digital products are characterized by two elements: copyrighted
digital content and associated licensing or sale rights. Copyrighted products
have traditionally been distributed through a physical distribution chain. The
book text or sheet music is copied onto physical media, inserted into physical
packaging and physically distributed through a multi-party distribution chain
that eventually delivers the goods to a retail store or a corporate reseller
where they are ultimately purchased by the customer.
Each participant in the physical distribution of proprietary digital
products must manage independently the costs of manufacturing, warehousing and
shipping physical inventory. In addition, the physical distribution process
imposes significant time delays and geographic constraints on the delivery of
products. These numerous and complex inter-relationships pose challenges to the
timely and accurate sharing of information about customers, products, pricing,
inventory and order status. Further, limitations on warehousing, transportation
systems and retail shelf space restrict the number of products that publishers
can make available to customers and discourage distributors from carrying low
volume products.
INTERNET BACKGROUND
The Internet has emerged not only as the fastest growing communications
medium in history, but also as one of the most efficient distribution channels
for commerce. According to International Data Corporation, total worldwide
Internet commerce spending was $50.4 billion in 1998 and is estimated to grow to
$1.3 trillion in 2003.
While most Internet commerce to date has involved the delivery of physical
goods like books and compact discs ordered online, the Internet is also becoming
a leading distribution channel for proprietary digital products. Today, most
content is in, or can be put into, digital form. This content includes music,
videos, games, books, software, publications, business information, and images.
The Internet can be used to disseminate this digital information efficiently to
broad audiences across geographic boundaries, and eliminates many of the
traditional costs associated with manufacturing, packaging, and distribution.
The growing number of households and businesses connected to the Internet, and
the widespread use of electronic devices other than personal computers, such as
set-top boxes, portable music players, mobile phones, and other hand-held
devices, all of which are becoming connected to the Internet, make the Internet
an ideal channel for the distribution of proprietary digital products. In
addition, downloading digital content is becoming significantly easier with the
emergence and adoption of broadband technologies including digital subscriber
lines and cable modems, and enhanced compression technologies including MP3 for
music and MPEG-4 for video. The Internet also complements the existing channels
for distributing proprietary digital products on physical media like compact
discs and DVDs.
SALE AND DISTRIBUTION OF PROPRIETARY DIGITAL PRODUCTS OVER THE INTERNET
The Internet provides an efficient platform for the electronic distribution
of proprietary digital products. The electronic distribution of proprietary
digital products can:
Reduce costs. Electronic distribution can reduce manufacturing, packaging,
inventory and shipping costs associated with physical media alternatives.
For sheet music and
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other proprietary digital products distributed electronically, businesses
can reduce costs incurred managing physical product and improve asset
management through the electronic use reporting. Secure electronic
management of distribution and analysis of compliance with licensing rights
can also reduce illegal distribution and piracy.
Increase selling opportunities. Because electronic inventory requires no
physical shelf space, retailers, such as Sunhawk.com, can offer a virtually
unlimited number of products. Publishers, authors, artists and other
digital content owners can deliver new products and upgrades to retailers
or customers worldwide immediately upon their release. Retailers and
original equipment manufacturers can also expand distribution by providing
customers with encrypted digital content stored on computer hard drives,
DVDs or CDs and by allowing customers to complete the sales process through
the subsequent purchase of the proprietary digital product over the
Internet.
Facilitate real-time information exchange. Electronic distribution can
provide publishers and retailers access to sales information on a real time
basis.
SUNHAWK.COM'S SOLUTION FOR THE SECURE SALE AND DISTRIBUTION OF PROPRIETARY
DIGITAL PRODUCTS OVER THE INTERNET.
The characteristics that make the Internet ideal for distributing
proprietary digital products also make it susceptible to piracy and misuse.
Digital content, if not properly protected and managed, can be easily copied
without any degradation in quality, altered and defaced, and distributed with
the touch of a button to a large number of recipients. As the number of users
connected to the Internet and the amount of digital content transmitted over the
Internet increases, these users and this information become more vulnerable to
parties who wish to interfere with the integrity of digital information and
digital transactions. As a result, owners of proprietary digital products,
including text, music and video publishers, are concerned about the ability to
protect the digital distribution of their content.
Recent events in the music industry provide the most visible example of an
industry facing the problem of protecting and managing its rights related to
digital information. MP3 technology, which compresses music with near-compact
disc quality, has rapidly become recognized as a major threat to the music
industry. With readily available MP3-enabled software, music can be copied from
compact discs into computers, compressed to under 10% of its former size,
redistributed, played, and even copied back onto a blank compact disc for
private use or pirated resale. Songs in the MP3 format can be moved from
personal computers to portable consumer devices and then played through
headphones or stereo speakers. Every compact disc published and distributed is
at risk of being copied. Already, many popular titles have been digitized in the
MP3 format and widely distributed throughout the Internet. As a result, the
Internet is the principal channel of direct MP3 distribution.
Our digital rights management distribution system uses encryption as the
centerpiece for securely protecting, distributing and managing digital data sold
over the Internet. Encryption is the process of changing data into a format that
can be accessed only by the intended recipient. The patent entitled "Encryption
System with Transaction Coded
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Decryption Key" is directed to a technology for monitoring the distribution of
encrypted digital data. The following is a description of how our system works:
- A customer identifies himself/herself. In our system this is the
registration of the Solero(R) Viewer whereby each download Solero(R)
Viewer is assigned a unique identifier.
- A customer downloads data. When a customer requests data for download,
the data is uniquely encrypted for that customer's Solero(R) Viewer based
on the customer's unique identifier.
- A customer purchases data. When a customer purchases a license to use the
data, we also distribute the unique digital "key" necessary to unlock the
data.
- The data remains encrypted. The distributed file remains encrypted at all
times, and each time the digital content is used, it is decrypted
"on-the-fly" using the key provided to that Solero(R) Viewer system.
Since each digital file is uniquely encrypted and can only be decrypted by
the specific Solero(R) Viewer which was used to purchase the digital content,
unauthorized redistribution of the digital content is limited. Specifically,
digital rights are protected and managed at numerous levels:
- If a user passes a digital file to a friend, because the file remains
encrypted at all times and can only be decrypted by the unique "key"
provided upon purchase, the recipient cannot open the encrypted file and
therefore it cannot be used.
- If a user is able to identify the key and decrypt a file, and then
attempts to pass the decrypted file along to a friend, the friend's
Solero(R) Viewer will not read the decrypted file because only the
original user's key enabled Solero(R) Viewer works with that particular
decrypted file.
- If a user illegally passes a decrypted file along with a purchased key to
a friend the key identifies the user and can be used to track users who
illegally provide files to other users.
Our digital rights management distribution system includes a
download-then-pay feature. The download-then-pay feature allows a customer to
first download the file onto his PC and preview a portion of the product before
paying for it. This feature minimizes online transaction failures, such as
customer cancellations and download malfunctions. Upon receipt of the customer's
credit card information, the digital content is "unlocked" with the digital key
described above and the customer can then view, play and print the content.
Our digital rights management distribution system provides a total solution
to the concerns of publishers that their copyrighted content be protected when
distributed over the Internet. Further, this distribution system and other
proprietary technology provides publishers and content owners with a method for
efficiently monitoring the distribution of content so that royalties due and
owed to the publisher are paid in a timely manner.
STRATEGY
Our business strategy is to use our patented and operational digital rights
management distribution system to empower artists, authors, musicians,
publishers and other owners of
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proprietary digital products to sell their digital content on the Internet
through us in a secure and efficient manner and to become a leading secure
digital distribution solution provider. The key elements of our strategy are:
Extend the application of our digital rights management distribution
system -- We will target leading technology and device companies that can, on an
OEM basis, incorporate our digital rights management technology in computers,
consumer electronics and portable devices, including lap tops and music players,
so that it is readily available for applications over the Internet. We are in
the process of establishing strategic relationships with certain of these
companies to achieve "Sunhawk Inside" status.
Apply our digital rights management distribution system to other
proprietary digital products markets -- To date, we have focused predominantly
on the sheet music market because we believe it is a finite, identifiable and
manageable market for proprietary digital products. As electronic distribution
of other digital goods such as audio, video, books, music, and film images
develops commercially, we may build our presence in these markets. We believe
the security, distribution and piracy concerns of these markets are similar to
those of the music industry, in general, and the sheet music industry, in
particular, and we believe that our solution will allow us to address these
needs successfully.
Expand strategic partnerships -- We will expand our strategy of providing
our digital rights management distribution system to artists, authors,
musicians, publishers and owners of proprietary digital products to enable them
to achieve greater control over the distribution of their digital content and
receive larger revenue streams from the sale of their content. We are targeting
relationships that will establish our digital rights management distribution
system initially in several specific markets, including sheet music, audio,
video and book publishing. We intend to leverage our activities in the sheet
music market to help encourage adoption and usage in other markets, including
establishing relationships with one or more artists.
Promote content preparation and enhancement services -- We have developed
interactive, animated and content rich sheet music on behalf of our strategic
partners Warner Bros. Publications U.S. Inc. and EMI Christian Music Publishing.
We intend to continue entering into direct relationships with premier and
emerging publishers, artists, musicians and other owners of digital content and
developing various features for this content that enhance both the content
owner's presentation and the user's experience. In addition, we will encourage
content providers to use our digital rights management distribution system for
the secure delivery of their content.
Provide electronic commerce services -- We enable our strategic partners to
sell their proprietary digital products on our website and refer customers and
benefit from sales which originate from our strategic partners' websites. In
either case, our digital rights management distribution system securely manages
all aspects of every transaction.
By providing a combination of digital rights management technology, digital
content preparation and enhancement services and electronic commerce technology
in multiple markets, we will be able to offer a wide variety of services and
technology to strategic partners desiring to securely distribute proprietary
digital products over the Internet.
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PRODUCTS AND SERVICES
We have used sheet music as the initial product for the application of our
digital rights management distribution system, preparation and enhancement
services and e-commerce technology. In converting traditional printed sheet
music into a digital encrypted format that can be delivered over the Internet
through our digital rights management distribution system and then viewed,
listened to, stored on and printed from a customer's computer, we have changed
the manner in which sheet music is published, distributed and purchased. We are
replacing traditional printed sheet music with a playable, interactive digital
format containing security and educational features. Our products offer
customers a highly efficient and more complete and enjoyable musical experience
while providing music publishers with a means to limit the unauthorized
redistribution of their digital sheet music and efficiently monitor the
royalties due upon purchase.
DIGITAL RIGHTS MANAGEMENT DISTRIBUTION TECHNOLOGY. Our digital rights
management distribution technology delivers digital sheet music and music in the
MP3 format over the Internet to individuals and businesses in a manner that is
user-friendly and protects the copyrighted content of composers, owners, authors
and publishers. Utilizing our proprietary technology, we are able to convert
scanned images of printed music into interactive digital music, which customers
are then able to download, play and purchase. Through our digital rights
management distribution technology, we are able to limit the unauthorized
distribution by the end-user of the music files and efficiently track the
royalty payments to be paid to the publisher and others. As a result, our
offerings are attractive both to end-user consumers as well as to composers,
authors, owners, publishers and other strategic partners.
DIGITAL AND PRINTED SHEET MUSIC CATALOG. Our web site provides customers
with easy access to our catalog of print and digital sheet music products. Our
current customers include musicians, composers, educators, recreational
musicians and other individuals interested in music. A customer can access our
store front at www.sunhawk.com or through referrals from the Warner Bros.
Publications U.S. Inc. and EMI Christian Music Publishing web sites. Once a
customer has entered our web site, he may search for a song by composer, artist,
title or keyword. In addition, our titles are arranged by music type such as
rock, classical, Christian and country, and a customer can browse these pages
based on his own music preferences and interests. Our site also features "top
ten" lists, new releases and editor's picks to further stimulate customer
interest in our products.
Our library of interactive digital sheet music in the Solero(R) format
contains numerous song titles and represents many genres of classical and
popular music. Customers may also purchase traditional printed sheet music on
our web site by ordering the selected song titles online and having the sheet
music delivered in print form by mail or courier service.
We must continue to develop new or enhanced proprietary digital products in
a timely manner in order to take advantage of rapid technological change and new
business opportunities. In order to remain competitive we may change our
business model to take advantage of new business opportunities, including
business areas in which we do not have extensive experience. For example, we
intend to extend our technology to digital content types other than music, and
may start licensing our digital rights management technology.
PREPARATION AND ENHANCEMENT. Our preparation and enhancement services
provide publishers and customers with a content rich digital product. We have
the ability to
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digitize large amounts of content that, heretofore, has not been converted into
a digital format and to add features to this content that create a unique and
enhanced user experience. We are currently digitizing significant portions of
Warner Bros. Publications U.S. Inc.'s and EMI Christian Music Publishing's sheet
music catalogs and creating and selling an interactive sheet music product that
provides the customer with a variety of features not otherwise available from
the traditional paper product.
Our Sunhawk software allows us to create a library of digital content. The
Solero(R) software provides a digital format for the conversion, creation,
completion, storage and distribution of digital sheet music as well as other
digital content. This format can capture standard music notation, audio, lyrics,
guitar tablature and chords, big note formats and other forms of digital
content. The digital information is then stored in a sophisticated relational
database, which allows for advanced searches and efficient distribution to end-
users.
The Solero(R) musical optical character recognition software performs
"musical OCR" by converting scanned images of printed music into digital music.
We have a proprietary technology for electronically storing the musical symbols
contained in a musical score, such as note heads and stems, in a nonsequential
format. The patent entitled "Method and Apparatus for Nonsequential Storage of
and Access to Digital Musical Score and Performance Information" is directed to
processing musical scores in a nonsequential format. Our technology for
electronically storing musical symbols works as follows:
- The digital music technology assigns a different table for each type of
symbol, such as a table for stems.
- Each table contains cross-references that enable the musical score to be
quickly and accurately generated in visual or audio form.
- The nonsequential format facilitates forward and backward compatibility
of different versions of the format and produces files that are highly
compressible.
The Solero(R) Editor is used to complete the conversion to digital music
initiated by the Solero(R) OCR software and is also used by composers to create
and engrave, the process of typesetting music notation and original music. The
Solero(R) Editor was specifically developed with the needs of music publishers
in mind in order to encourage its adoption as a standard for music engraving.
The Solero(R) Editor enables us to finalize and refine our digital sheet music.
The Solero(R) Viewer is used to play and print the music and view the
animation of the Solero(R) format files that have been created with the
Solero(R) OCR software and the Solero(R) Editor, and to play the Sunhawk Audio
files.
SOLERO(R) VIEWER. We provide our Solero(R) Viewer free of charge on our web
site. Simply by clicking the "download" button on the Sunhawk.com web site,
customers can download our Solero(R) Viewer, thus gaining the ability to
download and view our digital sheet music products. As of September 30, 1999,
approximately 50,000 Solero(R) Viewers had been downloaded and registered.
Once a customer has selected a title that is available in our Solero(R)
format, he can download the digitized music file onto his PC and listen to a
portion of the music before paying for the title, thus allowing him to preview
various selections before electing to purchase. In addition, our Solero(R)
Viewer allows the customer, upon purchase, to view and print the music, or, when
listening to its audio playback, change its tempo, instruments or
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sing or play his own musical instrument along with it. A screen shot of our
Solero(R) Viewer and its various features is set forth below:
[SOLERO VIEWER PICTURE]
1) Open the music index
2) Purchase music
3) Print the score
4) Move from page to page
5) Select one or two page view
6) Visit Sunhawk.com
7) Change the instruments
8) Adjust the tempo
9) Start, stop or pause playback
10) Notes are highlighted on playback
11) Optional player piano view
12) View of the music index
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SUNHAWK AUDIO. Our e-commerce technology enables us to compress recorded
music files utilizing MP3 technology, encrypt these files and deliver them to
customers in our Sunhawk Audio format. These Sunhawk Audio files can be
downloaded from our web site and stored on the customer's PC. When Sunhawk Audio
files are delivered and downloaded, they can only be played using our Solero(R)
Viewer and, by virtue of our encryption technology, can be accessed only by the
purchasing customer. In addition, as with digital sheet music, our digital
rights management distribution system facilitates the purchase of the music,
limits any unauthorized redistribution of this digital music and tracks royalty
payments owed to publishers and others.
ENHANCED CDS. We also enhance traditional audio CDs by including our
Solero(R) Viewer on these CDs. By including our Solero(R) Viewer on the CD, a
record company can include digital liner notes, graphics, text or any other
information on the enhanced CD. At the same time, the record company can include
on the CD a digital sheet music version of one of the songs featured on the CD
as well as links to our web site where the customer can download other digital
sheet music versions of the songs included on the audio CD. To date, EMI
Christian Music Publishing has distributed approximately 85,000 enhanced CDs
containing our Solero(R) Viewer.
DIGITAL BOOKS. We are in discussions with publishers and other owners of
books to acquire the rights to digitize and distribute this content as
proprietary digital products through our digital rights management system.
THE SUNHAWK.COM WEBSITE
Our website offers a variety of benefits to publishers, customers, artists,
musicians and other owners of digital content. We update our website frequently
to address expressed needs of our strategic partner publishers, customers,
musicians and artists and continue to seek to improve the user experience. The
following table describes some of the features of our current website:
FEATURES FOR CUSTOMERS
<TABLE>
<CAPTION>
NAME OF FEATURE DESCRIPTION
--------------- -----------
<S> <C>
- - Search................... Quick search by artist/composer, title, keyword;
advanced search by product type.
- - Browse................... Browse catalog by genre, artist, title,
publisher.
- - Free Software............ Free Solero(R) Viewer, regular free songs.
- - New Releases............. Master list for current month and preceding
month; featured list.
- - Special Selections....... Cover art and description on home page and 8
genre pages, 10 selections on each page, updated
regularly.
- - Special Offers........... Regular and seasonal special offers for both
Solero(R) and print products.
- - Collections.............. Solero(R) and print collections with significant
savings over individual titles.
- - Help..................... Instructions on how to shop.
</TABLE>
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<TABLE>
<CAPTION>
NAME OF FEATURE DESCRIPTION
--------------- -----------
<S> <C>
- - Music Lovers Club........ Discount incentive plan and other benefits of
membership.
- - Sponsored Links.......... Links to our strategic partners and special
interest music pages.
</TABLE>
FEATURES FOR PUBLISHERS
<TABLE>
<CAPTION>
NAME OF FEATURE DESCRIPTION
--------------- -----------
<S> <C>
- - Tracking................. Publishers can track downloads and sales on
secure publisher-specific pages.
- - Cross-Links.............. Links to publisher sites.
- - Catalog.................. Separate listings and search by publisher
catalog.
- - Associates Program....... Publisher revenue opportunities by referring
customers from publisher website.
- - Cross-Promotions......... Opportunities for publishers to feature new music
and special promotions on the Sunhawk.com
website.
</TABLE>
SALES AND MARKETING
We employ several concurrent Internet and traditional marketing strategies
in an effort to drive traffic to our web site, increase customer interest in our
products and generate sales. As part of this multi-prong marketing approach, we
are expanding our program of establishing inbound links to our web site from
other third-party sites, such as portals, search engines, musical instrument
sites and related web sites. In addition, we have launched a related associates
program in which web site owners receive sales-based referral fees when they
link customers to us from their web sites. We also intend to augment our online
advertising efforts on industry-specific sites, such as music e-commerce,
publisher, artist and special interest music sites. Finally, we intend to
increase our use of one-to-one customer relationship marketing by continuing our
efforts of sending periodic informational and promotional emails to our current
Solero(R) registrants and expanding the number of individuals in our target
market who receive such online materials.
In addition to driving traffic to our web site through the use of Internet
advertising, we intend to strengthen our brand name and increase customer appeal
through the use of traditional marketing methods. Moreover, we intend to utilize
numerous forms of advertising to promote the Sunhawk and Solero(R) names and
products, including advertising in industry-specific publications, direct
mailing efforts to our target market, distributing CD-ROMs and enhanced audio
CDs containing our Solero(R) Viewer, and participation in trade show events.
These techniques will enable us to target existing and prospective customers in
a cost-efficient manner.
We believe that many traditional retail music stores prefer to carry very
little sheet music in order to avoid the expense of maintaining inventory. We
intend to structure alliances with retail music stores that will allow the music
store to access our web site directly at the store location. We believe this
on-site capability will both generate sales and increase our exposure to our
target market. In addition, we see an opportunity for reciprocal advertising
efforts between our web site and traditional retailers whereby these retailers
agree to promote our web site to their customers in exchange for free or
low-cost
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advertising of their stores on our web site. We also intend to penetrate the
music education market by establishing relationships with private and public
schools and music institutions, thereby increasing our target customer base and
expanding our distribution channels.
INTELLECTUAL PROPERTY
Our success will depend in large part on our ability to protect our
proprietary software and other intellectual property. To protect our proprietary
rights, we rely generally on patent, copyright, trademark and trade secret laws
and generally require our employees, consultants, vendors and corporate business
partners to execute confidentiality agreements. Despite these protections, a
third party could, without authorization, copy or otherwise obtain and use our
products or technology to develop similar technology. Moreover, our agreements
with employees, consultants and others who participate in product and service
development activities may be breached, we may not have adequate remedies for
any breach, and our trade secrets may become known or independently developed by
competitors.
Patents. We have been issued two patents and have two patent applications
and one continuation application pending in the United States relating to our
product architecture and technology. Specifically, we have been issued a patent
relating to our e-commerce technology, "Encryption System with Transaction Coded
Decryption Key," Patent Number 5,889,860, for which a continuation has been
filed to pursue the broader applications of this invention, as well as a patent
relating to our relational database storage of music information, "Method and
Apparatus for Nonsequential Storage of and Access to Digital Musical Score and
Performance Information," Patent Number 5,773,741. Two other patents relating to
music notation and music notation input, respectively, are pending.
Despite these efforts, our pending or future patent applications may not be
granted and our existing or future patents may be challenged, invalidated or
circumvented. Many of our current and potential competitors dedicate
substantially greater resources to protection and enforcement of intellectual
property rights, especially patents. If a blocking patent has been issued or is
issued in the future, we would need either to obtain a license or to design
around the patent. We may not be able to obtain a required license on acceptable
terms, if at all, or to design around the patent.
We attempt to avoid infringing known proprietary rights of third parties in
our product and service development efforts. We have not, however, conducted and
do not conduct comprehensive patent searches to determine whether the technology
used in our products infringes patents 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. If we
were to discover that our products violate third-party proprietary rights, we
may not be able to obtain licenses on commercially reasonable terms to continue
offering these products, and efforts to re-engineer these products may not be
successful. Any subsequent litigation could involve substantial expense and
possible damages awards.
We depend, to a very material extent, on our patents and other technology
related to our digital rights management system and related to our sheet music
proprietary digital products. We understand that the patenting of digital and
Internet technologies has increasingly become a major focus of e-commerce
companies. Patents are perceived as a means of barring competition and adding
value. While we attempt to avoid infringing known proprietary rights of third
parties, there is no assurance that we will not be found to
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infringe upon the proprietary and other rights of others. We generally have not
conducted, and do not conduct comprehensive patent searches to determine whether
the technology used in our products infringe third party patents. Since the
United States patenting process takes an extended period of time, during which
there is usually no disclosure of the patent application, we would generally not
know about a patent that blocks the use of one or more aspects of our technology
until the patent is granted. It can be expected that patents granted in key
areas of Internet commerce will be subject to vigorous challenge. There is no
assurance as to what blocking patents may be granted, or as to how a challenge
to such patents would be resolved. In any event, we expect that the process will
be time consuming and expensive, and potentially materially adverse to our
business.
At the present time, patents have been issued to third parties relating,
for example, to the Internet and e-commerce in general, as well as to the secure
distribution of digital information over the Internet, and the downloading of
music over the Internet in particular. Other digital rights management and
online music distribution companies have received letters from companies
alleging infringement of their patents. In the future, we, or if we decide to
license our technology, our licensees, could be found to infringe upon these and
other patent rights.
Trademarks. Sunhawk(R), Sunhawk.com, the Sunhawk.com logo and Solero(R) are
our trademarks and registered trademarks. We intend to continue to pursue the
registration of our other trademarks in the United States and in other
countries. However, we cannot assure you that we can prevent all third-party use
of our trademarks or that our trademarks will be available for use in
association with other proprietary digital products. All other trademarks and
trade names appearing in this prospectus are the property of their respective
holders.
Copyrights and other proprietary rights. The underlying music we distribute
in digital and print form is protected by copyright law, unless the music has
become part of the public domain. Even if the underlying music has become part
of the public domain, we take steps to add copyrightable and other proprietary
elements in creating our Solero(R) editions. There is no assurance that the
steps we take will be adequate to protect these rights or that we will be
successful in preventing the illegal duplication, distribution or other use of
our products. Our failure to adequately limit the unauthorized redistribution of
our music products could result in litigation or liability, which could harm our
business.
We generally procure licenses for the music distributed in digital and
print form from third-party licensors, including music publishers and composers,
on a non-exclusive basis. Some of our competitors offer, or could offer, the
same sheet music song titles that we have licensed from these music publishers.
In some cases we own the copyrights in the underlying music. The underlying
music may be owned by a single copyright owner or have multiple copyright
owners. We have different licensing arrangements with these parties depending on
what rights we acquire. These arrangements range from formal contracts to
informal agreements based on the nature of the subject matter. We often rely on
our positive working relationships with copyright owners to obtain licenses on
favorable terms. Any changes in the nature or terms of these arrangements,
including any requirement that we pay significant fees for the use of the
content, or if such arrangements are found to be unenforceable, could have a
negative impact on the availability of content and could harm our business.
We currently hold various Internet domain names relating to our brands,
including the "Sunhawk.com" domain name. Domain names generally are regulated by
Internet
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regulatory bodies. The manner in which domain names are regulated in the United
States and in foreign countries is subject to change, and any adverse change in
these regulations could harm our business.
The laws of some foreign countries do not protect our proprietary rights to
the same extent as do the laws of the United States, and effective patent,
copyright, trademark and trade secret protection may not be available in these
jurisdictions.
Circumstances may arise that would cause us to pursue legal remedies in
order to protect our rights and interests in our intellectual property. Any such
litigation, while in our best interests, may be lengthy and expensive. In
addition, any such litigation may be against parties better able than we are to
afford the extensive costs often associated with such litigation.
We rely on technology that we license from third parties, including
software that is integrated with internally developed software and used in our
products and services, to perform key functions. Third-party technology licenses
may not continue to be available to us on commercially reasonable terms. The
loss of any of these technologies could harm our business. Moreover, although we
are generally indemnified against claims that our third-party technology
infringes the proprietary rights of others, this indemnification may be
unavailable or inadequate for all types of intellectual property rights. These
claims, even if not meritorious, could result in the expenditure of significant
financial and managerial resources in addition to potential product service
redevelopment costs and delays, all of which could harm our business.
We consider our patents, trademarks, trade secrets and other similar
intellectual property to be an important part of our business. To protect our
intellectual property rights, we rely upon copyright, trademark, patent and
trade secret laws and generally enter into confidentiality agreements with our
employees, consultants, vendors and corporate business partners. We cannot
assure you that applicable U.S. or foreign laws or our use of confidentiality
agreements will provide sufficient protection from misappropriation or
infringement of our intellectual property rights or the unauthorized use or
distribution of our products, particularly in foreign countries where laws or
law enforcement practices may not protect our intellectual property rights as
fully as in the United States. If third parties were to use or otherwise
misappropriate our copyrighted materials, trademarks or other intellectual
property rights without our consent or approval, independently develop products
utilizing our technologies or breach the security provided by our encryption and
e-commerce technology, our competitive position could be harmed, or we could
become involved in litigation to enforce our rights.
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COMPETITION
As an operator of a digital rights management distribution system for
digital publishing and, in particular, the distribution of digital sheet music
over the Internet, we currently or potentially compete with a variety of
companies. With respect to the market for digital rights management solutions,
we believe competition is intense and rapidly evolving. We expect competition to
continue to increase both from existing competitors and new market entrants. The
digital rights management market is new and we are not aware of any one
competitor that has established a dominant position in the market. However, it
is possible that one or more companies could become a dominant, competitive
force in the future. Our primary competition currently comes from or is
anticipated to come from:
- companies offering secure digital distribution systems, including AT&T,
IBM, Liquid Audio, Microsoft, Preview Systems, Xerox and Intertrust
Technologies; and
- companies offering hardware-based content metering and copy protection
systems, including Sony, Wave Systems, and the 4C Entity, comprised of
IBM, Intel, Matsushita, and Toshiba.
- companies representing combined Internet distribution and proprietary
digital products ownership such as AOL -- Time Warner Bros. Publications
U.S. Inc. -- EMI.
In addition to these two categories, in the future, operating system
manufacturers are likely to attempt to develop or license digital rights
management solutions for inclusion in their operating systems.
Some of our competitors have longer operating histories and significantly
greater financial, technical, marketing, and other resources than we do. Many of
these companies have broader customer relationships that could be leveraged,
including relationships with many of our customers. These companies also have
more established customer support and professional services organizations than
we do. Nonetheless, we believe our digital rights management distribution system
has operated in a reliable and commercial manner over an extended period of time
for Warner Bros. Publications U.S. Inc. and EMI Christian Music Publishing.
With respect to the market for the preparation, enhancement and secure
distribution of digital sheet music, we do not believe any of our competitors,
other than Musicnotes, have converted substantial portions of sheet music into
an interactive digital format that can be stored, encrypted, previewed, played
and printed on a PC. Companies that are currently in similar or potentially
competing businesses include:
- Sheet Music Direct. Sheet Music Direct has developed an Internet-based,
purchase-on-demand delivery system for digital sheet music, but their
music is non-interactive and does not allow the user to play the music,
choose instruments or select tempo. The web site is affiliated with sheet
music distributors Hal Leonard Corporation and Music Sales Corporation.
- Infomusique S.A. Infomusique operates a web site that permits online
printing of non-interactive sheet music purchased from the web site as
well as the purchase of pre-printed sheet music by mail order.
- Net4Music. Net4Music has developed an Internet-based system that enables
publishers to digitize their sheet music from multiple sources into
Adobe's PDF format, and then distribute these scores through customized
orders.
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- Coda Music Technology. Coda has announced that it has developed an alpha
version of a product that would allow online transmission and viewing of
musical scores.
- Musicnotes. Musicnotes has developed an Internet-based,
purchase-on-demand delivery system for digital sheet music. The music is
interactive with notes that light up on playback. The user also has the
ability to change tempo and select instruments. In the current version,
files must be purchased before download, and the program indicates that
printing of the files must be done at the time of download.
As we expand the Sunhawk Audio portion of our business as well as apply our
digital rights management distribution system and digital content preparation
and enhancement services to other digital content, we will face significantly
increased competition and different competitive challenges from other digital
rights management and Internet content providers than we currently experience.
We believe that we have established a variety of barriers to entry to
discourage others from entering into the business of online sale and
distribution of digital music over the Internet, including the following:
- We have developed proven technologies for encrypting and managing the
rights to digital content.
- This technology enables us to provide publishers with the comfort and
security that the digital music files will be used as authorized and that
they will receive the royalties for the purchase of the copyrighted
material.
- We have built a digital production process designed to create what we
believe is one of the largest interactive digital sheet music catalogs
available.
- We have developed and deployed a proven method of digital distribution
which has been adopted by Warner Bros. Publications U.S. Inc. and EMI
Christian Music Publishing, two important music publishers.
- We have developed a process for creating additional features for, and
enhancing the customer's experience with a traditional media form (i.e.
sheet music) and believe we can extend this process into other digital
content.
- We have secured two patents to a portion of our technology and have
developed significant other proprietary software for the conversion and
distribution of digital content.
Despite these potential barriers to entry, many of our current and
potential competitors are well-established companies that have greater
financial, marketing, distribution, brand recognition and other resources than
we have, and there can be no assurance that we will be able to compete
effectively against these companies.
RESEARCH AND DEVELOPMENT
Since our inception, all of the time and financial resources dedicated to
research and development activities to develop our technology and digital sheet
music catalog have been expensed. Accordingly, we have not capitalized any
research and development expenditures. However, we estimate that we spent
approximately $220,000 in research and development activities during the last
three fiscal years. We cannot assure you that we will successfully develop new
technology or that competitors will not develop products, services or other
technology that are superior to ours.
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GOVERNMENT REGULATION
As a Washington-based company, we collect sales taxes for transactions in
the State of Washington only. However, the future taxation requirements for
online transactions are uncertain. One or more local, state, federal or foreign
jurisdictions may seek to impose additional sales or other tax obligations on
us. Proposals have been made at various state and local levels that would impose
additional taxes on the sale of goods and services over the Internet. None of
these has been adopted as of this date. If adopted such taxes could impair the
growth of e-commerce and our business could be harmed. In 1998, Congress passed
the Internet Freedom Act, which imposes a three-year moratorium on state and
local taxes on Internet-based transactions. We cannot assure you, however, that
this moratorium will be extended.
As commerce on the Internet continues to evolve, federal, state, local or
foreign agencies may adopt laws and regulations that may impact our business,
including legislation and regulations relating to the distribution of music and
other content over the Internet and privacy and encryption issues. Moreover, the
applicability to the Internet of existing laws governing issues such as property
ownership, content, taxation, defamation and personal privacy is uncertain.
Further, the growing use of the Internet has burdened the existing
telecommunications infrastructure and has caused interruptions in telephone
service. Telephone carriers have petitioned the government to regulate the
Internet and impose usage fees on Internet service providers. The imposition of
such laws and regulations could expose us to significant liability. In addition,
any such new legislation or regulation or government enforcement of existing
regulations may limit the growth of the Internet, increase our cost of doing
business or increase our legal exposure, any of which could harm our business.
FACILITIES
We lease approximately 20,000 square feet of office space in Seattle,
Washington at an annual rent of approximately $327,000. The remaining lease term
expires on September 1, 2001. These facilities currently house our employees,
and we conduct general corporate and administrative matters, software
development, cataloging, scanning, quality control, music editing, web site
development, server operations and data warehousing from this location. We
believe that our current leasehold facilities are adequate for our intended use
for the foreseeable future.
EMPLOYEES
As of February 11, 2000, we had approximately 60 full-time and 5 part-time
employees. None of our employees is represented by a labor union, and we believe
that our employee relations are good.
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MANAGEMENT
DIRECTORS, EXECUTIVE OFFICERS AND KEY EMPLOYEES
The following table sets forth information about our directors, executive
officers and certain key employees.
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Marlin Eller 46 Chairman of the board, chief executive
officer and president
Tricia Parks-Holbrook 44 Chief financial officer
Jill Ohara 43 Vice president of operations
Gary Martin 46 Vice president of publishing
Mary E. McConney, Ph.D 45 Treasurer
Fred Anton 52 Director
Luis F. Talavera 34 Director
Patricia Tangora 45 Director
</TABLE>
Marlin Eller is a co-founder of Sunhawk.com and is currently our chairman
of the board, chief executive officer and president, positions he has held from
time to time since our inception in 1992. From 1982 to 1995, Mr. Eller held the
position of manager, software development, at Microsoft Corporation. At
Microsoft, Mr. Eller was the development lead for GDI, the graphics subsystem of
Windows 1.0; development lead for Pen Windows; and the designer of handwriting
recognition software. While at Microsoft, he was named as the inventor on six
patents. He also led groups involved in video and data compression and
encryption and started the Microsoft online services. He received his bachelor
of arts, phi beta kappa and magna cum laude, in mathematics/physics from Whitman
College in 1974 and his master of science in mathematics from the University of
Washington in 1979. Mr. Eller also co-authored the book, Barbarians Led by Bill
Gates, published by Henry Holt, Inc. in 1998, and co-authored the article,
Multiple-Scattering Calculations of X-Ray Absorption Spectra, published by The
American Physical Society in 1995. He was a visiting instructor in computer
sciences at Williams College for two years prior to joining Microsoft. Mr. Eller
is married to Ms. McConney, our treasurer.
Tricia Parks-Holbrook joined Sunhawk.com in June 1999 as our chief
financial officer. From 1989 to 1998, Ms. Parks-Holbrook was with KPMG Peat
Marwick, LLP as senior manager and was responsible for supervising the planning
and performance of assurance engagements with clients in a variety of
industries. From 1988 to 1989, she was with CP National Corporation in their
external reporting department. From 1979 to 1988, Ms. Parks-Holbrook worked with
PGL Corporation, a subsidiary of F.H. Tompkins, PLC, a public company in the
United Kingdom, serving the last three years in the capacity of controller. Ms.
Parks-Holbrook received her bachelor of science, cum laude, in business
administration with an accounting option from California State University at
Hayward, California in 1988. While there she received the San Francisco
Financial Executive Institutes Medallion Award. She is licensed and certified as
a public accountant in California (1991) and Washington (1998), and is a member
of the American Institute of Certified Public Accountants and the Washington
Society of Certified Public Accountants.
Jill Ohara joined Sunhawk.com in February 1998 as music production manager,
was promoted to vice president of production in April 1998 and has served as
vice president of operations since June 1999. From 1981 to 1997, Ms. Ohara
served with the U.S. National Academy of Sciences and was assigned to the
Radiation Effects Research Foundation, a
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multicultural research foundation in Japan, where she served as chief of the
information technology department. Ms. Ohara received outstanding service awards
from NAS in 1995 and 1996. In other management and research roles at RERF, she
engaged in hardware/ software support, statistical programming, data analysis
and support of a dosimetry system used in the setting of worldwide radiation
protection standards. From 1979 to 1981, she served as statistician in the
Jonsson Comprehensive Cancer Center at the University of California at Los
Angeles, performing extensive programming for database management and
statistical analysis. Ms. Ohara received her bachelor of arts, magna cum laude,
in mathematics from UCLA in 1977 and her master of science in biostatistics from
UCLA in 1979. She has published articles in Biometrics, Radiation Research and
the American Journal of Roentgenology.
Gary Martin joined Sunhawk.com in January 1995 as our program manager and
has served as our vice president of publishing since June 1999. Mr. Martin
developed our digital music production operations and set up the initial Russia
music production facility. He also created the engraving specifications for our
Solero(R) Editor and the proprietary graphical font used in our Solero(R) music
scores. Mr. Martin currently oversees the quality of music production, promotes
and maintains new contracts with music publishers and coordinates the
development of our marketing team. From 1993 to 1994, while serving as vice
president of MacArthur Publishers, Inc., a desktop publishing company, Mr.
Martin worked with the Ancient Biblical Manuscript Center in California and
typeset The Dead Sea Scrolls Catalog (Scholars Press, 1994), one of the most
comprehensive database compilations on this topic to date. Mr. Martin earned a
bachelor of arts, cum laude, in physics-astronomy from Whitman College in 1975.
Mary E. McConney, Ph.D is a co-founder of Sunhawk.com and is currently our
treasurer. From 1992 until June 1999, Ms. McConney served as our chief financial
officer, secretary and treasurer and as a director. In addition, from 1988 to
the present, Ms. McConney has served as the president of HiroSoft International
Corporation, a corporation she founded that writes statistical programs for
modeling different kinds of risk functions. From 1985 to 1988, Ms. McConney was
employed in the fields of applied statistics and database design and
implementation by NAS. From 1977 to 1985, she was employed in the fields of
applied statistics, database design and policy analysis by the University of
Washington and the University of Pennsylvania. Ms. McConney received her
bachelor of arts in physics and environmental studies from Whitman College in
1976. While at the University of Pennsylvania, she received two master degrees,
one in economics in 1979 and one in urban planning in 1980, and a Ph.D in
spatial economics in 1983. Ms. McConney's duties at HiroSoft do not interfere
with her duties at Sunhawk.com since she devotes substantially all of her time
to her duties at Sunhawk.com. She has published articles in the Annals of the
New York Academy of Sciences, Urban Studies, Circulation and the Journal of the
American College of Cardiology.
Fred Anton has been a director of Sunhawk.com since July 1998. Since March
1998, Mr. Anton has served as the president/chief operating officer of Warner
Bros. Publications U.S. Inc., where he also served as the chief financial
officer/chief operating officer from September 1996 to March 1998. From 1994 to
September 1996, Mr. Anton served as vice president of finance for the Warner
Music Group and subsequently was made executive vice president/chief operating
officer for Warner Vision Entertainment. From July 1990 to 1994, he served as
the vice president international finance and administration at Time Warner Inc.
Mr. Anton has a bachelor of arts degree in economics from Clark University in
Worcester, Massachusetts and a master of business administration degree from
Washington University in St. Louis, Missouri. He is a member of the American
Institute
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<PAGE> 37
of Certified Public Accountants and the New York State Society of Certified
Public Accountants. He is also on the board of directors of the Music
Publisher's Association.
Luis F. Talavera has been a director of Sunhawk.com since June 1999. Since
1998, Mr. Talavera has overseen seed-capital funding by N.S.L., an international
venture capital fund specializing in computer and communications ventures. Mr.
Talavera also currently serves as a board member for various technology
companies, including Global Product Channel, a Norwegian e-commerce solutions
company, and Poseidon, a French developer of swimming pool safety technology.
From 1988 to 1997, Mr. Talavera was employed by Microsoft Corporation, most
recently as a director of research and development. At Microsoft, Mr. Talavera
was one of the first members of the Pen Windows computing team and the co-author
of Microsoft's first handwriting recognition software. As a director of research
and development for Softimage, a subsidiary of Microsoft, from 1995 to 1997, Mr.
Talavera was responsible for the development and launch of Softimage IDS, the
first non-linear professional post-production system. Mr. Talavera received a
bachelor of science degree in computer engineering from the University of
California at San Diego in 1987. He also holds two patents that have been issued
and three patents that are pending.
Patricia Tangora has been a director of Sunhawk.com since June 1999. Ms.
Tangora is currently a member of Dethman & Tangora, LLC, an environmental
consulting firm. From 1989 to 1998, Ms. Tangora was a senior project manager at
R.W. Beck, Inc., a national consulting and engineering firm. She was made an
owner in that firm in 1997. At R.W. Beck, her work included conducting due
diligence reviews for project financing, negotiating long-term, multi-million
dollar service contracts and advising clients on development and environmental
compliance strategies for major projects. She was also responsible for
approximately $1 million in annual sales and participated in strategic planning
and marketing efforts within her area of practice. Ms. Tangora received her
bachelor of arts degree in english from Whitman College in 1976 and a bachelor
of science degree in civil/environmental engineering from the University of
Washington in 1979.
We currently have authorized five directors; however, one board seat
currently remains vacant. We are in the process of identifying a fifth director.
Both Ms. Tangora and Mr. Talavera are independent directors. We intend to
maintain at least two independent directors in the future. Directors are elected
by the shareholders at each annual meeting of shareholders to serve until the
next annual meeting of shareholders or until their successors are duly elected
and qualified.
AUDIT COMMITTEE AND COMPENSATION COMMITTEE
Our board of directors has established an audit committee and a
compensation committee. The audit committee, which currently consists of
Patricia Tangora and Luis Talavera, is responsible for reviewing our internal
accounting procedures and consulting with and reviewing the services provided by
our independent auditors. The compensation committee, which currently consists
of Fred Anton and Patricia Tangora, is responsible for reviewing and
recommending to our board of directors the compensation and benefits of all
officers of Sunhawk.com and establishing and reviewing general policies relating
to the compensation and benefits of our employees.
EXECUTIVE COMPENSATION AND OTHER INFORMATION
Directors' compensation. Effective as of the date of the completion of this
offering, as an inducement to joining our board of directors, each of our
non-employee directors has been granted, at the initial public offering price,
an immediately exercisable option under
37
<PAGE> 38
our 1996 Stock Option Plan to purchase 2,500 shares of common stock. In
addition, we pay each non-employee director $2,500 per board meeting attended.
All directors are entitled to reimbursement for expenses incurred in traveling
to and from meetings of our board of directors.
Executive officers' compensation. During the fiscal year ended September
30, 1999, and prior to the closing this offering, Mr. Eller was not paid a
salary. Brent Mills, our former chief executive officer, received a salary of
$55,000 during the fiscal year ended September 30, 1998, and a salary of $23,163
during the fiscal year ended September 30, 1999 prior to the termination of his
employment with us in March 1999. None of our other executive officers received
total annual salary and bonus during the fiscal year ended September 30, 1999 in
excess of $100,000. To date, we have not granted Mr. Eller any stock options or
other equity-based compensation. Effective October 1, 1999, Mr. Eller entered
into an employment agreement with us with an initial three-year term. This
employment agreement entitles Mr. Eller to an annual salary of $95,000 for the
first year, which will be increased by 10% during each of the two subsequent
years. Mr. Eller is also entitled to receive options under our 1996 Stock Option
Plan to purchase 30,000 shares of our common stock vesting over five years at an
exercise price equal to the initial public offering price and an annual bonus to
be determined by our compensation committee on an annual basis.
KEY MAN INSURANCE
Our success depends substantially on the continued services of our
executive officers and key employees, in particular Marlin Eller, our chairman
of the board, chief executive officer and president. We have obtained a
$1,000,000 key man life insurance policy on the life of Mr. Eller.
STOCK OPTION PLAN
Our board of directors adopted our 1996 Stock Option Plan in June 1996, and
our shareholders approved it in June 1996. There are currently 17,932 options to
purchase common stock outstanding as of September 30, 1999. We have reserved a
total of 303,526 shares of common stock for issuance under the plan, of which
266,210 shares were available for issuance as of September 30, 1999. The plan
provides for the granting to employees, including officers and directors, of
incentive stock options within the meaning of Section 422 of the Internal
Revenue Code of 1986 and for the granting to employees, consultants and
nonemployee directors of nonstatutory stock options. Unless terminated earlier,
the plan will terminate in June 2006. Generally, options granted under the plan
vest over five years and have a term of ten years and are nontransferable.
After this offering, the plan will be administered by our compensation
committee, known as the "administrator." The administrator determines the terms
of options granted under the plan, including the number of shares subject to an
option, the vesting terms, the exercise price, and the term and exercisability
of options. The exercise price of all incentive stock options granted under the
plan generally must be at least equal to the fair market value of our common
stock on the date of grant, and the exercise price of non-statutory options
granted under the plan must be at least equal to 85% of the fair market value of
our common stock on the date of grant. Payment of the purchase price of options
may be made in cash or other consideration as determined by the administrator.
If an optionee would have the right in any calendar year to exercise for the
first time incentive stock options for shares having an aggregate fair market
value in excess of $100,000,
38
<PAGE> 39
determined for each share as of the date the option to purchase the shares was
granted, any such excess options shall be treated as nonstatutory stock options.
In the event that we are acquired by another company, we expect that awards
outstanding under the plan will be assumed or equivalent awards substituted by
our acquiror. If an acquiror did not agree to assume or substitute awards, the
vesting of outstanding options will accelerate prior to consummation of the
transaction.
The board of directors has the authority to amend or terminate the plan as
long as such action does not materially and adversely affect any outstanding
options and provided that shareholder approval for any amendments to the plan
shall be obtained to the extent required by applicable law.
RELATED-PARTY TRANSACTIONS
On March 31, 1999, the Eller and McConney 1995 Family Living Trust
converted $3,568,406 of debt owed to it by Sunhawk.com into 267,968 shares of
our common stock at a price per share of $13.31. On this same date, the Eller
and McConney 1995 Family Living Trust forgave $1,000,000 of long-term debt owed
to it by Sunhawk.com and purchased an additional 112,659 shares of our common
stock for $1,500,000, at a price per share of $13.31.
We currently receive for review approximately 4,100 pages of digital sheet
music per month from Avtograf, a Russian joint stock company in which Eller
McConney LLC holds a 94% ownership interest, under a five-year agreement, and
accrue and expect to pay to Eller McConney LLC $7.00 per page upon acceptance.
Mr. Eller and Ms. McConney are the sole members of Eller McConney LLC. This
sheet music is sold to us under an agreement between us and Eller McConney LLC,
which has an agreement with Avtograf to receive production services for digital
sheet music. Upon the closing of this offering, we will enter into an assignment
and assumption agreement with Avtograf, Eller McConney LLC and an independent
Russian production company, Music Production International, which will require
that Eller McConney LLC assign to us all of its rights to receive from Avtograf
its services for the production of digital sheet music in exchange for a letter
agreement between Sunhawk.com and Eller McConney LLC whereby Sunhawk.com will
agree to pay Eller McConney LLC $1,000,000 subject to the receipt and acceptance
of a sufficient number of pages of sheet music. Payment of the principal and
interest is based on the number of pages received and accepted from Music
Production International over a period of five years and is to be paid quarterly
in arrears with a maximum principal payment of $200,000 per annum. In connection
with this agreement, Avtograf will transfer to Music Production International
its obligation to provide production services for digital sheet music.
Thereafter, Music Production International will be obligated to provide
production services for digital sheet music to us at a rate of a minimum of
4,500 pages per month totaling 270,000 pages over a period of five years, for a
cost of $3.70 per page, at no additional cost to us. The letter agreement
reflecting the payment of $1,000,000 to Eller McConney LLC is expected to be
accounted for as a prepayment for digital sheet music production services from
Music Production International over a period of five years, with recourse to
Eller McConney LLC in the event of non-performance. Neither Eller McConney LLC,
Mr. Eller, Ms. McConney nor Sunhawk.com will have an interest in the new Russian
production company.
On May 18, 1998, we entered into a distribution agreement with Warner Bros.
Publications U.S. Inc.. As part of the consideration paid by us for the rights
granted to us
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<PAGE> 40
under the distribution agreement, we agreed to issue 99,073 shares of our common
stock to Warner Bros. Publications U.S. Inc., contingent upon the occurrence of
an initial public offering or the sale of a specified percentage of our common
stock. Consequently, on March 31, 1999, as a result of the sale of shares of our
common stock to the Eller McConney 1995 Family Living Trust, we issued Warner
Bros. Publications U.S. Inc. 99,073 shares of our common stock. Further, under
the terms of the Warner Bros. Publications U.S. Inc. distribution agreement, Mr.
Eller and Brent Mills, one of our former directors, officers and employees,
agreed to vote any shares of our common stock held or controlled by them for the
election of an individual to be designated by Warner Bros. Publications U.S.
Inc. to our board of directors. This right will continue for so long as Warner
Bros. Publications U.S. Inc. owns shares representing at least 2% of our
outstanding common stock. Warner Bros. Publications U.S. Inc. has currently
designated Fred Anton to serve as its underwriter on our board of directors. A
breach by either party may be cured within thirty days, or ten days if the
breach relates to the payment of money or the rendition of accounting, of notice
from the other party.
Each of the above transactions was entered into on terms that were as
favorable to us and our affiliates as those that were generally available from
unaffiliated parties. At the time these transactions were entered into, our
board lacked sufficient independent directors to ratify them. We currently have
two independent directors. There are no affiliated transactions presently
planned or contemplated. Should there be any future material affiliated
transactions or loans, these transactions will be made or entered into on terms
that are no less favorable to us than those that can be obtained from
unaffiliated third parties. In addition, all affiliated transactions and any
forgiveness of loans must be approved by a majority of our independent directors
who do not have an interest in the transaction and who have access, at our
expense, to our independent legal counsel.
On December 23, 1999, Sunhawk.com's board of directors approved a
transaction to give 0.716 shares for every 1 share of common stock, thereby
giving effect to a 1.397 to 1 reverse stock split effective December 23, 1999.
All outstanding common and common equivalent shares and per-share amounts in the
accompanying financial statements and related notes to the financial statements
have been retroactively adjusted to give effect to the reverse stock split.
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<PAGE> 41
PRINCIPAL SHAREHOLDERS
The following table sets forth information regarding the beneficial
ownership of our common stock as of the date of this prospectus, including
options that are immediately exercisable or exercisable within 60 days of the
date of this prospectus under our stock option plan, and as adjusted to reflect
this offering, by:
- each person or group that we know owns 5% or more of our common stock;
- each of the named executive officers and each of our directors; and
- our executive officers and directors as a group.
Unless otherwise noted, we believe that each of the shareholders has sole
investment and voting power with respect to the common stock indicated, except
to the extent shared by spouses under applicable law. Mr. Eller, our chairman of
the board, chief executive officer and president, and Ms. McConney, our
treasurer, are the trustees of the Eller and McConney Family 1995 Living Trust
and, as such, retain voting and investment power with respect to these shares.
<TABLE>
<CAPTION>
BENEFICIALLY OWNED SHARES
-------------------------------------
PRIOR TO OFFERING AFTER OFFERING
------------------- --------------
NAME AND ADDRESS OF BENEFICIAL OWNER NUMBER PERCENT PERCENT
------------------------------------ --------- ------- --------------
<S> <C> <C> <C>
Eller and McConney 1995 Family Living Trust........ 1,024,284 73.2% 36.6%
c/o Sunhawk.com Corporation
223 Taylor Avenue North, Suite 200
Seattle, Washington 98109
Marlin Eller....................................... 1,024,284 73.2% 36.6%
Mary E. McConney, Ph.D............................. 1,024,284 73.2% 36.6%
Brent R. Mills(1).................................. 266,658 19.1% 9.5%
7720 39th Avenue N.E.
Seattle, Washington 98105
Judy E. McOstrich(2)............................... 266,658 19.1% 9.5%
7720 39th Avenue N.E.
Seattle, Washington 98105
Warner Bros. Publications U.S. Inc. ............... 99,073 7.1% 3.5%
15800 N.W. 48th Avenue
P.O. Box 4340
Miami, Florida 33014
Fred Anton(3)...................................... 99,073 7.1% 3.5%
Gary Martin(4)..................................... 2,384 * *
Patricia Tangora................................... -- -- --
Luis F. Talavera................................... -- -- --
Jill Ohara......................................... -- -- --
All directors and executive officers as a group (7
persons)......................................... 1,125,741 80.3% 40.2%
</TABLE>
- -------------------------
* Less than 1%
(1) Includes 36,780 shares of common stock held by Mr. Mills' spouse, Judy E.
McOstrich.
(2) Includes 229,878 shares of common stock held by Ms. McOstrich's spouse,
Brent R. Mills.
(3) Includes 99,073 shares of our common stock owned by Warner Bros.
Publications U.S. Inc., of which Mr. Anton is president and chief operating
officer. Mr. Anton disclaims beneficial ownership of these shares.
(4) Represents options to purchase shares of common stock issued under our stock
option plan that are immediately exercisable.
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<PAGE> 42
LOCK-UP AGREEMENT
Under the underwriting agreement between us and the underwriter of this
offering, shareholders who hold shares of our common stock issued prior to the
date of the closing or have been granted options to purchase shares of our
common stock prior to such date will not be able to, directly or indirectly,
offer, sell, announce an intention to sell, contract to sell, pledge,
hypothecate, grant any option to purchase or otherwise dispose of any shares of
our common stock or any securities convertible into or exchangeable or
exercisable for shares of our common stock for a period of 24 months following
the closing of this offering without the prior written consent of the
underwriter.
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<PAGE> 43
DESCRIPTION OF SECURITIES
The following summary description of our capital stock is not intended to
be complete and is subject to and qualified in its entirety by reference to our
amended and restated articles of incorporation and our amended and restated
bylaws, copies of each of which are filed as exhibits to the registration
statement of which this prospectus forms a part.
On March 30, 1999 our board of directors approved a transaction to issue
one share for every 6.007 shares of our common stock then outstanding, giving
effect to a 1-for-6.007 reverse stock split effective March 31, 1999.
On December 23, 1999, Sunhawk.com's board of directors approved a
transaction to give 0.716 shares for every 1 share of common stock thereby
giving effect to a 1.397 to 1 reverse stock split effective December 23, 1999.
All outstanding common and common equivalent shares and per-share amount in the
accompanying financial statements and related notes to the financial statement
have been retroactively adjusted to give effect to the reverse stock split.
GENERAL
Immediately prior to the date of this prospectus, we had authorized capital
stock consisting of 30,000,000 shares of common stock, no par value, of which
1,399,380 shares were issued and outstanding. Immediately prior to the date of
this prospectus, there were six holders of record of our common stock.
We have reserved 303,526 shares of common stock for issuance under our 1996
Stock Option Plan, of which 266,210 shares were available for issuance as of
September 30, 1999.
COMMON STOCK
Holders of outstanding shares of our common stock are entitled to one vote
per share on all matters submitted to a vote of our shareholders. Except as may
be required by applicable law, holders of outstanding shares of our common stock
vote together as a single class. Holders of a majority of the outstanding shares
of our common stock constitute a quorum at any meeting of our shareholders, and
the vote by the holders of a majority of our common stock is required to effect
specific fundamental corporate changes, including liquidation, merger or sale of
substantially all of our assets.
Holders of our common stock are entitled to receive dividends if and when
declared by our board of directors out of funds legally available for that
purpose. In the event of our liquidation, dissolution or winding up, holders of
our common stock are entitled to share ratably in all assets remaining after
payment of liabilities. Holders of our common stock have no preemptive rights or
other rights to subscribe for unissued or treasury shares or securities
convertible into or exercisable or exchangeable for shares of our common stock.
The outstanding shares of common stock are, and the shares of common stock being
offered in this prospectus when issued will be, duly authorized and validly
issued and, upon payment of the purchase price, fully paid and nonassessable.
SELLING SHAREHOLDERS' WARRANTS
In January, we issued warrants to persons who have provided bridge
financing loans of $1,000,000 to us. The warrants, which are exercisable upon
the closing of this offering, entitle the holders to purchase an aggregate of
41,680 shares of common stock at an
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<PAGE> 44
exercise price equal to the initial public offering price per share for five
years. The shares underlying the warrants are being registered in this offering
and may not be resold prior to six months after the close of this offering.
REGISTRATION RIGHTS
Under the terms of our distribution agreement with Warner Bros.
Publications U.S. Inc., Warner Bros. Publications U.S. Inc. is entitled to have
its shares registered by us under the Securities Act. Specifically, following
the expiration of the "lock-up" period to be agreed to by existing shareholders,
Warner Bros. Publications U.S. Inc. may request that we register all or a part
of its shares. Warner Bros. Publications U.S. Inc. may make this request no more
than twice. Under the terms of Warner Bros. Publications U.S. Inc.'s agreement,
we will bear all registration expenses other than underwriting discounts and
commissions in connection with any such registration.
ANTI-TAKEOVER LAW
Washington law contains provisions which could make our acquisition by a
third party more difficult. These provisions, summarized below, are expected to
discourage coercive takeover practices and inadequate takeover bids and to
encourage persons seeking to acquire control of Sunhawk.com to negotiate with us
first.
Chapter 19 of the Washington Business Corporation Act generally prohibits a
"target corporation" from engaging in a "significant business transaction" with
an "acquiring person," which is defined as a person or group of persons that
beneficially owns or acquires 10% or more of the voting securities of the target
corporation, for a period of five years after such acquisition, unless the
"significant business transaction" or the acquisition of shares is approved by a
majority of the members of the target corporation's board of directors prior to
the time of acquisition. Prohibited "significant business transactions" include,
among other things:
- a merger or consolidation with, disposition of assets to or issuance or
redemption of stock to or from the acquiring person;
- termination of 5% or more of the employees of the target corporation as a
result of the acquiring person's acquisition of 10% or more of the
shares; or
- allowing the acquiring person to receive any disproportionate benefits as
a shareholder.
After the five-year period, a "significant business transaction" may occur, as
long as it complies with the "fair price" provisions of the statute. A
corporation may not "opt out" of this statute.
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<PAGE> 45
DIRECTOR AND OFFICER LIABILITY AND INDEMNIFICATION
Our amended and restated articles of incorporation currently limit the
liability of directors to the fullest extent permitted by the Washington
Business Corporation Act. Consequently, subject to the Washington Business
Corporation Act, no director will be personally liable to us or our shareholders
for monetary damages resulting from his or her conduct as a director of
Sunhawk.com, except liability for:
- acts or omissions involving intentional misconduct or knowing violations
of law;
- unlawful distributions; or
- transactions from which the director personally receives a benefit in
money, property or services to which the director is not legally
entitled.
Our amended and restated bylaws provide for indemnification of our directors,
officers, employees and agents to the maximum extent permitted by Washington
law. Our directors and officers also may be indemnified against liability they
may incur for serving in those capacities pursuant to our liability insurance
policy maintained for such purpose.
To the extent the provisions of our corporate governance documents provide
for indemnification of directors or officers for liabilities arising under the
Securities Act those provisions are, in the opinion or the Securities and
Exchange Commission, against public policy as expressed in the Securities Act
and are therefore unenforceable.
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<PAGE> 46
SHARES ELIGIBLE FOR FUTURE SALE
Prior to this offering, there has been no public market for our common
stock. Sales of a substantial amount of common stock in the public market, or
the perception that such sales may occur, could adversely affect the market
price of the common stock prevailing from time to time in the public market and
could impair our ability to raise additional capital through the sale of our
equity securities in the future.
Upon completion of this offering, there will be 2,799,380 shares of our
common stock outstanding, consisting of 1,400,000 shares of common stock being
offered in this prospectus, and 1,399,380 restricted shares of common stock. In
addition, we have reserved 303,526 shares of common stock for issuance under our
1996 Stock Option Plan, of which 17,932 shares were subject to outstanding
options and 266,210 shares were available for future issuance as of September
30, 1999.
The shares of common stock currently being offered will be freely tradable
without restriction or further registration under the Securities Act by persons
other than our affiliates. The restricted shares will be freely tradable if
subsequently registered under the Securities Act or to the extent permitted by
Rules 144 or 701 or some other exemption from registration under the Securities
Act, subject to the "lock-up" provisions to be agreed to by existing
shareholders.
In general, under Rule 144 as currently in effect, if one year has elapsed
since the date of acquisition of restricted shares from Sunhawk.com or an
affiliate of Sunhawk.com, the holder is entitled to sell, in the public market,
within any three-month period, that number of shares of common stock which does
not exceed the greater of 1% of the total number of then outstanding shares of
common stock or the average weekly trading volume of shares of common stock
during the four calendar weeks preceding the date on which notice of the sale is
filed with the Securities and Exchange Commission. Sales under Rule 144 are also
subject to requirements as to the manner of sale, notice and availability of
current public information about Sunhawk.com. If two years have elapsed, a
holder, other than an affiliate of Sunhawk.com, is entitled to sell restricted
shares in the public market under Rule 144(k) without regard to the volume
limitations, manner of sale requirements, public information requirements or
notice requirements.
Rule 701, as currently in effect, permits our employees, officers,
directors or consultants who purchased shares under a written compensatory plan
or contract to resell such shares in reliance upon Rule 144 but without
compliance with specific restrictions. Rule 701 provides that affiliates may
sell their Rule 701 shares under Rule 144 without complying with the holding
period requirement and that non-affiliates may sell such shares in reliance on
Rule 144 without complying with the holding period, public information, volume
limitation or notice provisions of Rule 144.
Of the restricted shares, 8,829 shares of common stock will be eligible for
sale under Rule 144 under the Securities Act 90 days after the date of this
prospectus, subject to the lock-up provisions described below.
Under the underwriting agreement between us and the underwriters of this
offering, shareholders who hold shares of our common stock issued prior to the
date of the closing of this offering or have been granted options to purchase
shares of our common stock prior to such date will not be able to, directly or
indirectly, offer, sell, announce an intention to sell, contract to sell,
pledge, hypothecate, grant any option to purchase or otherwise dispose of any
shares of our common stock or any securities convertible into or exchangeable or
46
<PAGE> 47
exercisable for shares of our common stock for a period of 24 months following
the closing of this offering without the prior written consent of the
underwriter. The shares of common stock currently being offered will not be
subject to this "lock-up" provision and will be freely tradable. We have also
agreed not to file with the Securities and Exchange Commission a registration
statement under the Securities Act relating to any of these shares during this
24-month "lock-up" period. Additionally, in accordance with the policy
statements promulgated by the North American Securities Administrators
Association, Inc., three of our shareholders have agreed to enter into a
promotional share escrow agreement. Under this agreement, these shareholders
agree, with respect to an aggregate of approximately 1,300,000 shares of our
common stock owned by them prior to this offering, not to transfer or dispose of
all of those shares for the first two years, and 2 1/2% of those shares for each
of years three and four, after the completion of this offering.
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<PAGE> 48
SELLING SHAREHOLDERS
The following table sets forth the number of shares of common stock which
may be owned as of the date of this prospectus by each of the participants in a
bridge loan to Sunhawk.com, who have received warrants to purchase our Common
Stock, based on the exercise of such warrants, and the resulting percentage
ownership by such person. As of the date of this prospectus, such persons own no
other shares of Common stock of Sunhawk.com. Accordingly, after the offer and
sale of the shares set forth below, such persons will own no shares of common
stock of Sunhawk.com. None of such persons has had any position, office or other
material relationship with Sunhawk.com within the past three years other than as
a result of the ownership of such warrants and the bridge loan notes.
Such persons will sell their common stock only in "brokers' transactions"
within the meaning of Section 4(4) of the Securities Act of 1933 or in
transactions directly with a "market maker," as that term is defined in Section
3(a)(38) of the Securities Exchange Act of 1934. Such persons will sell their
common stock at prevailing market prices. No sale of any common stock can occur
until six months after consummation of this offering, since the warrants will
not be exercisable until such time.
The bridge loan was underwritten by Joseph Gunnar & Co., LLC, which
received a commission equal to 7% of the aggregate loan amount an a structuring
fee equal to 3% of the aggregate loan amount. The notes and warrants issued in
connection with the bridge loan are exempt from registration under Rule 506 of
Regulation D of the General Rules and Regulations under the Securities Act.
<TABLE>
<CAPTION>
PERCENTAGE SHARES
NUMBER OF SHARES DOLLAR OF COMMON BEING
UNDERLYING EACH AMOUNT OF SHARES OFFERED
DATE NAME INVESTOR'S WARRANT LOAN OUTSTANDING HEREBY**
---- ---- ------------------ ---------- ----------- --------
<S> <C> <C> <C> <C> <C>
1/26/00 Actinor Shipping ASA 1042 $ 25,000 * 1042
1/26/00 Neil Anderson 6252 150,000 * 6252
1/26/00 Elliot J. Baum 1042 25,000 * 1042
1/26/00 Continental Concessions 1042 25,000 * 1042
1/26/00 Geoffrey DeBelloy 3126 75,000 * 3126
1/26/00 Peter Durham 1042 25,000 * 1042
1/26/00 Robert & Karen Edwards 1042 25,000 * 1042
1/26/00 Donald & Betty Goldrich 1042 25,000 * 1042
1/26/00 Mark & Denise Goldschmidt 1042 25,000 * 1042
1/26/00 Brian Hilgendorf 2084 50,000 * 2084
1/26/00 Jerry L. Ivy, Jr. 3126 75,000 * 3126
1/26/00 K.K. Investors Co. 6252 150,000 * 6252
1/26/00 Mitchell & Allison Kersch 2084 50,000 * 2084
1/26/00 Robert MacDonald 1042 25,000 * 1042
1/26/00 Francine Manzo 1042 25,000 * 1042
1/26/00 John & Ann Pillote 1042 25,000 * 1042
1/26/00 Clinton & Sharon Plant 1042 25,000 * 1042
1/26/00 Edmund O. Rothschild 1042 25,000 * 1042
1/26/00 Achyut Sahaerabudhe 2084 50,000 * 2084
1/26/00 Jay & Bernice Salomon 1042 25,000 * 1042
1/26/00 Michael J. Valenzo 1042 25,000 * 1042
1/26/00 Jerold Weinger 1042 25,000 * 1042
- ----------------------------------------------------------------------------------------------
Total 41,680 $1,000,000 41,680
</TABLE>
- ------------------------
* Less than 1%
** The offering and sale of such shares shall not take place until six months
after the offering of the common stock to be sold by Sunhawk.com.
48
<PAGE> 49
UNDERWRITING
Subject to the terms and conditions set forth in the underwriting agreement
between us and the underwriters named below, the underwriter has agreed to
purchase from us, and we have agreed to sell to the underwriters, the number of
shares of common stock set forth below opposite the underwriter's name, at the
initial public offering price per share less the underwriting discounts and
commissions set forth on the cover page of this prospectus.
<TABLE>
<CAPTION>
NUMBER
UNDERWRITER OF SHARES
----------- ---------
<S> <C>
Joseph Gunnar & Co., L.L.C.................................. 1,400,000
</TABLE>
The underwriting agreement sets forth the obligations of the underwriters
to pay for and accept delivery of the shares and provides that the underwriter
will purchase all of the shares, if any of the shares are purchased.
The underwriter initially proposes to offer the shares of common stock
directly to the public at the initial public offering price per share set forth
on the cover page of this prospectus and to selected dealers at such price less
a concession not in excess of $0.45 per share. The underwriter may allow, and
these dealers may reallow, a concession not in excess of $0.10 per share to
other dealers. After this offering, the public offering price, concession and
re-allowance may be changed.
We have granted to the underwriter an option, exercisable during the 30-day
period after the date of this prospectus, to purchase up to an aggregate of
210,000 additional shares of common stock at the initial public offering price
per share less the underwriting discounts and commissions set forth on the cover
page of this prospectus. The underwriter may exercise this option only to cover
over-allotments, if any, made in connection with the sale of the shares of
common stock offered in this prospectus.
We have agreed to pay the underwriter a non-accountable expense allowance equal
to 2% of the gross proceeds of this offering and to cover the underwriting costs
and due diligence expenses relating to this offering, $25,000 of which has
already been paid. We have also agreed to pay the reasonable expenses of
underwriter's counsel.
We have agreed to permit the underwriter to have an observer attend
meetings of our board of directors for a period of three years from the
effective date of the registration statement of which this prospectus forms a
part. The underwriter's observer will be reimbursed for all out-of-pocket
expenses incurred in connection with the observer's attendance at meetings of
our board of directors and will receive cash compensation equal to the cash
compensation payable by us to our outside directors for attendance at meetings
of our board of directors, provided, however, that the per meeting fees payable
to the underwriter's observer shall not be less than $1,500 and that there shall
be a minimum of four meetings per year. The underwriter shall also receive the
same coverage under our directors and officers insurance policy that is extended
to our officers and directors. Additionally, the underwriter has been retained
as our investment banking advisor for a 18-month period commencing upon the
closing of this offering, and, for such services, we have agreed to pay the
underwriter a fee of $4,000 per month.
In connection with this offering, we have agreed to sell warrants to the
underwriter for a nominal price. The underwriter's warrants entitle the
underwriter to purchase 140,000 shares. The shares issuable upon exercise of the
underwriter's warrants will be in all
49
<PAGE> 50
respects identical to the shares offered to you. The underwriter's warrants will
be limited to a term of five years from the date of this prospectus and will
become exercisable commencing one year after the completion of this offering at
a per share exercise price equal to 145% of the initial public offering price
per share set forth on the cover page of this prospectus. The underwriter's
warrants may not be sold, assigned, transferred, pledged or hypothecated except
to officers or partners (not directors) of the underwriter and members of the
selling group and/or their officers or partners, to the underwriter's officers
and employees. In accordance with the terms of the underwriting agreement, we
are registering the shares issuable upon exercise of the underwriter's warrants
under the registration statement of which this prospectus forms a part, and we
have agreed to use our best efforts to permit the public sale of the shares
issued or issuable upon exercise of the underwriter's warrants and to include
all or part of the shares underlying the underwriter's warrants in future
registration statements at our expense. For the term of the underwriter's
warrants, the holders of the warrants are given the opportunity to profit from a
rise in the market price of the common stock, which may result in a dilution of
the interest of other shareholders. As a result, we may find it more difficult
to raise additional equity capital if it should be needed for our business while
the underwriter's warrants are outstanding. The holders of the underwriter's
warrants might be expected to exercise them at a time when we would, in all
likelihood, be able to obtain additional equity capital on terms more favorable
to us than those provided by the underwriter's warrants. Any profit realized on
the sale of the shares issuable upon the exercise of the underwriter's warrants
may be deemed additional underwriting compensation.
We and the underwriter have agreed to indemnify each other against, or to
contribute to losses arising out of, untrue statements or omissions of material
facts contained in this prospectus and the registration statement of which it is
a part in connection with this offering. We and the underwriter are each aware
that, in the opinion of the Securities and Exchange Commission, such
indemnification is against public policy as expressed in the Securities Act and
is therefore unenforceable.
The underwriter, may engage in over-allotment, stabilizing transactions,
syndicate and covering transactions in accordance with Regulation M under the
Securities Exchange Act. Over-allotment involves sales in excess of the offering
size, which creates a syndicate short position. Stabilizing transactions permit
bids to purchase shares so long as the stabilizing bids do not exceed a
specified maximum. Covering transactions involve purchases of shares in the open
market after the distribution has been completed in order to cover short
positions. Such over-allotment and covering transactions may cause the price of
the common stock to be higher than it would otherwise be in the absence of such
transactions. These transactions may be effected on the Nasdaq SmallCap(R)
Market or the Pacific Stock Exchange and, if commenced, may be discontinued at
any time.
Application has been made for quotation of the common stock on the Nasdaq
SmallCap(R) Market under the symbol "SNHK," and listing on the Pacific Stock
Exchange under the symbol "SHA." It is anticipated that these applications will
be effective at the time of this offering.
Prior to this offering, there has been no public trading market for our
common stock. The public offering price of the shares of common stock offered in
this prospectus was determined by negotiation between us and the underwriter.
Factors to be considered in determining the initial public offering price, in
addition to prevailing market conditions, include the history of and prospects
for the industry in which we operate, an assessment of our management, our
prospects, our capital structure and such other factors as are deemed relevant.
We cannot assure you that an active trading market will develop and be sustained
50
<PAGE> 51
upon the completion of this offering or that the market price of our common
stock will not decline below the initial public offering price.
The stock market and Internet stocks specifically have experienced
significant price and volume fluctuations that have affected the market price of
common stock for many companies engaged in industries similar to that of
Sunhawk.com. As a result, investors purchasing in this offering may not be able
to resell their shares at or above the initial public offering price and could
lose all of their investment.
The preceding description includes a summary of the principal terms of the
underwriting agreement and the underwriter's warrant agreement and does not
purport to be complete. The underwriting agreement and the underwriter's warrant
agreement are filed as exhibits to the registration statement of which this
prospectus forms a part and should be referenced for the complete contents of
these documents.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for our common stock is American Stock
Transfer and Trust Company.
LEGAL MATTERS
The validity of the shares of common stock being sold in this offering will
be passed on for us by The Otto Law Group, PLLC of Seattle, Washington.
Effective upon the closing of this offering, The Otto Law Group has been
granted, at the initial public offering price, an immediately exercisable
warrant to purchase 27,500 shares of our common stock.
Legal matters related to this offering will be passed on for the
underwriters by Kelley Drye & Warren LLP of New York, New York.
EXPERTS
The financial statements of Sunhawk.com at September 30, 1999 and 1998, and
for each of the three years in the period ended September 30, 1999, appearing in
this prospectus and registration statement have been audited by Ernst & Young
LLP, independent auditors, as set forth in their report thereon which contain an
explanatory paragraph describing conditions that raise substantial doubt about
the Sunhawk.com's ability to continue as a going concern as described in Note 1
to the financial statements appearing elsewhere in this prospectus, and are
included in reliance upon such report given on the authority of such firm as
experts in accounting and auditing.
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the Securities and Exchange Commission a registration
statement on Form SB-2 under the Securities Act with respect to the common stock
being sold in this offering. This prospectus, filed as a part of such
registration statement, does not contain all the information set forth in the
registration statement, portions of which have been omitted in accordance with
the rules and regulations of the Securities and Exchange Commission. For further
information with respect to us and our common stock we are offering, reference
is made to the registration statement. Statements made in this prospectus as to
the contents of any contract or document are not necessarily complete and, in
each instance, reference is made to the copy of such contract or other document
filed as an exhibit to the registration statement and each such statement is
qualified in its entirety by such reference. The registration statement,
including exhibits and schedules,
51
<PAGE> 52
may be inspected without charge at the Public Reference Room of the Securities
and Exchange Commission, Judiciary Plaza Building, 450 Fifth Street, N.W.,
Washington D.C. 20549, and the regional offices of the Securities and Exchange
Commission at Seven World Trade Center, Suite 1300, New York, New York 10048,
and at Citicorp Center, 500 West Madison Street, Suite 1400, Chicago, Illinois
60661-2511. Copies of such material may be obtained at prescribed rates from the
Public Reference Room of the Securities and Exchange Commission at Room 1024,
Judiciary Plaza Building, 450 Fifth Street, N.W. Washington D.C. 20549. You may
obtain information regarding the Public Reference Room by calling the Securities
and Exchange Commission at 1-800-SEC-0330. The Securities and Exchange
Commission maintains a web site that contains registration statements, reports,
proxy statements and other information regarding registrants, including
Sunhawk.com, that file electronically with the Securities and Exchange
Commission. The address of the Securities and Exchange Commission's web site is
www.sec.gov.
As a result of this offering, we will be subject to the informational
requirements of the Exchange Act. So long as we are subject to the informational
reporting requirements of the Exchange Act, we will provide our shareholders
with annual reports containing audited financial statements and interim
quarterly reports containing unaudited financial information.
52
<PAGE> 53
SUNHAWK.COM CORPORATION
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of Ernst and Young LLP, independent auditors......... F-2
Audited financial statements
Balance sheets as of September 30, 1999 and 1998............ F-3
Statements of operations for the years ended September 30,
1999, 1998, and 1997...................................... F-4
Statements of shareholders' equity (deficit) for the years
ended September 30, 1999, 1998, and 1997.................. F-5
Statements of cash flows for the years ended September 30,
1999, 1998, and 1997...................................... F-6
Notes to financial statements............................... F-7
</TABLE>
F-1
<PAGE> 54
REPORT OF ERNST AND YOUNG LLP, INDEPENDENT AUDITORS
Board of Directors
Sunhawk.com Corporation
We have audited the accompanying balance sheets of Sunhawk.com Corporation as of
September 30, 1999 and 1998, and the related statements of operations,
shareholders' equity (deficit), and cash flows for each of the three years in
the period ended September 30, 1999. These financial statements are the
responsibility of Sunhawk.com Corporation management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Sunhawk.com Corporation as of
September 30, 1999 and 1998, and the results of its operations and its cash
flows for each of the three years in the period ended September 30, 1999, in
conformity with accounting principles generally accepted in the United States.
The accompanying financial statements have been prepared assuming that
Sunhawk.com will continue as a going concern. As more fully described in Note 1,
Sunhawk.com has recurring net losses and has both a working capital deficiency
and an accumulated deficit at September 30, 1999. These conditions raise
substantial doubt about Sunhawk.com's ability to continue as a going concern.
Management's plans in regard to these matters are described in Note 1. The
financial statements do not include any adjustments to reflect the possible
future effects on the recoverability and classification of assets or the amounts
and classification of liabilities that may result from the outcome of this
uncertainty.
Seattle, Washington
November 24, 1999 except for Note 7 (sixth paragraph)
as to which the date is December 23, 1999,
and Note 7 (fourth paragraph) and Note 13 as to which the date is January 26,
2000
F-2
<PAGE> 55
SUNHAWK.COM CORPORATION
BALANCE SHEETS
<TABLE>
<CAPTION>
SEPTEMBER 30,
--------------------------
1999 1998
----------- -----------
<S> <C> <C>
ASSETS
Current assets:
Cash.................................................. $ 18,300 $ 59,093
Accounts receivable................................... 7,649 --
CD-ROMs and printed sheet music....................... 17,091 16,507
Prepaid expense....................................... 4,569 27,234
----------- -----------
Total current assets.......................... 47,609 102,834
----------- -----------
Property and equipment, net............................. 253,840 195,880
Other assets:
Digital sheet music masters (net of accumulated
amortization of $31,097 and $10,151 in 1999 and
1998, respectively)................................ 396,154 69,868
Patent and trademarks, at cost (net of accumulated
amortization of $9,228 and $3,926, in 1999 and
1998, respectively)................................ 98,456 77,240
Music catalog distribution rights (net of accumulated
amortization of $75,378 in 1999)................... 1,243,740 --
Deferred offering costs............................... 1,063,095 --
Deposits.............................................. 27,234 62,694
----------- -----------
Total other assets............................ 2,828,679 209,802
----------- -----------
Total assets.................................. $ 3,130,128 $ 508,516
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Line of credit........................................ $ 100,000 $ --
Accounts payable and accrued expenses................. 709,267 92,162
Payable to Eller McConney LLC......................... 169,957 10,850
Notes payable to shareholder.......................... 290,000 2,927,367
Accrued interest to shareholder....................... 115,394 286,039
----------- -----------
Total current liabilities..................... 1,384,618 3,316,418
----------- -----------
Shareholders' equity (deficit):
Preferred stock, no par value:........................ -- --
Authorized shares -- 10,000,000
Outstanding shares -- none
Common stock, no par value:
Authorized shares -- 30,000,000
Outstanding shares -- 1,399,380 and 891,559 at
September 30, 1999 and 1998, respectively........ 3,345,219 197,221
Accumulated deficit................................... (1,599,709) (3,005,123)
----------- -----------
Total shareholders' equity (deficit).......... 1,745,510 (2,807,902)
----------- -----------
Total liabilities and shareholders' equity
(deficit)................................... $ 3,130,128 $ 508,516
=========== ===========
</TABLE>
See accompanying notes to financial statements.
F-3
<PAGE> 56
SUNHAWK.COM CORPORATION
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
---------------------------------------
1999 1998 1997
----------- ----------- ---------
<S> <C> <C> <C>
Sales................................... $ 100,575 $ 27,263 $ 15,066
Cost of goods sold:
Royalties, materials, shipping, and
credit card processing fees........ 75,401 14,170 3,210
Amortization of digital sheet music
and music catalog distribution
rights............................. 96,324 8,347 1,804
----------- ----------- ---------
171,725 22,517 5,014
----------- ----------- ---------
Gross profit (loss)..................... (71,150) 4,746 10,052
Selling, general and administrative..... 2,660,933 1,353,871 854,458
----------- ----------- ---------
Loss from operations.................... (2,732,083) (1,349,125) (844,406)
Interest income......................... 13,140 -- --
Interest expense on notes payable to
shareholders.......................... (115,394) (126,454) (66,577)
----------- ----------- ---------
Net loss................................ (2,834,337) $(1,475,579) $(910,983)
=========== =========== =========
Net loss per share:
Basic and diluted..................... (2.46) $ (1.66) $ (1.04)
=========== =========== =========
Weighted average common shares for net
loss per share computations:
Basic and diluted.................. 1,154,214 887,689 875,424
=========== =========== =========
</TABLE>
See accompanying notes to financial statements.
F-4
<PAGE> 57
SUNHAWK.COM CORPORATION
STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
TOTAL
COMMON STOCK SHAREHOLDERS'
----------------------- ACCUMULATED EQUITY
SHARES AMOUNT DEFICIT (DEFICIT)
--------- ---------- ----------- -------------
<S> <C> <C> <C> <C>
Balance, October 1, 1996....... 643,657 $ 901 $ (618,561) $ (617,660)
Exercise of common stock
options................... 9,195 -- -- --
Sale of common stock......... 229,878 4 -- 4
Compensation related to sale
of common stock........... -- 96,316 -- 96,316
Net loss..................... -- -- (910,983) (910,983)
--------- ---------- ----------- -----------
Balance, September 30, 1997.... 882,730 97,221 (1,529,544) (1,432,323)
Sale of common stock......... 8,829 100,000 -- 100,000
Net loss..................... -- -- (1,475,579) (1,475,579)
--------- ---------- ----------- -----------
Balance, September 30, 1998.... 891,559 197,221 (3,005,123) (2,807,902)
Exercise of common stock
options................... 28,121 225 -- 225
Issuance of common stock to
acquire music catalog
distribution rights....... 99,073 1,319,118 -- 1,319,118
Sale of common stock......... 112,659 1,500,000 -- 1,500,000
Conversion of notes payable
to shareholders, including
accrued interest of
$286,039.................. 267,968 3,568,406 -- 3,568,406
Forgiveness of note payable
to shareholder............ -- 1,000,000 -- 1,000,000
Recapitalization of
accumulated deficit due to
termination of "S"
corporation status
effective April 1, 1999... -- (4,239,751) 4,239,751 --
Net loss..................... -- -- (2,834,337) (2,834,337)
--------- ---------- ----------- -----------
Balance, September 30, 1999.... 1,399,380 $3,345,219 $(1,599,709) $ 1,745,510
========= ========== =========== ===========
</TABLE>
See accompanying notes to financial statements.
F-5
<PAGE> 58
SUNHAWK.COM CORPORATION
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
----------------------------------------
1999 1998 1997
------------ ----------- ---------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net loss....................................... $ (2,834,337) $(1,475,579) $(910,983)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation................................. 79,780 79,683 42,944
Amortization................................. 101,626 11,182 2,895
Stock compensation........................... -- -- 96,316
Loss on disposal of property and equipment... -- 4,061 16,270
Changes in operating assets and liabilities:
Increase in accounts receivable............ (7,649)
Decrease (increase) in CD-ROMs and printed
sheet music............................. (584) 2,315 (2,424)
Decrease (increase) in prepaid expense..... 22,665 (27,234) --
Decrease (increase) in deposits............ 35,460 (62,694) --
Increase in accounts payable and accrued
expenses................................ 617,105 47,960 33,940
Increase in payable to Eller McConney
LLC..................................... 159,107 10,850 --
Increase (decrease) in accrued interest on
notes payable to shareholder............ 115,394 198,552 66,577
------------ ----------- ---------
Net cash used in operating activities.......... (1,711,433) (1,210,904) (654,465)
INVESTING ACTIVITIES
Purchases of property and equipment............ (137,740) (153,014) (97,216)
Purchase of digital sheet music masters........ (347,232) (60,830) (19,189)
Cost of patents and trademarks................. (26,518) (53,689) (27,301)
------------ ----------- ---------
Net cash used in investing activities.......... (511,490) (267,533) (143,706)
FINANCING ACTIVITIES
Proceeds from line of credit................... 100,000
Proceeds from notes payable issued to
shareholders................................. 1,645,000 1,413,902 794,377
Increase in deferred offering costs............ (1,063,095) -- --
Proceeds from sale of common stock to existing
shareholders................................. 1,500,000 100,000 4
Exercise of options............................ 225
------------ ----------- ---------
Net cash provided by financing activities...... 2,182,130 1,513,902 794,381
------------ ----------- ---------
Net increase (decrease) in cash................ (40,793) 35,465 (3,790)
Cash at beginning of period.................... 59,093 23,628 27,418
------------ ----------- ---------
Cash at end of period.......................... $ 18,300 $ 59,093 $ 23,628
============ =========== =========
NON-CASH SUPPLEMENTARY DISCLOSURE
Issuance of common stock in conjunction with
the acquisition of music catalog distribution
rights....................................... $ 1,319,118 $ -- $ --
Conversion of notes payable and accrued
interest to shareholders of common stock..... (3,568,406) -- --
Forgiveness of notes payable to shareholder.... (1,000,000)
</TABLE>
See accompanying notes to financial statements.
F-6
<PAGE> 59
SUNHAWK.COM CORPORATION
NOTES TO FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS AND LIQUIDITY
BUSINESS AND ORGANIZATION
Sunhawk.com Corporation (Sunhawk.com) was incorporated in the state of
Washington on August 20, 1992. Sunhawk.com sells interactive digital sheet music
in its proprietary format, traditional printed sheet music, and CD-ROMs on their
internet retail site at www.sunhawk.com. Sunhawk.com's internally developed
proprietary technology, Solero(R), allows customers to view, play, print and
store the encrypted digital sheet music files.
NAME CHANGE
On June 10, 1999, Sunhawk.com's Articles of Incorporation were amended to change
the company's name to Sunhawk.com Corporation.
LIQUIDITY
At September 30, 1999, Sunhawk.com had cash of $18,300 available to fund
operations. For the year ended September 30, 1999, Sunhawk.com recorded a net
loss of $2,834,337, had a working capital deficiency of $1,337,009 and an
accumulated deficit of $1,599,709. These factors raise substantial doubt about
Sunhawk.com's ability to continue as a going concern. The financial statements
do not include any adjustments that might result from the outcome of this
uncertainty.
Since inception, Sunhawk.com has financed its operations and capital
expenditures through sales of common stock, borrowings from the Eller and
McConney 1995 Family Living Trust, and more recently through borrowing from the
line of credit of $500,000 of which $100,000 was outstanding at September 30,
1999. Sunhawk.com's business will require additional equity or debt financing to
continue operations. Sunhawk.com has entered into bridge-financing loan
agreements "the Loans" to allow it to operate until it is able to raise
additional equity financing through an initial public offering or a private
equity investor. Currently, Sunhawk.com plans to file a registration statement
to obtain such funding, or part thereof, during the second quarter of fiscal
year 2000.
Management believes that proceeds from the loans, initial public offering,
and/or a private equity investor will provide Sunhawk.com with the necessary
cash proceeds to allow Sunhawk.com to have the wherewithal to continue
operations through at least September 30, 2000. However, if Sunhawk.com is not
otherwise able to raise sufficient capital in order to continue its current
operations, it may be unable to meet its obligations as they become due. As a
result, Sunhawk.com might be unable to continue as a going concern, and it would
then be necessary to consider other alternatives, such as substantially
curtailing its operations.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost less accumulated depreciation.
Depreciation is calculated using the straight-line method over the estimated
useful lives of the related assets, which range from three to seven years.
F-7
<PAGE> 60
SUNHAWK.COM CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CD-ROMS
CD-ROMs are stated at the lower of cost, determined by the first-in, first-out
method, or market.
DIGITAL SHEET MUSIC MASTERS
Digital sheet music masters are valued at cost less accumulated amortization.
Digital sheet music masters are amortized over the shorter of (1) the estimated
useful life of the music category, or (2) the estimated useful life of the
related electronic medium, or (3) the remaining term of the underlying music
licensing agreement (for licensed music). The amortization periods generally
range from five to fifteen years. Amortization expense is included in cost of
goods sold and was $20,946, $8,347 and $1,804 for the years ended September 30,
1999, 1998, and 1997, respectively. Sunhawk.com periodically evaluates the
digital sheet music masters for impairment.
PATENTS AND TRADEMARKS
Patents and trademarks are stated at cost less accumulated amortization.
Amortization is calculated on a straight-line basis over fifteen years.
Amortization expense is included in selling, general and administrative expense
and was $5,302, $2,835, and $1,091 for the years ended September 30, 1999, 1998
and 1997, respectively. Sunhawk.com periodically evaluates these intangible
assets for impairment.
MUSIC CATALOG DISTRIBUTION RIGHTS
Music Catalog Distribution rights are stated at cost less accumulated
amortization. Amortization is calculated on a straight-line basis over the
remaining term of the underlying distribution agreement, approximately eight and
one-half years. Amortization expense is included in the cost of goods sold and
was approximately $75,400 for the year ended September 30, 1999. Sunhawk.com
periodically evaluates these music catalog distribution rights for impairment.
DEFERRED OFFERING COSTS
Deferred offering costs represent costs incurred in conjunction with
Sunhawk.com's proposed initial public offering. Deferred offering costs will be
applied against the proceeds of the offering, if successful, or expensed if the
initial public offering is unsuccessful.
REVENUE RECOGNITION
Revenue from product sales is recorded when products are purchased and
downloaded by customers via Sunhawk.com's web site or shipped via regular mail
or overnight courier. Shipping charges are separately charged to the customers
and are included in sales.
ROYALTIES
In conjunction with the various distribution agreements, Sunhawk.com is required
to pay royalties ranging from 10% to 70% on gross receipts less credit card
processing fees to the
F-8
<PAGE> 61
SUNHAWK.COM CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
respective music publishers on each digital music title sold. Total royalty
expense incurred during the years ended September 30, 1999, 1998 and 1997
amounted to $38,159, $4,183 and $0, respectively, and is recorded in cost of
goods sold.
ADVERTISING COSTS
Advertising costs, including promotional materials, are expensed as incurred.
Costs for placement of advertising are prepaid and charged to expense at the
time the advertisement is initially publicized. Advertising expense totaled
$218,043, $36,005, and $21,557 during the years ended September 30, 1999, 1998
and 1997, respectively.
RESEARCH AND DEVELOPMENT COSTS
Research and development costs are expensed as incurred. Research and
development expenses totaled $0, $93,529, and $126,017 during the years ended
September 30, 1999, 1998, and 1997, respectively.
INCOME TAXES
The shareholders of Sunhawk.com changed their election from an "S" corporation
to a "C" corporation effective April 1, 1999. As an "S" corporation, any tax
liability or benefit is passed directly to the shareholders. Accordingly,
Sunhawk.com did not realize any tax provision or benefit prior to April 1, 1999.
Subsequent to March 31, 1999, Sunhawk.com accounts for income taxes under the
liability method. Under the liability method, deferred tax assets and
liabilities are determined based on differences between financial reporting and
tax bases of assets and liabilities and are measured using the enacted tax rates
and laws that will be in effect when the differences are expected to be
recovered. Valuation allowances are established, when necessary, to reduce
deferred tax assets to the amounts expected to be realized.
STOCK-BASED COMPENSATION
Sunhawk.com accounts for stock-based compensation using the intrinsic value
method and provides pro forma footnote disclosure of the impact of the fair
value method.
NET LOSS PER SHARE
Basic and diluted net loss per share is computed based on the weighted-average
number of common shares outstanding during each period.
USE OF ESTIMATES
These financial statements have been prepared in conformity with generally
accepted accounting principles, which require management to make estimates and
assumptions that impact amounts reported in the financial statements and
accompanying notes. Actual results could differ from those amounts reported and
disclosed herein.
F-9
<PAGE> 62
SUNHAWK.COM CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
3. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30,
----------------------
1999 1998
--------- ---------
<S> <C> <C>
Computers and equipment................................ $ 398,728 $ 302,574
Furniture.............................................. 55,051 39,295
Software............................................... 41,446 15,649
Other.................................................. 1,854 1,820
--------- ---------
497,079 359,338
Less accumulated depreciation.......................... (243,239) (163,458)
--------- ---------
$ 253,840 $ 195,880
========= =========
</TABLE>
4. DISTRIBUTION AGREEMENTS
In May and June 1998, Sunhawk.com entered into distribution agreements with
Warner Bros. Publications U.S. Inc. and EMI Christian Music Publishing,
respectively. These agreements provide Sunhawk.com with nonexclusive rights to
distribute selected digital sheet music from the respective music catalogs
maintained by Warner Bros. Publications U.S. Inc. and EMI Christian Music
Publishing. The terms of the agreements are approximately ten and five years,
respectively.
The Warner Bros. Publications U.S. Inc. agreement provides Sunhawk.com with
nonexclusive right to distribute selected digital sheet music from the Warner
Bros. Publications U.S. Inc. music catalog. As a nonforfeitable part of the
consideration and as inducement to enter into the agreement, Sunhawk.com agreed
to issue 99,073 shares of its common stock to Warner Bros. Publications U.S.
Inc., contingent upon either the closing of a firmly underwritten public
offering or the private sale or other disposition of 15% or more of
Sunhawk.com's common stock then authorized and outstanding.
As a result of the sale of common stock to certain founders on March 31, 1999,
the contingency was removed, the shares were issued to Warner Bros. Publications
U.S. Inc. and became fully vested and non-forfeitable under the terms of the
agreement. The value of the shares of common stock issued to Warner Bros.
Publications U.S. Inc. were measured at the fair value of common stock on
issuance date and capitalized as a long-term asset, which will be amortized over
the remaining life of the distribution agreement.
5. NOTES PAYABLE TO SHAREHOLDER
On September 30, 1998, Sunhawk.com entered into two demand note payable
agreements with a shareholder. On March 31, 1999, the shareholder exchanged
these notes, including interest accrued through September 30, 1998 for 267,968
shares of common stock. Interest accrued during the six-month period ended March
31, 1999 of $113,928 was not converted to shares of common stock and is included
in accrued interest on notes payable to shareholder. On August 17, 1999 and
September 21, 1999, Sunhawk.com entered into note payable agreements in the
amount of $80,000 and $210,000, respectively, with a
F-10
<PAGE> 63
SUNHAWK.COM CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
5. NOTES PAYABLE TO SHAREHOLDER (CONTINUED)
shareholder. The notes are due on February 1, 2000, and carry interest at the
federal applicable short-term rate, or approximately 5%.
6. LINE-OF-CREDIT
On September 29, 1999, Sunhawk.com entered into a $500,000 line-of-credit
agreement with a financial institution. As of September 30, 1999, borrowings
totaling $100,000 were outstanding. Borrowings under the line of credit bear
interest at 5.64% and are due on demand, or if no demand is made, on December
29, 1999. On November 1, 1999, the line-of-credit was increased to $1,000,000
with an applicable interest rate of 6.35%. The line-of-credit remains due on
demand, or if no demand is made, on April 29, 2000. A shareholder of Sunhawk.com
has guaranteed payment on the line-of-credit.
7. SHAREHOLDERS' EQUITY
In October 1996, in conjunction with the sale of 229,878 shares of common stock
to an employee for past services for $4.00, Sunhawk.com recorded compensation
expense of $96,316. The compensation expense represented the difference between
the value of consideration paid for the common stock and the fair market value
at the date of issuance.
On March 30, 1999, the Board of Directors of Sunhawk.com approved the sale of
380,627 shares of common stock to the Eller and McConney 1995 Family Living
Trust in exchange for cash of $1,500,000 and the exchange of outstanding notes
payable to a shareholder of $3,568,406 outstanding at March 31, 1999,
($2,213,406 of notes payable to shareholder, including accrued interest, as of
September 30, 1998 plus additional borrowings provided to Sunhawk.com during the
six months ended March 31, 1999 of $1,355,000). In addition, on March 31, 1999,
the Eller and McConney 1995 Family Living Trust contributed capital of
$1,000,000 by forgiving the remaining notes payable to shareholder outstanding
at that date.
On August 25, 1999, Sunhawk.com's Board of Directors and its shareholders
amended its Articles of Incorporation to decrease the total number of shares of
common stock which Sunhawk.com has the authority to issue from 20,000,000 to
10,000,000.
On January 12, 2000, Sunhawk.com's Board of Directors and its shareholders
amended it Articles of Incorporation to increase the total number of shares of
common stock which Sunhawk.com has the authority to issue from 10,000,000 to
30,000,000. This amendment also granted Sunhawk.com the authority to issue
10,000,000 in preferred stock.
REVERSE STOCK SPLIT
On March 30, 1999, Sunhawk.com's Board of Directors approved a transaction to
give one share for every 6.007 shares of common stock, thereby giving effect to
a 1-for-6.007 reverse stock split effective March 31, 1999.
On December 23, 1999, Sunhawk.com's Board of Directors approved a transaction to
give 0.716 shares for every 1 share of common stock, thereby giving effect to a
1.397 to 1 reverse stock split effective December 23, 1999. All outstanding
common and common equivalent shares and per-share amounts in the accompanying
financial statements and
F-11
<PAGE> 64
SUNHAWK.COM CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
7. SHAREHOLDERS' EQUITY (CONTINUED)
related notes to the financial statements have been retroactively adjusted to
give effect to the reverse stock splits.
8. STOCK OPTIONS
STOCK OPTION PLAN
Under the terms of Sunhawk.com's 1996 Stock Option Plan, the Board of Directors
(the "Board") was authorized to issue 513,374 shares of common stock through
incentive and nonqualified stock options to any former, current, or future
employees, officers, directors, agents or consultants, including members of
technical advisory boards, and any independent contractors of Sunhawk.com. On
March 30, 1999, the Board amended the 1996 Stock Option Plan to reduce the
number of shares the Board is authorized to issue to 303,526. Generally, stock
compensation, if any, is measured as the difference between the exercise price
of a stock option and the fair market value of Sunhawk.com's stock at the date
of grant, which is then amortized over the related service period. Options are
granted with exercise prices equal to the fair market value of the common stock
on the date of the grant, as determined by Sunhawk.com's Board. Options vest
over a five-year period and expire ten years from the date of grant.
A summary of the status of Sunhawk.com's stock option plan is presented
below:
<TABLE>
<CAPTION>
OUTSTANDING OPTIONS
-----------------------
WEIGHTED-
NUMBER AVERAGE
OF EXERCISE
SHARES PRICE
------- ------------
<S> <C> <C>
Balance at October 1, 1996............................ 0 $--
Options granted, at estimated fair value............ 65,286 1.52
Options exercised................................... (9,195) 0.00001341
-------
Balance at September 30, 1997......................... 56,091 1.77
Options granted, at estimated fair value............ 12,984 17.66
Options canceled.................................... (8,224) 9.32
-------
Balance at September 30, 1998......................... 60,851 4.14
Options exercised................................... (28,121) 0.0080186
Options canceled.................................... (14,798) 3.95
-------
Balance at September 30, 1999......................... 17,932 10.77
=======
</TABLE>
At September 30, 1999 options to acquire 248,278 shares of common stock were
available for future grant.
F-12
<PAGE> 65
SUNHAWK.COM CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
8. STOCK OPTIONS (CONTINUED)
The following table summarizes information about stock options outstanding
at September 30, 1999:
<TABLE>
<CAPTION>
OUTSTANDING OPTIONS
------------------------------------------------------------------------
WEIGHTED-AVERAGE
REMAINING
NUMBER OF WEIGHTED-AVERAGE CONTRACTED LIFE
EXERCISE PRICE SHARES EXERCISE PRICE (YEARS)
--------------- --------- ---------------- --------------------
<S> <C> <C> <C>
$0.42 7,153 $ .42 7.02
$0.43 - $11.33 4,765 $11.33 8.20
$11.34 - $22.65 6,014 $22.65 8.79
------
17,932
======
</TABLE>
As of September 30, 1999, in connection with the stock option plan, 266,210
shares of common stock were available for future issuance. At September 30,
1999, 3,159 options were exercisable at an exercise price of $2.07 per share.
Sunhawk.com applies Accounting Principles Board Opinion No. 25 and related
interpretations in accounting for its stock option plan. Accordingly, no
compensation cost has been recognized for its stock options issued to employees
in the accompanying financial statements because the fair value of the
underlying common stock equals the exercise price of the stock options granted.
Had the stock compensation expense for Sunhawk.com's stock option plan been
determined based on the fair value at the grant dates for options granted in
1999, 1998, and 1997, consistent with the fair value method of Statement of
Financial Accounting Standards No. 123, Sunhawk.com's net loss for the years
ended September 30, 1999, 1998, and 1997 would have been increased to the
following pro forma amount:
<TABLE>
<CAPTION>
1999 1998 1997
---------- ---------- --------
<S> <C> <C> <C>
Net loss:
As reported...................... $2,834,337 $1,475,579 $910,983
Pro forma........................ 2,859,040 $1,486,649 $911,609
Net loss per share, basic and
diluted:
As reported...................... $ 2.46 $ 1.66 $ 1.04
Pro forma........................ 2.48 1.67 1.04
</TABLE>
The fair value of each option grant was estimated on the date of grant using the
Minimum Value Option Pricing model using the following weighted-average
assumptions: risk-free interest rate of 4.77%, 5.49%, and 6.11% for 1999, 1998,
and 1997, respectively; expected life of five years; and dividend yield of 0%.
F-13
<PAGE> 66
SUNHAWK.COM CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
9. COMMITMENTS
Sunhawk.com leases office space and equipment under operating lease agreements
expiring in 2001 and 2002, respectively. Future minimum lease payments under
noncancelable operating leases at September 30, 1999 are as follows:
<TABLE>
<S> <C>
Year ending September 30:
2000........................................................ $343,749
2001........................................................ 344,436
2002........................................................ 686
--------
Total minimum lease payments................................ $688,871
========
</TABLE>
Total rent expense paid during the years ended September 30, 1999, 1998, and
1997 amounted to $334,494, $54,686 and $9,216, respectively.
10. FEDERAL INCOME TAXES
Sunhawk.com, with the consent of its shareholders, elected to be taxed under the
provisions of Subchapter S of the Internal Revenue Code from August 20, 1992
(date of inception) through March 31, 1999, when it became no longer eligible to
be taxed as such. Accordingly, through March 31, 1999, the shareholders of
Sunhawk.com were entitled to report on their personal income tax returns their
proportionate share of Sunhawk.com's operating losses. Effective April 1, 1999,
Sunhawk.com became subject to federal corporate income taxes and therefore began
to account for income taxes in accordance with Statement of Financial Accounting
Standard No. 109 "Accounting for Income Taxes." There was no income tax
provision in 1999 due to the net loss.
A reconciliation of the income tax provision is as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30,
1999
------------------
<S> <C>
Income tax benefit based on federal statutory rate of
34%.................................................. $(964,000)
Loss allocated to shareholders under the provision of
subchapter S......................................... 482,000
Unrealized net operating loss benefits................. 533,000
Other.................................................. (51,000)
---------
Income tax provision................................. $ 0
=========
</TABLE>
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts
F-14
<PAGE> 67
SUNHAWK.COM CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
10. FEDERAL INCOME TAXES (CONTINUED)
used for income tax purposes. Significant components of Sunhawk.com's deferred
tax assets and liabilities are as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30,
1999
-------------
<S> <C>
Deferred tax assets:
Net operating loss carryforwards......................... $ 533,000
Payable to Eller McConney LLC............................ 58,000
Accrued interest......................................... 39,000
Accrued expense.......................................... 16,000
---------
Total deferred tax assets.................................. 646,000
Valuation allowance for deferred tax assets.............. (639,000)
---------
Total deferred tax asset less valuation allowance.......... 7,000
---------
Deferred tax liabilities:
Depreciation and amortization............................ (5,000)
Prepaid expense.......................................... (2,000)
---------
Total deferred tax liability............................... (7,000)
---------
Net deferred tax asset..................................... $ 0
=========
</TABLE>
At September 30, 1999, Sunhawk.com had net operating loss carryforwards (NOLs)
of approximately $1,567,000, which, if not utilized, will expire in the year
2019. Utilization of NOLs may be limited in any given year by alternative
minimum tax (AMT) restrictions, depending upon each year's AMT calculation.
11. RELATED-PARTY TRANSACTIONS
Sunhawk.com pays to Eller McConney LLC, which is wholly owned by Marlin Eller
and Mary McConney, executive officers and trustees of a trust which owns a
majority of shares of Sunhawk.com, for certain services in connection with the
production of digital sheet music masters. Avtograf, a Russian joint stock
company in which Eller McConney LLC has a 94% interest, provides these services
under an informal agreement with Eller McConney LLC. At September 30, 1999,
Sunhawk.com owed $169,957 to Eller McConney LLC for these services. The digital
sheet music masters for which production services were provided represented
approximately 64% and 10% of the digital sheet music acquired by Sunhawk.com
during the year ended September 30, 1999 and 1998, respectively.
During the year ended September 30, 1999, Sunhawk.com's Board of Directors
approved entering into a ten-year assignment and assumption agreement with
Avtograf, Eller McConney LLC, Music Production International. The assumption and
assignment agreement will require that Eller McConney LLC assign to Sunhawk.com
all of its rights to receive from Avtograf its services for the production of
digital sheet music in exchange for a promissory note payable to Eller McConney
LLC in the amount of $1,000,000. Payment of the principal and interest is based
on the number of pages received and accepted from Music Production International
over a period of five years and is to be paid
F-15
<PAGE> 68
SUNHAWK.COM CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
11. RELATED-PARTY TRANSACTIONS (CONTINUED)
quarterly in arrears with a maximum principal payment of $200,000 per annum. The
promissory note payable will bear interest at the applicable federal short-term
rate, which was approximately 5% at September 30, 1999. The promissory note
payable of $1,000,000 to Eller McConney LLC is expected to be accounted for as a
prepayment for services to be provided for the production of digital sheet music
from Music Production International, with recourse to Eller McConney LLC in the
event of non-performance. In connection with this agreement, Avtograf will
assign to Music Production International its obligation to provide production
services for digital sheet music. Thereafter, Music Production International
will be obligated to provide production services for digital sheet music for
Sunhawk.com at an anticipated minimum rate of 4,500 pages per month totaling
270,000 pages over a period of five years, at no additional cost to Sunhawk.com.
Neither Eller McConney LLC, Mr. Eller, Ms. McConney nor Sunhawk.com will have an
ownership interest in Music Production International. This agreement is
contingent upon Sunhawk.com's initial public offering becoming effective.
Marlin Eller, Chairman of the Board, Chief Executive Officer, and President, and
Mary McConney, Treasurer (Chief Financial Officer until June 10, 1999), of
Sunhawk.com provided services to Sunhawk.com as officers of Sunhawk.com. They
have received no compensation for these services from inception of Sunhawk.com
through to September 30, 1999.
12. OTHER
INITIAL PUBLIC OFFERING
On June 10, 1999, Sunhawk.com's Board of Directors authorized Sunhawk.com to
file a Registration Statement under the Securities Act of 1933, as amended, to
permit Sunhawk.com to proceed with an initial public offering of its common
stock.
13. SUBSEQUENT EVENTS
BRIDGE FINANCING LOAN AGREEMENTS
On January 12, 2000, Sunhawk.com entered into an Agency Agreement with Joseph
Gunnar & Co., LLC to obtain from third parties bridge financing loans totaling
$1,000,000. The loans bear interest at a rate of 8.5% per annum and will be due
at the earlier of the closing of the initial public offering or September 26,
2000. The loans hold a first security on Sunhawk.com's assets as collateral. The
Loans have a 50% warrant coverage, which equates to 1,042 warrants per $25,000
of loan proceeds for a total of 41,680 warrants at the initial public offering
price, which is assumed to be $12.00 per share. The warrants may be adjusted for
stock splits, recapitalization, or reorganization of Sunhawk.com. The warrants
are exercisable commencing six months following the closing date of the
offering. Sunhawk.com will, at the closing of the bridge financing, pay to
Joseph Gunnar & Co., LLC (i) a commission equal to 7% of the aggregate loan
amount; (ii) a structuring fee equal to 3% of the aggregate loan amount; (iii)
reimbursement of out-of-pocket expenses; and (iv) reimbursement of reasonable
fees and disbursements of counsel to Joseph Gunnar & Co., LLC. The loans closed
on January 26, 2000.
F-16
<PAGE> 69
- --------------------------------------------------------------------------------
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. WE HAVE
NOT AUTHORIZED ANYONE TO PROVIDE YOU WITH INFORMATION DIFFERENT FROM THAT
CONTAINED IN THIS PROSPECTUS. WE ARE OFFERING TO SELL, AND SEEKING OFFERS TO
BUY, SHARES OF OUR COMMON STOCK ONLY IN JURISDICTIONS WHERE OFFERS AND SALES ARE
PERMITTED. THE INFORMATION CONTAINED IN THIS PROSPECTUS IS ACCURATE ONLY AS OF
THE DATE OF THIS PROSPECTUS, REGARDLESS OF THE TIME OF DELIVERY OF THIS
PROSPECTUS OR OF ANY SALE OF OUR COMMON STOCK. IN THIS PROSPECTUS,
"SUNHAWK.COM," "WE," "US" AND "OUR" REFER TO SUNHAWK.COM CORPORATION.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus summary................... 3
Risk factors......................... 5
Forward-looking statements........... 8
Use of proceeds...................... 9
Capitalization....................... 10
Dilution............................. 11
Dividend policy...................... 11
Selected financial data.............. 12
Management's discussion and analysis
of financial condition and results
of operations...................... 13
Business............................. 19
Management........................... 35
Related-party transactions........... 39
Principal shareholders............... 41
Description of securities............ 43
Shares eligible for future sale...... 46
Selling shareholders................. 48
Underwriting......................... 49
Transfer agent and registrar......... 51
Legal matters........................ 51
Experts.............................. 51
Where you can find more
information........................ 51
Index to financial statements........ F-1
</TABLE>
UNTIL MARCH 10, 2000 ALL DEALERS THAT BUY, SELL OR TRADE SHARES OF OUR COMMON
STOCK, 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.
- ------------------------------------------
1,400,000 Shares
LOGO
Common Stock
-----------------
PROSPECTUS
-----------------
JOSEPH GUNNAR & CO., LLC
February 14, 2000
- ------------------------------------------
