<PAGE>
Proxy Statement Pursuant to Section 14(a) of the
Securities Exchange Act of 1934 (Amendment No. / / )
Filed by the registrant /X/
Filed by a party other than the registrant / /
Check the appropriate box:
/ / Preliminary proxy statement
/X/ Definitive proxy statement
/ / Definitive additional materials
/ / Soliciting material pursuant to Rule 14(a)-11(c) or Rule 14a-12
Sound Source Interactive, Inc.
(Name of Registrant as Specified in Its Charter)
Board of Directors of Sound Source Interactive, Inc.
(Name of Person(s) Filing Proxy Statement)
Payment of filing fee (Check the appropriate box):
/ / $125 per Exchange Act Rule 0-11(c)(1)(ii), 14a-6(i)(1),
14a-6(j)(2) or Item 22(a)(2) of Schedule 14A.
/ / $500 per each party to the controversy pursuant to Exchange Act
Rule 14(a)-6(i)(3).
/ / Fee computed on table below per Exchange Act Rules 14a-6(i)(4) and
0-11.
(1) Title of each class of securities to which transaction applies:
.............................................................................
(2) Aggregate number of securities to which transaction applies:
.............................................................................
(3) Per unit price or other underlying value of transaction computed
pursuant to Exchange Act Rule 0-11:(1)
.............................................................................
(4) Proposed maximum aggregate value of transaction:
.............................................................................
/ / Check box if any part of the fee is offset as provided by Exchange Rule
0-11(a)(2) and identify the filing for which the offsetting fee was
previously. Identify the previous filing by registration statement number,
or the Form or Schedule and the date of its filing.
(1) Amount previously paid:
.............................................................................
<PAGE>
(2) Form, Schedule or Registration Statement No.:
.............................................................................
(3) Filing party:
.............................................................................
(4) Date filed:
.............................................................................
(1) Set forth the amount on which the filing fee is calculated and state how
it was determined.
<PAGE>
SOUND SOURCE INTERACTIVE, INC.
October 28, 1996
DEAR STOCKHOLDER:
You are cordially invited to attend the Annual Meeting of Stockholders of
Sound Source Interactive, Inc., to be held on December 9, 1996, at 10:00 a.m.
local time at the Century Plaza Hotel, 2025 Avenue of the Stars, Los Angeles,
California. I encourage you to attend.
At the meeting, we will elect five directors, and act upon approval of
the Company's 1995 Stock Option Plan. There will also be a report on the
Company's business, and stockholders will have an opportunity to ask
questions.
The vote of each stockholder is important. Therefore, whether or not you
plan to attend the meeting, I urge you to complete and sign the accompanying
proxy and return it in the enclosed envelope as promptly as possible.
Very truly yours,
Vincent J. Bitetti
CHAIRMAN OF THE BOARD AND
CHIEF EXECUTIVE OFFICER
<PAGE>
SOUND SOURCE INTERACTIVE, INC.
2985 East Hillcrest Drive, Suite A
Westlake Village, California 91362
NOTICE OF ANNUAL MEETING OF STOCKHOLDERS
To be held Monday, December 9, 1996
To the Stockholders of Sound Source Interactive, Inc.:
The Annual Meeting of Stockholders of Sound Source Interactive, Inc. (the
"Company") will be held on December 9, 1996 at 10:00 a.m. local time at the
Century Plaza Hotel, 2025 Avenue of the Stars, Los Angeles, California, for
the following purposes:
1. To elect five directors, each to hold office for a term of one year
ending in 1997 or when their successors are elected;
2. To consider and act upon a proposal to approve the Company's 1995
Stock Option Plan; and
3. To transact such other business as may properly come before the
meeting or any adjournment thereof.
Only stockholders of record as shown on the books of the Company at the
close of business on October 25, 1996, the record date and time fixed by the
Board of Directors, will be entitled to vote at the meeting and any
adjournment thereof.
Ulrich E. Gottschling
CHIEF FINANCIAL OFFICER,
SECRETARY AND TREASURER
October 28, 1996
Westlake Village, California
TO ASSURE YOUR REPRESENTATION AT THE MEETING, PLEASE SIGN, DATE AND
RETURN YOUR PROXY IN THE ENCLOSED ENVELOPE WHETHER OR NOT YOU EXPECT TO
ATTEND IN PERSON. STOCKHOLDERS WHO ATTEND THE MEETING MAY REVOKE THEIR
PROXIES AND VOTE IN PERSON IF THEY DESIRE.
<PAGE>
SOUND SOURCE INTERACTIVE, INC.
2985 East Hillcrest Drive, Suite A
Westlake Village, California 91362
-----------
PROXY STATEMENT
-----------
GENERAL INFORMATION
SOLICITATION OF PROXIES
This Proxy Statement is furnished by the Board of Directors of Sound
Source Interactive, Inc., a Delaware corporation (the "Company"), in
connection with its solicitation of proxies for use at the Company's Annual
Meeting of Stockholders (the "Annual Meeting") to be held on December 9, 1996
at 10:00 a.m. local time at the Century Plaza Hotel, 2025 Avenue of the
Stars, Los Angeles, California, and any and all adjournments thereof.
Holders of record of the Company's common stock, par value $.001 (the "Common
Stock"), at the close of business on October 25, 1996 will be entitled to one
vote for each share of Common Stock held on all matters to come before the
Annual Meeting. On October 25, 1996, there were outstanding 4,367,824 shares
of Common Stock.
A stockholder giving a proxy on the enclosed form may revoke it at any
time prior to the actual voting at the Annual Meeting by filing written
notice of the termination of the appointment with an officer of the Company,
by attending the Annual Meeting and voting in person or by filing a new
written appointment of a proxy with an officer of the Company. The
revocation of a proxy will not affect any vote taken prior to the revocation.
Unless a proxy is revoked or there is a direction to abstain on one or
more proposals, it will be voted on each proposal and, if a choice is made
with respect to any matter to be acted upon, in accordance with such choice.
If no choice is specified, the proxy will be voted as recommended by the
Board.
The Annual Meeting has been called for the purpose of electing five
directors to the Company's Board of Directors for a one-year term, and to
consider and act upon a proposal to approve the Company's 1995 Stock Option
Plan (the "1995 Stock Option Plan").
Solicitations of proxies will be made by preparing and mailing the Notice
of Annual Meeting, Proxy Statement and proxy to stockholders of record as of
the close of business on October 25, 1996. These materials are expected to
be first mailed to stockholders on or about November 7, 1996. The cost of
making the solicitation includes the cost of preparing and mailing the Notice
of Annual Meeting, Proxy Statement and proxy and the payment of charges made
by brokerage houses and other custodians, nominees and fiduciaries for
forwarding documents to stockholders. In certain instances, officers of the
Company may make special solicitations of proxies either in person or by
telephone. Expenses incurred in connection with special solicitations are
expected to be nominal. The Company will bear all expenses incurred in
connection with the solicitation of proxies for the Annual Meeting.
<PAGE>
VOTING AT THE MEETING
A majority of the votes entitled to be cast on matters to be considered
at the Annual Meeting constitutes a quorum. If a share is represented for
any purpose at the Annual Meeting, it is deemed to be present for all other
matters. Abstentions and shares held of record by a broker or its nominee
("Broker Shares") that are voted on any matter are included in determining
the number of votes present. Broker Shares that are not voted on any matter
at the Annual Meeting will not be included in determining whether a quorum is
present.
The election of each nominee for director requires a plurality of the
votes cast. For the 1995 Stock Option Plan to be approved, the votes cast
for approval must exceed the votes cast against. Abstentions and Broker
Shares that are not voted on the matter will not be included in determining
the number of votes cast.
A list of those stockholders entitled to vote at the Annual Meeting will
be available for a period of ten days prior to the Annual Meeting for
examination by any stockholder at the Company's principal executive offices,
2985 East Hillcrest Drive, Suite A, Westlake Village, California, and at the
Annual Meeting.
ELECTION OF DIRECTORS
(PROPOSAL #1)
GENERAL INFORMATION
The Bylaws of the Company provide that the Company is authorized to have
five directors, and that stockholders will elect the directors of the Company
at each annual meeting. Directors are elected to serve a one-year term.
Directors being elected at the Annual Meeting will serve until the Company's
next annual meeting of stockholders, or until their successors have been duly
elected and qualified.
THE BOARD RECOMMENDS A VOTE "FOR" THE ELECTION OF EACH OF THE DIRECTOR
NOMINEES NAMED BELOW.
INFORMATION REGARDING NOMINEES
All nominees have consented to serve if elected, but if any becomes
unable to serve, the persons named as proxies may exercise their discretion
to vote for a substitute nominee. The name, age, business experience and
offices held by each director nominee are as follows:
VINCENT J. BITETTI, age 41, founded Sound Source Interactive, Inc., a
California corporation (the "Subsidiary"), in 1989 and served as the
President of the Subsidiary from its formation. Since the Company acquired
the Subsidiary in 1994, Mr. Bitetti has served as the Chairman of the Board
and Chief Executive Officer and as a director of the Company and the
Subsidiary. Prior to founding the Subsidiary, from 1986 to 1988, Mr. Bitetti
was President of Fantastic Planet Consultants, a sound and musical instrument
design consulting company. Mr. Bitetti is a published music composer and
lyricist. From 1986 to 1993, Mr. Bitetti was a consultant to manufacturers
of keyboard synthesizers in the music industry. Mr. Bitetti developed the
concepts for the Company's CREATIVITY CENTERS-TM-, INTERACTIVE
MOVIEBOOKS-TM-, AUDIOCLIPS-TM- and VISUALCLIPS-TM- products.
2
<PAGE>
ULRICH E. GOTTSCHLING, age 38, was appointed as Chief Financial Officer,
Treasurer and director of the Company on October 9, 1995, and as Secretary of
the Company on November 17, 1995. Prior to joining the Company, Mr.
Gottschling was employed from June 1991 through September 1995 as a certified
public accountant with Corbin & Wertz, the Company's independent auditors.
From 1987 through May 1991, he was employed as a certified public accountant
by Deloitte & Touche. From 1980 through 1986, Mr. Gottschling held various
management positions with Westin Hotels and Marriott Corporation.
DR. RONALD W. HART, age 54, has held the position of Distinguished
Scientist in Residence for the Food and Drug Administration, U.S. Public
Health Service, since 1992. From 1980 to 1992, he was the Director of the
National Center for Toxicological Research, Food and Drug Administration,
Public Health Service, Department of Health and Human Services. Dr. Hart
served on the board of directors of First Commercial Bank Corporation of
Little Rock, Arkansas from 1987 to 1993. He also is a director of Telescan,
Inc. and CyberAction, Ltd.
MARK A. JAMES, age 37, is a founding member of the law firm of James,
Driggs & Walch in Las Vegas, Nevada, where he has been a partner since April
1996. From 1991 until the founding of James, Driggs & Walch, he was a
partner in the Las Vegas firm of Jolley, Urga, Wirth & Woodbury. In 1992,
Mr. James was elected to the Nevada State Senate. He was reelected in 1994,
and continues to serve as Chairman of the Senate Committee on Judiciary, and
on the Natural Resources and Legislative Affairs and Operations committees.
Mr. James is a director of ASSI, Inc.
ERNEST T. KLINGER, age 61, has been the Chief Financial Officer and Vice
President -- Finance and Administration of Arden Group, Inc. since 1983. He
has held various finance and operating positions at Arden Group, Inc. since
1980.
Mr. Bitetti was appointed as a director in May 1994 by action of the
Board to fill a then existing Board vacancy. Mr. Gottschling was appointed
as a director in October 1995 by action of the Board to fill a then existing
Board vacancy. Messrs. Hart, James and Klinger were appointed as directors
in July 1996 by action of the Board to fill then existing Board vacancies.
During the fiscal year ended June 30, 1996, the Board of Directors took
action by unanimous written consent on 22 occasions.
BOARD COMMITTEES
The Board of Directors has appointed two standing committees: the Audit
Committee and the Compensation Committee. Each of these committees was
established in July 1996, and therefore neither held any meetings during the
fiscal year ended June 30, 1996.
The Audit Committee consists of Dr. Ronald W. Hart, Mark A. James and
Ernest T. Klinger. Its purpose is to recommend the appointment of an
independent auditor for the Company, review the scope of the audit, examine
the auditor's reports, make appropriate recommendations to the Board of
Directors as a result of such review and examination and make inquiries into
the effectiveness of the financial and accounting functions and controls of
the Company.
The Compensation Committee consists of Dr. Ronald W. Hart, Mark A. James
and Ernest T. Klinger. It is responsible for reviewing and setting the
compensation of executive officers of the Company and for administering the
Company's stock option plans.
3
<PAGE>
EXECUTIVE COMPENSATION
SUMMARY COMPENSATION. The following table sets forth information
concerning compensation of the Company's Chief Executive Officer and each of
the Company's other executive officers who received compensation from the
Company in excess of $100,000 for the fiscal year ended June 30, 1996 (the
"Named Executives"). No other executive officer's compensation exceeded
$100,000 during fiscal year 1996.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
SUMMARY ANNUAL
COMPENSATION LONG-TERM COMPENSATION
------------------ ----------------------------------
STOCK OPTIONS ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS(1) (SHARES) COMPENSATION(2)
- --------------------------- ---- ------ -------- ------------- ---------------
<S> <C> <C> <C> <C> <C>
Vincent J. Bitetti, Chairman of the 1996 $187,500 $31,874 0 $19,018
Board and Chief Executive Officer 1995 150,000 75,000 0 6,200
Eric H. Winston, President 1996 $168,750 $31,874 0 $21,141
and Chief Operating Officer 1995 150,000 75,000 0(3) 9,600
</TABLE>
- --------------
(1) The bonuses accrued for fiscal year 1995 were fully paid in December 1995.
(2) The amounts in this column consist of the following: (a) personal
use of Company car (50 percent of payment for car expenses): Mr.
Bitetti -- $9,576 (1996), $4,800 (1995), Mr. Winston -- $9,302 (1996),
$4,800 (1995); (b) life insurance premiums: Mr. Bitetti -- $4,311 (1996),
$1,400 (1995), Mr. Winston -- $4,750 (1996); and (c) medical insurance
premiums: Mr. Bitetti -- $5,131 (1996), Mr. Winston -- $7,089 (1996),
$4,800 (1995).
(3) Does not include an option to purchase 100,000 shares granted to Mr.
Winston by Mr. Bitetti in April 1995.
OPTION GRANTS. The Company did not grant any options to any of the Named
Executives during its fiscal year ended June 30, 1996.
OPTION EXERCISES AND HOLDINGS. The following table sets forth
information concerning each exercise of a stock option during the fiscal year
ended June 30, 1996 by each of the Named Executives and the number and value
of unexercised options granted by the Company held by each of the Named
Executives on June 30, 1996.
4
<PAGE>
AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL
YEAR-ENDED OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF SHARES VALUE OF UNEXERCISED IN-
NUMBER OF UNDERLYING UNEXERCISED THE-MONEY OPTIONS AT
SHARES OPTIONS AT 6/30/96 6/30/96(I)
ACQUIRED ON VALUE ------------------------- -------------------------
NAME EXERCISE REALIZED EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE
- ---- ----------- -------- ------------------------- --------------------------
<S> <C> <C> <C> <C>
Vincent J. Bitetti 0 $0 0/0 $ 0/0
Eric H. Winston(1) 0 0 292,838/0 1,153,782/0
</TABLE>
- -------------
(1) Based on the fair market value of the Common Stock in the Company's
initial public offering ($4.00 per share), which commenced on July 2,
1996, less the option exercise price.
(2) Does not include a presently exercisable option held by Mr. Winston to
purchase 100,000 shares of Common Stock from Mr. Bitetti at $2.00 per
share.
COMPENSATION OF DIRECTORS
Prior to June 30, 1996, all of the Company's directors were employees and
received no compensation for their services as directors. In fiscal 1997,
the Company's employee directors will continue to receive no compensation for
their services as directors. However, the Company will pay each director who
is not an employee of the Company a director's fee of $15,000 per year, and
reimburse them for out-of-pocket expenses incurred in connection with their
attendance at meetings. In addition, the 1995 Stock Option Plan provides for
the grant of stock options to nonemployee directors of the Company without
any action on the part of the Board of Directors or the Compensation
Committee, upon the terms and conditions set forth in the 1995 Stock Option
Plan. Each nonemployee director shall automatically receive nonqualified
stock options to acquire 10,000 shares of Common Stock upon appointment as a
director, and shall receive nonqualified options to acquire an additional
10,000 shares of Common Stock for each additional year that the nonemployee
director continues to serve on the Board of Directors. Each option granted
to a nonemployee director shall vest and become exercisable as to 50 percent
of the shares of Common Stock subject to the option on the first anniversary
date of the grant and as to the remaining 50 percent on the second
anniversary date of the grant, and will expire on the earlier of ten years
from the date the option was granted, upon expiration of the 1995 Stock
Option Plan, or three weeks after the optionee ceases to be a director of the
Company. The exercise price of such options shall be equal to 100 percent of
the fair market value of the Common Stock subject to the option on the date
on which such options are granted. Each option shall be subject to the other
provisions of the 1995 Stock Option Plan.
EMPLOYMENT AGREEMENTS
The Company has entered into an employment agreement with Vincent J.
Bitetti, Chairman of the Board and Chief Executive Officer, for a term ending
on September 15, 1998. Pursuant to that employment agreement, commencing
September 15, 1995, Mr. Bitetti was entitled to receive annual base
compensation of $200,000. The employment agreement was amended to provide
that effective July 2, 1996, Mr. Bitetti's base compensation was reduced to
$160,000 per annum, subject to an increase by $40,000 per annum at such time
as the Company realizes net sales (gross sales less returns and allowances)
of $1,500,000 or more for any three consecutive calendar months. Mr.
Bitetti's annual base compensation also is subject to escalation annually in
accordance
5
<PAGE>
with the Consumer Price Index (the "CPI"). In addition, Mr.
Bitetti's employment agreement entitles him to receive bonuses based on three
criteria: attainment of specified gross revenues, attainment of specified
gross profits, and attainment of specified pre-tax profitability. If the
Company acquires any new businesses in the future, the related revenues and
profits will not be taken into account in determining entitlements to these
bonuses.
The employment agreement would entitle Mr. Bitetti to receive a bonus in
the following amounts if the following gross revenues are attained for the
fiscal year ending June 30, 1997:
GROSS REVENUES CUMULATIVE CASH BONUS
-------------- ----------------------
$ 7,500,000 $ 25,000
10,000,000 $ 75,000
15,000,000 125,000
The gross revenue attainment levels required to receive each bonus level for
each subsequent fiscal year will be increased by 60 percent annually.
The employment agreement would entitle Mr. Bitetti to receive a bonus in
the following amounts if the following levels of gross profits (defined as
annual sales revenue less all costs of sales as determined by the Company's
independent public accountants) are attained for the fiscal year ending June
30, 1997:
GROSS PROFITS CUMULATIVE CASH BONUS
------------- ---------------------
$2,000,000 $ 50,000
2,250,000 $ 75,000
2,500,000 100,000
The gross profit levels required to receive each bonus level for each
subsequent fiscal year will be increased by 60 percent annually.
The employment agreement would entitle Mr. Bitetti to the following
amounts if the following levels of pre-tax profitability (defined as annual
earnings before interest, taxes, depreciation and amortization divided by
gross revenues) are attained for each fiscal year during the term of Mr.
Bitetti's employment agreement:
PROFITABILITY CUMULATIVE CASH BONUS
------------- ---------------------
10% $ 50,000
15% $100,000
Pursuant to his employment agreement, Mr. Bitetti is entitled to certain
other fringe benefits including use of a Company automobile or automobile
allowance, $5,000,000 in life insurance coverage (provided that in no event
will the Company be required to pay a premium for such insurance in excess of
$7,500 per year) and the right to participate in the Company's customary
benefit plans. Mr. Bitetti's employment agreement further provides that
following the voluntary or involuntary termination of his employment by the
Company, Mr. Bitetti is entitled to two demand
6
<PAGE>
registration rights with respect to the Common Stock held by or issuable to
him. These registration rights will only become effective upon the voluntary
or involuntary termination of Mr. Bitetti's employment with the Company. Mr.
Bitetti has agreed not to sell any shares of his Common Stock during the
18-month period beginning July 2, 1996 (except for 20,000 shares sold by Mr.
Bitetti pursuant to that offering) except with the consent of the
underwriters of the Company's initial public offering. Mr. Bitetti's
employment agreement further provides that if the Company employs a new Chief
Executive Officer, Mr. Bitetti's salary may not be less than that of such new
Chief Executive Officer, up to a maximum of $300,000.
The Company has entered into an employment agreement with Eric H.
Winston, President and Chief Operating Officer, for a term ending on
September 15, 1998. Pursuant to that employment agreement, commencing
September 15, 1995, Mr. Winston was entitled to receive annual base
compensation of $175,000. The employment agreement was amended to provide
that effective July 2, 1996, Mr. Winston's base compensation was reduced to
$140,000 per annum, subject to an increase of $35,000 per annum at such time
as the Company realizes net sales of $1,500,000 or more for any three
consecutive calendar months. This employment agreement makes Mr. Winston's
salary also subject to escalation annually in accordance with the CPI. Mr.
Winston's employment agreement entitles him to receive annual bonuses based
on the same three criteria, and payable in accordance with the same
provisions, described above with respect to Mr. Bitetti's employment
agreement. Mr. Winston is also entitled to the same fringe benefits as Mr.
Bitetti.
Pursuant to a prior employment agreement, the Company has granted Mr.
Winston options to purchase 292,838 shares of Common Stock at an exercise
price of $0.06 per share. Mr. Winston's employment agreement further
provides that following the voluntary or involuntary termination of his
employment by the Company, Mr. Winston is entitled to two demand registration
rights with respect to the Common Stock held by or issuable to him. The
registration rights will only become effective upon the voluntary or
involuntary termination of Mr. Winston's employment with the Company. Mr.
Bitetti has separately granted Mr. Winston a presently exercisable option to
acquire 100,000 shares of Common Stock at a purchase price of $2.00 per
share. Mr. Winston has agreed not to sell more than 10,000 shares of this
Common Stock during the 18-month period beginning July 2, 1996 except with
the consent of the underwriters of the Company's initial public offering.
Pursuant to his employment agreement, Mr. Winston has granted Mr. Bitetti
a right of first refusal as to all Common Stock that Mr. Winston may from
time to time acquire. Such first refusal right provides that before Mr.
Winston offers to sell any such Common Stock to any third party, he must
first offer to sell such shares to Mr. Bitetti on no less favorable terms
than proposed to be offered to the third party. If Mr. Bitetti rejects such
offer, Mr. Winston is free to sell to the third party on terms no less
favorable than offered to Mr. Bitetti.
On October 25, 1996, the Company entered into a Separation and Release
Agreement with Eric H. Winston. Such agreement cannot become effective until
November 1, 1996, until which time Mr. Winston has a statutory right of
rescission. Upon the effectiveness of that agreement, Mr. Winston will cease
to be an officer, employee and director of the Company, and will remain
entitled to receive compensation and other benefits as provided in the
agreement.
The Company entered into an employment with Ulrich E. Gottschling, Chief
Financial Officer, Treasurer and Secretary, for a term ending October 9,
1997. The employment agreement entitles Mr. Gottschling to receive annual
cash compensation of $110,000. Pursuant to his employment agreement, on
October 9, 1995 Mr. Gottschling also was granted options to purchase 100,000
7
<PAGE>
shares of Common Stock at an exercise price of $5.00 per share. On April 30,
1996, Mr. Gottschling agreed to the termination of his existing 100,000 share
option in consideration for the Company's agreement to grant to him a new
200,000 share option pursuant to the Company's 1992 Stock Option Plan. The
Company granted this option to Mr. Gottschling on April 30, 1996. The option
is exercisable upon the date of its grant as to 100,000 shares at a purchase
price of $3.40 per share, and will become exercisable as to 100,000 shares on
September 30, 1997 at a purchase price of $4.00 per share.
Mr. Gottschling's employment agreement further provides that following
the voluntary or involuntary termination of his employment by the Company,
Mr. Gottschling is entitled to a single demand registration right with
respect to the Common Stock held by or issuable to him pursuant to his
employment agreement. This registration right has been satisfied as a result
of the registration of all Common Stock underlying options issued pursuant to
the 1992 Stock Option Plan.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information regarding the
ownership of the Common Stock of the Company by (i) each person who is known
to the Company to own, of record or beneficially, more than five percent of
the Common Stock, (ii) each of the Company's directors and director nominees
and (iii) all directors and executive officers as a group. Where the persons
listed have the right to acquire additional shares of Common Stock through
the exercise of options or warrants within 60 days, such additional shares
are deemed to be outstanding for the purpose of computing the percentage of
outstanding shares owned by such persons, but are not deemed to be
outstanding for the purpose of computing the percentage ownership interests
of any other person. Unless otherwise indicated, each of the stockholders
shown in the table below has sole voting and investment power with respect to
the shares beneficially owned.
SHARES BENEFICIALLY OWNED
NAME AND ADDRESS -----------------------------
OF BENEFICIAL OWNER SHARES PERCENT(1)
- ------------------- ---------- ----------
Vincent J. Bitetti(1)
2985 E. Hillcrest Drive
Suite A
Westlake Village, CA 91362 1,342,184 30.7%
Eric H. Winston(2)
5567 Springhill Court
Westlake Village, CA 91362 392,838 8.4%
Louis A. Habash(3)
5075 Spyglass Hill Drive
Las Vegas, NV 89122 4,856,657 52.9%
All directors, director nominees
and executive officers as a
group (six persons)(4) 1,735,022 36.4%
8
<PAGE>
- --------------
(1) Includes 100,000 shares of Common Stock which Mr. Winston is entitled to
acquire from M. Bitetti pursuant to a presently exercisable option. Does
not include up to 292,838 shares that may be acquired by Mr. Winston from
the Company pursuant to the options described in (2) below, as to which
Mr. Bitetti has a right of first refusal.
(2) Includes 292,838 shares of Common Stock issuable under stock options
granted by the Company to Mr. Winston which are presently exercisable.
Also includes 100,000 shares of Common Stock which Mr. Winston is entitled
to acquire from Mr. Bitetti pursuant to a presently exercisable option.
(3) Includes 40,000 shares of Common Stock and 4,816,657 shares of Common
Stock issuable upon exercise of presently exercisable redeemable
warrants. All such Common Stock and redeemable warrants are owned of
record by ASSI, Inc., of which Mr. Habash is the sole beneficial owner.
(4) Includes 292,838 shares of Common Stock issuable to Mr. Winston and
100,000 shares of Common Stock issuable to an executive officer under
presently exercisable options.
VOTING AGREEMENTS
The Company has granted ASSI, Inc. and the underwriters for its initial
public offering, The Boston Group, L.P. and Joseph Stevens & Company, L.P.,
each the right to nominate from time to time one director of the Company or
to have an individual designated thereby attend all Board meetings as a
nonvoting advisor. Neither The Boston Group, L.P. nor Joseph Stevens &
Company, L.P. has exercised its rights to nominate a director. Mark A. James
is the director nominee of ASSI, Inc.
Vincent J. Bitetti and Eric H. Winston have entered into voting
agreements with each of ASSI, Inc., The Boston Group, L.P. and Joseph Stevens
& Co., L.P. Pursuant to these agreements, Messrs. Bitetti and Winston have
agreed to vote all of their Common Stock for the director nominees of ASSI,
Inc., The Boston Group, L.P. and Joseph Stevens & Co., L.P. In addition,
ASSI, Inc. has agreed to vote all of its shares of Common Stock for two
directors nominated by Mr. Bitetti as long as he holds at least 20 percent of
the outstanding Common Stock, and for one director nominated by Mr. Bitetti
for as long as he holds at least ten percent but less than 20 percent of the
outstanding Common Stock. Vincent J. Bitetti has designated himself and
Ulrich E. Gottschling as his nominees for such purpose. The voting
agreements with ASSI, Inc. will terminate when Messrs. Bitetti and Winston
together cease to owe at least ten percent of the outstanding Common Stock.
CERTAIN RELATIONSHIPS AND TRANSACTIONS
In April 1995, Vincent J. Bitetti, for nominal consideration, granted
Eric H. Winston, the Company's President and Chief Operating Officer, an
option to purchase 100,000 shares of the Common Stock owned by Mr. Bitetti at
an exercise price of $2.00 per share, such price determined to be the fair
market value by management.
The Company conducted a private offering (the "Private Placement") during
September and October 1995, pursuant to which it sold 52.5 units (the
"Units") at a price of $100,000 per Unit. Each Unit consisted of $95,000
principal amount of the Company's 10% Secured Promissory Notes
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due 1996 (the "Notes") and warrants to purchase 100,000 shares of Common
Stock (the "Private Warrants"). ASSI, Inc. purchased a total of 11 Units
pursuant to such Private Placement, comprising $1,045,000 in principal amount
of Notes and Private Warrants to purchase 1,100,000 shares of Common Stock.
Upon the completion of the Company's initial public offering on July 8, 1996,
all of the Notes were repaid in full. The Company paid ASSI, Inc. $1,122,588
in satisfaction of the Notes held by it. In addition, the Private Warrants
were converted to redeemable warrants, as more fully described below.
Contemporaneously with the Private Placement, Vincent J. Bitetti, the
Company's Chairman of the Board and Chief Executive Officer, privately sold
107,500 shares of Common Stock for total cash consideration of $537,500.
ASSI, Inc. purchased 40,000 of such shares for total cash consideration of
$200,000.
The Company entered into a Consulting Agreement with ASSI, Inc. dated
April 30, 1996. Pursuant to that agreement, ASSI, Inc. is to provide certain
consulting services to the Company, including advising the Company regarding
executive recruiting. In consideration of the services to be provided by
ASSI, Inc. pursuant to the Consulting Agreement, on April 30, 1996, the
Company issued to ASSI, Inc. warrants to purchase 2,000,000 shares of Common
Stock at an exercise price of $4.40 per share (the "ASSI Warrants," as
previously defined). Pursuant to the Consulting Agreement, the Company also
agreed to certain changes to the terms of the Private Warrants held by ASSI,
Inc. as described below.
On May 30, 1996, the Company entered into a Note Purchase Agreement with
ASSI, Inc. pursuant to which ASSI, Inc. loaned the Company $500,000 (the
"ASSI Convertible Loan"). The ASSI Convertible Loan bore interest at the
rate of eight percent per annum. The principal of and all accrued interest
on the ASSI Convertible Loan was due in full on the earlier of September 1,
1996 or the closing date of the Company's initial public offering, which
occurred on July 8, 1996. Upon the closing of the Company's initial public
offering, ASSI, Inc. exercised its option to convert all of the ASSI
Convertible Loan into warrants to purchase Common Stock at a conversion price
of $.25 per warrant. Warrants to purchase a total of 2,016,657 shares of
Common Stock were issued upon the conversion of the ASSI Convertible Loan.
Upon the completion of the Company's initial public offering on July 8,
1996, the terms of all of the warrants held by ASSI, Inc. became
substantially the same as those of the redeemable warrants issued by the
Company in the initial public offering except that (i) they became
exercisable October 1, 1996, (ii) they are not mandatorily redeemable by the
Company and (iii) they are subject to separate registration rights, including
one demand registration right and unlimited piggy-back registration rights
for as long as they are held by ASSI, Inc. or one of its affiliates. Upon a
transfer of the ASSI warrants to any nonaffiliate of ASSI, Inc., the terms of
such transferred ASSI warrants will become identical to those of the
Company's redeemable warrants. The demand registration rights will expire on
August 31, 2001. Until and unless exercised, the holders of the ASSI
warrants will have no voting, dividend or other rights as stockholders of the
Company.
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APPROVAL OF THE
1995 STOCK OPTION PLAN
(PROPOSAL #2)
GENERAL
On October 9, 1995, the Board of Directors of the Company adopted the
Company's 1995 Stock Option Plan. The Board of Directors adopted the
Company's Amended and Restated 1995 Stock Option Plan (the "1995 Stock Option
Plan") on May 15, 1996, and has directed that it be submitted for
consideration and action at the Annual Meeting. The following summary of the
Company's 1995 Stock Option Plan is qualified in its entirety by the 1995
Stock Option Plan, a copy of which is contained in its entirety as Exhibit A
hereto.
The 1995 Stock Option Plan is designed to promote and advance the
interests of the Company and its stockholders by (i) enabling the Company to
attract, retain and reward managerial and other key employees and nonemployee
directors, and (ii) strengthening the mutuality of interests between
participants in the 1995 Stock Option Plan and the stockholders of the
Company in its long term growth, profitability and financial success by
offering stock options.
The 1995 Stock Option Plan empowers the Company to award or grant from
time to time until September 30, 2005 to eligible participants incentive and
nonqualified stock options ("Options") authorized by the Compensation
Committee, which will administer the 1995 Stock Option Plan.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" THE APPROVAL OF THE 1995
STOCK OPTION PLAN.
ADMINISTRATION
The 1995 Stock Option Plan will be administered by the Compensation
Committee. The 1995 Stock Option Plan provides that the Compensation
Committee must consist of at least two directors of the Company who are
"disinterested directors" within the meaning of Rule 16b-3 under the
Securities Exchange Act of 1934, as amended (the "Exchange Act"). The
Compensation Committee has the sole authority to construe and interpret the
1995 Stock Option Plan, to make rules and procedures relating to the
implementation of the 1995 Stock Option Plan, to select participants, to
establish the terms and conditions of Options and to grant Options. The
Compensation Committee has broad authority to delegate its responsibilities
to others, except with respect to the selection for participation of, and the
granting of Options to, persons subject to Sections 16(a) and 16(b) of the
Exchange Act. Members of the Compensation Committee will not be eligible to
receive discretionary Options under the 1995 Stock Option Plan.
SHARES SUBJECT TO 1995 STOCK OPTION PLAN
The maximum number of shares of Common Stock in respect of which Options
may be granted under the 1995 Stock Option Plan (the "Plan Maximum") is
500,000. For purposes of computing the total number of shares of Common Stock
available for Options under the 1995 Stock Option Plan, the above limitations
shall be reduced by the number of shares of Common Stock subject to issuance
upon exercise or settlement of Options previously granted, determined at the
date of the grant of such Options. However, if any Options previously
granted are forfeited, terminated, settled in cash or exchanged for other
Options or expire unexercised, the shares of
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Common Stock previously subject to such Options shall again be available for
further grants under the 1995 Stock Option Plan. The shares of Common Stock
which may be issued to participants in the 1995 Stock Option Plan upon
exercise of an Option may be either authorized and unissued Common Stock or
issued Common Stock reacquired by the Company. No fractional shares may be
issued under the 1995 Stock Option Plan.
The maximum number of shares of Common Stock issuable upon exercise of
Options granted under the 1995 Stock Option Plan is subject to appropriate
equitable adjustment in the event of a reorganization, stock split, stock
dividend, combination of shares, merger, consolidation or other
recapitalization of the Company. The effect of such adjustment would be to
provide customary antidilution protection.
TRANSFERABILITY
No Option granted under the 1995 Stock Option Plan, and no right or
interest therein, shall be assignable or transferable by a participant except
by will or the laws of descent and distribution.
TERM, AMENDMENT AND TERMINATION
The 1995 Stock Option Plan will terminate on September 30, 2005 except
with respect to Options then outstanding. The Board of Directors may amend
or terminate the 1995 Stock Option Plan at any time, except that, to the
extent restricted by Rule 16b-3 promulgated under the Exchange Act, as
amended and in effect from time to time (or any successor rule), the Board of
Directors may not, without approval of the stockholders of the Company, make
any amendment that would increase the total number of shares covered by the
1995 Stock Option Plan, change the class of persons eligible to receive
Options granted under the 1995 Stock Option Plan, reduce the exercise price
of Options granted under the 1995 Stock Option Plan or extend the latest date
upon which Options may be exercised.
INCENTIVE STOCK OPTIONS
Under the 1995 Stock Option Plan, Options designated as incentive stock
options ("Incentive Stock Options") within the meaning of Section 422 of the
Internal Revenue Code of 1986, as amended (the "Code"), may be granted to
eligible participants in respect of up to the Plan Maximum. The number of
shares of Common Stock in respect of which Incentive Stock Options are first
exercisable by any participant in the 1995 Stock Option Plan during any
calendar year shall not have a fair market value (determined at the date of
grant) in excess of $100,000 (or such other limit as may be imposed by the
Code). To the extent the fair market value of the shares for which options
are designated as Incentive Stock Options that are first exercisable by any
optionee during any calendar year exceed $100,000, the excess amount shall be
treated as Nonqualified Stock Options. Incentive Stock Options shall be
exercisable for such period or periods, not in excess of ten years after the
date of grant, as shall be determined by the Compensation Committee.
NONQUALIFIED STOCK OPTIONS
Nonqualified stock options ("Nonqualified Stock Options") may be granted
to eligible participants in respect of up to the Plan Maximum, for such
number of shares of Common Stock and for such period or periods of
exercisability, as the Compensation Committee shall determine.
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OPTIONS TO NONEMPLOYEE DIRECTORS
The 1995 Stock Option Plan also provides for the grant of Nonqualified
Stock Options to nonemployee directors of the Company without any action on
the part of the Board or the Compensation Committee, only upon the terms and
conditions set forth in the 1995 Stock Option Plan. Each nonemployee
director shall automatically receive Nonqualified Options to acquire 10,000
shares of Common Stock upon appointment, and shall receive Nonqualified
Options to acquire an additional 10,000 shares of Common Stock for each
additional year that the nonemployee director continues to serve on the Board
of Directors. Each Option shall vest and become exercisable as to 50 percent
of the shares of Common Stock subject to the Option on the first anniversary
date of the grant and as to the remaining 50 percent on the second
anniversary date of the grant, and will expire on the earlier of ten years
from the date the Option was granted, upon expiration of the 1995 Stock
Option Plan or three weeks after the optionee ceases to be a director of the
Company. The exercise price of such Options shall be equal to 100 percent of
the fair market value of the Common Stock subject to the Option on the date
on which such Options are granted. Each option shall be subject to the other
provisions of the 1995 Stock Option Plan.
ELIGIBILITY CONDITIONS
Incentive Options may be granted only to persons who are employees of the
Company or its subsidiaries on the date of grant. Nonqualified options may
be granted to any person. Nonemployee directors are only eligible to receive
Nonqualified Stock Options under the 1995 Stock Option Plan. Except for
Nonqualified Stock Options granted to nonemployee directors, to whom Option
grants are automatic, the selection of recipients of, and the nature and size
of, Options granted under the 1995 Stock Option Plan will be wholly within
the discretion of the Compensation Committee. Subject to specific formula
provisions relating to the grant of Options to nonemployee directors and
except with respect to the exercisability of Incentive Stock Options and the
total shares available for Option grants under the 1995 Stock Option Plan,
there is no limit on the number of shares of Common Stock or type of option
in respect of which Options may be granted to or exercised by any person.
OPTION EXERCISE PRICES
The exercise price of any Option granted under the 1995 Stock Option Plan
shall be at least 100 percent of the fair market value of the Common Stock on
the date of grant, except that the exercise price of any Option granted to
any participant in the 1995 Stock Option Plan who owns in excess of ten
percent of the outstanding voting stock of the Company shall be 110 percent
of the fair market value of the Common Stock on the date of grant. Fair
market value per share of Common Stock is quoted by the Nasdaq SmallCap
Market, or as the amount determined in good faith by the Compensation
Committee if the Common Stock is neither listed for trading on an exchange or
quoted by the Nasdaq SmallCap Market.
EXERCISE OF OPTIONS
No Option may be exercised, except as provided below, unless the holder
thereof remains in the continuous employ or service of the Company. Options
shall be exercisable upon the payment in full of the applicable option
exercise price in cash or, if approved by the Compensation Committee, by
instruction to a broker directing the broker to sell the Common Stock for
which such Option is exercised and remit to the Company the aggregate
exercise price of the Option or upon
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such terms as the Committee shall approve, in shares of Common Stock then
owned by the optionee (at the fair market value thereof at exercise date).
PLAN BENEFITS
It is impossible to determine the awards that will be made under the 1995
Stock Option to persons other then nonemployee directors. Each nonemployee
director will automatically be granted 10,000 Nonqualified Options for each
year of services as a director, as more fully described above under "Options
to Nonemployee Directors." During the fiscal year ended June 30, 1996, the
Company did not grant any Options pursuant to the 1995 Stock Option Plan.
The table below shows Nonqualified Options to be granted to the Company's
nonemployee directors during the current fiscal year pursuant to the 1995
Stock Option Plan.
DOLLAR VALUE NUMBER OF SHARES
------------ -----------------
All nonemployee directors
as a group (four persons) $20,625(1) 30,000
- ---------------
(1) Based on the fair market value of the Common Stock on October 15, 1996.
FEDERAL INCOME TAX CONSEQUENCES
The grant of an Incentive Stock Option or a Nonqualified Stock Option
would not result in income for the grantee or in a deduction for the Company.
The exercise of a Nonqualified Stock Option would result in ordinary
income for the grantee and a deduction for the Company measured by the
difference between the option exercise price and the fair market value of the
shares received at the time of exercise. Income tax withholding would be
required.
The exercise of an Incentive Stock Option would not result in income for
the grantee. If the grantee (i) does not dispose of the shares within two
years after the date of grant or one year after the transfer of shares upon
exercise and (ii) is an employee of the Company or a subsidiary of the
Company from the date of grant until three months before the exercise date,
the basis of the shares upon later disposition would be the option exercise
price. Any gain will be taxed to the employee as long-term capital gain and
the Company would not be entitled to a deduction. The excess of the market
value on the exercise date over the option price is an item of tax
preference, potentially subject to the alternative minimum tax.
If the grantee disposes of the shares prior to the expiration of either
of the holding periods, the grantee would recognize ordinary income and the
Company would be entitled to a deduction equal to the lesser of the fair
market value of the shares on the exercise date minus the option price or the
amount realized on disposition minus the option price. Any gain in excess of
the ordinary income portion would be taxable as long-term or short-term
capital gain.
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INDEPENDENT AUDITORS
Corbin & Wertz has audited and reported on the financial statements of
the Company for the fiscal year ended June 30, 1996. A representative of
Corbin & Wertz is expected to be present at the Annual Meeting with the
opportunity to make a statement if he or she so desires and is expected to be
available to respond to appropriate stockholder questions.
The Company has not yet determined whether to utilize Corbin & Wertz as
its independent auditors in the future. It is evaluating the desirability of
employing a national accounting firm now that it has become a public company.
DEADLINE FOR SUBMISSION OF STOCKHOLDER PROPOSALS FOR 1997
The rules of the Securities and Exchange Commission permit stockholders
of the Company, after notice to the Company, to present proposals for
stockholder action in the Company's proxy statement where such proposals are
consistent with applicable law, pertain to matters appropriate for
stockholder action and are not properly omitted by Company action in
accordance with the proxy rules published by the Securities and Exchange
Commission. The Company's 1997 annual meeting of stockholders is expected to
be held on or about December 8, 1997, and proxy materials in connection with
that meeting are expected to be mailed on or about November 3, 1997.
Stockholder proposals prepared in accordance with the proxy rules must be
received by the Company on or before September 1, 1997.
FILINGS UNDER SECTION 16(A)
Section 16(a) of the Exchange Act currently requires the Company's
directors and officers, and persons holding ten percent or more of a
registered class of the Company's equity securities, to file reports
regarding their ownership and regarding their acquisitions and dispositions
of the Company's equity securities with the Securities and Exchange
Commission. The Company, however, was not subject to the reporting
requirements of Section 16(a) during the fiscal year ended June 30, 1996, and
therefore no such reports were required to be filed.
OTHER MATTERS
The Board of Directors of the Company does not intend to present any
business at the Annual Meeting other than the matters specifically set forth
in this Proxy Statement and knows of no other business to come before the
Annual Meeting. However, on all matters properly brought before the Annual
Meeting by the Board or by others, the persons named as proxies in the
accompanying proxy will vote in accordance with their best judgment.
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It is important that your shares are represented and voted at the
meeting, whether or not you plan to attend. Accordingly, we respectfully
request that you sign, date and mail your Proxy in the enclosed envelope as
promptly as possible.
BY ORDER OF THE BOARD OF DIRECTORS
Ulrich E. Gottschling
CHIEF FINANCIAL OFFICER,
SECRETARY AND TREASURER
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EXHIBIT A
1995 STOCK OPTION PLAN
OF SOUND SOURCE INTERACTIVE, INC.
1. PURPOSE
Sound Source Interactive, Inc. (the "Company") desires to attract and
retain the best available talent and encourage the highest level of
performance in order to continue to serve the best interests of the Company
and its stockholders. By affording key personnel the opportunity to acquire
proprietary interests in the Company and by providing them incentives to put
forth maximum efforts for the success of the business, the Amended and
Restated 1995 Stock Option Plan of Sound Source Interactive, Inc. (the
"Plan") is expected to contribute to the attainment of those objectives.
2. SCOPE AND DURATION
Options under the Plan may be granted in the form of incentive stock
options ("Incentive Options") as provided in Section 422 of the Internal
Revenue Code of 1986, as amended (the "Code"), or in the form of
non-qualified stock options ("Non-qualified Options") (unless otherwise
indicated, references in the Plan to "options" include Incentive Options and
Non-qualified Options.) The maximum aggregate number of shares as to which
options may be granted from time to time under the Plan is 500,000 shares of
the Company's Common Stock, par value $.001 per share (the "Common Stock"),
which shares may be, in whole or in part, authorized but unissued shares or
shares reacquired by the Company. If an option shall expire, terminate or be
surrendered for cancellation for any reason without having been exercised in
full, the shares represented by the option or portion thereof not so
exercised shall (unless the Plan shall have been terminated) become available
for subsequent option grants under the Plan. As provided in Paragraph 13,
the Plan shall become effective on November 1, 1995, and unless terminated
sooner pursuant to Paragraph 14, the Plan shall terminate on October 31,
2005, and no option shall be granted hereunder after that date.
3. ADMINISTRATION
The Plan shall be administered by the Board of Directors of the Company,
at their discretion, by a committee which is appointed by the Board of
Directors to perform such function (the "Committee"). The Committee shall
consist of not less than two members of the Board of Directors, each of whom
shall serve at the pleasure of the Board of Directors and shall be a
"Non-Employee Director" as defined in Rule 16b-3 pursuant to the Securities
Exchange Act of 1934. Vacancies occurring in the membership of the Committee
shall be filled by appointment by the Board of Directors.
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The Board of Directors or the Committee, as the case may be, shall have
plenary authority in its discretion, subject to and not inconsistent with the
express provisions of the Plan, to grant options, to determine the purchase
price of the Common Stock covered by each option, the term of each option,
the persons to whom, and the time or times at which, options shall be granted
and the number of shares to be covered by each option; to designate options
as Incentive Options; to interpret the Plan; to prescribe, amend and rescind
rules and regulations relating to the Plan; to determine the terms and
provisions of the option agreements (which need not be identical) entered
into in connection with options under the Plan; and to make all other
determinations deemed necessary or advisable for the administration of the
Plan. The Board of Directors or the Committee, as the case may be, may
delegate to one or more of its members or to one or more agents such
administrative duties as it may deem advisable, and the Board of Directors or
the Committee, as the case may be, or any person to whom it has delegated
duties as aforesaid may employ one or more persons to render advice with
respect to any responsibility the Board of Directors or the Committee, as the
case may be; or such person may have under the Plan.
4. ELIGIBILITY; FACTORS TO BE CONSIDERED IN GRANTING OPTIONS
Incentive Options shall be limited to persons who are employees of the
Company or its present and future subsidiaries and at the grant of any option
are in the employ of the Company or its subsidiaries. In determining the
employees to whom Incentive Options shall be granted and the number of shares
to be covered by each Incentive Option, the Board of Directors or the
Committee, as the case may be, shall take into account the nature of the
employees' duties, their present and potential contributions to the success
of the Company and such other factors as it shall deem relevant in connection
with accomplishing the purposes of the Plan. An employee who has been
granted an option or options under the Plan may be granted an additional
option or options, subject, in the case of Incentive Options, to such
limitations as may be imposed by the Code on such options. Except as
provided below, a Non-qualified Option may be granted to any person,
including, but not limited to, employees, independent agents, consultants and
attorneys, who the Board of Directors or the committee, as the case may be,
believes has contributed, or will contribute, to the success of the Company.
5. OPTION PRICE
The purchase price of the Common Stock covered by each option shall
be determined by the Board of Directors or the Committee, as the case may
be, and in the case of Incentive Options shall not be less than 100% of
the Fair Market Value (as defined in Paragraph 15(a) below) of a share of
Common Stock on the date on which the option is granted; provided,
however, that the purchase price of Common Stock covered by an Incentive
Option granted to an employee who, at the date of grant, owns more than
10% of the total combined voting power of all classes of stock of the
Company or of its subsidiaries ("10% Stockholder") may not be less than
110% of the Fair Market Value of a share of Common Stock on the date on
which the Incentive Option is granted. The purchase price of the Common
Stock covered by each option shall be subject to adjustment as provided
in Paragraph 12 below. The Board of Directors or the Committee, as the
case may be, shall determine the date on which an option is granted; in
the absence of such a determination, the date on which the Board of
Directors or the Committee, as the case may be, adopts a resolution
granting an option shall be considered the date on which such option is
granted.
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6. TERM OF OPTIONS
The term of each option shall be not more than ten years from the date of
grant, as the Board of Directors or the Committee, as the case may be, shall
determine, subject to earlier termination as provided in Paragraphs 10, 11,
and 14 below. Notwithstanding the foregoing, an Incentive Option granted to
a 10% Stockholder shall have a term of no more than five years.
7. EXERCISE OF OPTIONS
(a) Subject to the provisions of the Plan and unless otherwise provided
in the option agreement, options granted under the Plan shall become
exercisable as determined by the Board of Directors or the Committee, as the
case may be. In its discretion, the Board of Directors or the Committee, as
the case may be, may, in any case or cases, prescribe that options granted
under the Plan become exercisable in installments or provide that an option
may be exercisable in full immediately upon the date of its grant. The Board
of Directors or the Committee, as the case may be, may, in its sole
discretion, also provide that an option granted pursuant to the Plan shall
immediately become exercisable in full upon the happening of any of the
following events: (i) the first purchase of shares of Common Stock pursuant
to a tender offer or exchange offer (other than an offer by the Company) for
all, or a majority of, the Common Stock, (ii) the approval by the
stockholders of the Company of an agreement of a merger in which the Company
will not survive as an independent, publicly-owned company, a consolidation,
or a sale, exchange or other disposition of all or substantially all of the
Company's assets, (iii) with respect to an employee, on his 65th birthday, or
(iv) with respect to an employee, on the employee's involuntary termination
from employment, subject to the limitations set forth in Paragraph 10. In
the event of a question or controversy as to whether or not any of the events
hereinabove described has taken place, a determination by the Board of
Directors or the Committee, as the case may be, that such event has or has
not occurred shall be conclusive and binding upon the Company and the
participants in the Plan.
(b) Any option at any time granted under the Plan may contain a
provision to the effect that the optionee (or any persons entitled to act
under Paragraph 11 hereof) may, at any time at which the Fair Market Value is
in excess of the exercise price and prior to exercising the option, in whole
or in part, request that the Company purchase all or any portion of the
option as shall then be exercisable at a price equal to the difference
between (i) an amount equal to the option price multiplied by the number of
shares subject to that portion of the option in respect of which such request
shall be made and (ii) an amount equal to such number of shares multiplied by
the Fair Market Value of the Company's Common Stock on the date of purchase.
The Company shall have no obligation to make any purchase pursuant to such
request, but if it elects to do so, such portion of the option as to which
the request is made shall be surrendered to the Company. The purchase price
for the portion of the option to be so surrendered shall be paid by the
Company, at the election of the Board of Directors or the Committee, as the
case may be, either in cash or in shares of Common Stock (valued as of the
date and in the manner provided in clause (ii) above), or in any combination
of cash and Common Stock which may consist, in whole or in part, of
authorized but unissued shares of Common Stock held in the Company's
treasury. No fractional share of Common Stock shall be issued or transferred
and any fractional share shall be disregarded. Shares covered by that
portion of any option purchased by the Company pursuant hereto and
surrendered to the Company shall not be available for the granting of further
options under the Plan. All determinations to be made by the Company
hereunder shall be made by the Board of Directors or the Committee, as the
case may be.
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(c) An option may be exercised, at any time or from time to time
(subject, in the case of Incentive Options, to such restrictions as may be
imposed by the Code), as to any or all full shares as to which the option has
become exercisable until the expiration of the period set forth in Paragraph
6 hereof, by the delivery to the Company, at its principal place of business
in Los Angeles, California, of (i) written notice of exercise in the form
specified by the Board of Directors or the Committee, as the case may be,
specifying the number of shares of Common Stock with respect to which the
option is being exercised and signed by the person exercising the option as
provided herein, (ii) payment of the purchase price, and (iii) in the case of
Non-qualified Options, payment in cash of all withholding tax obligations
imposed on the Company by reason of the exercise of the option. Upon
acceptance of such notice, receipt of payment in full, and receipt of payment
of all withholding tax obligations, the Corporation shall cause to be issued
a certificate representing the shares of Common Stock purchased. In the
event the person exercising the option delivers the items specified in (i)
and (ii) of this Subsection (b), but not the item specified in (iii) hereof,
if applicable, the option shall still be considered exercised upon acceptance
by the Corporation for the full number of shares of Common Stock specified in
the notice of exercise but the actual number of shares issued shall be
reduced by the smaller number of whole shares of Common Stock which, when
multiplied by the Fair Market Value of the Common Stock as of the date the
option is exercised, is sufficient to satisfy the required amount of
withholding tax.
(d) The purchase price of the shares as to which an option is exercised
shall be paid in full at the time of exercise. Payment shall be made in
cash, which may be paid by check or other instrument acceptable to the
Corporation; in addition, subject to a compliance with applicable laws and
regulations and such conditions as the Board of Directors or the Committee,
as the case may be, may impose, the Board of Directors or the Committee, as
the case may be, in its sole discretion, may, on a case-by-case basis, elect
to accept payment in shares of Common Stock of the Corporation which are
already owned by the option holder, valued at the Fair Market Value thereof
(as defined in Paragraph 15 below) on the date of exercise; provided,
however, that no such discretion may be exercised unless the option agreement
permits the payment of the purchase price in that manner.
(e) Except as provided in Paragraphs 10 and 11 below, no option granted
to an employee may be exercised at any time by such employee unless such
employee is then an employee of the Company or a subsidiary.
8. INCENTIVE OPTIONS
(a) With respect to Incentive Options granted, the aggregate Fair Market
Value (determined in accordance with the provisions of Paragraph 15 at the
time the Incentive Option is granted) of the Common Stock or any other stock
of the Company or its current or future subsidiary companies with respect to
which incentive stock options, as defined in Section 422 of the Code, are
exercisable for the first time by any employee during any calendar year
(under all incentive stock option plans of the Company and its parent and
subsidiary companies, as those terms are defined in Section 425 of the Code)
shall not exceed $100,000.
(b) No Incentive Option may be awarded to a 10% Stockholder unless the
exercise price under the Incentive Option is at least 110% of the Fair Market
Value and the option expires within 5 years from the date of grant.
(c) In the event of amendments to the Code or applicable regulations
relating to Incentive Options subsequent to the date hereof, the Company may
amend the provisions of the
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Plan, and the Company and the employees holding options may agree to amend
outstanding option agreements, to conform to such amendments.
9. NON-TRANSFERABILITY OF OPTIONS
Options granted under the Plan shall not be transferable except upon
death as provided in Paragraph 11 below, and options may be exercised during
the lifetime of the optionee only by the optionee. Any purported transfer in
violation of the foregoing prohibition shall be void and of no force and
effect.
10. TERMINATION OF EMPLOYMENT
In the event that the employment of an employee to whom an option
has been granted under the Plan shall be terminated (except as set forth
in Paragraph 11 below) such option may, subject to the provisions of the
Plan, be exercised (to the extent that the employee was entitled to do so
at the termination of his employment) at any time within 30 days after
such termination, but not later than the date on which the option
terminates; provided, however, that any option which is held by an
employee whose employment is terminated for cause shall, to the extent
not theretofore exercised, automatically terminate as of the date of
termination of employment. As used herein, "cause" shall mean conduct
amounting to fraud, dishonesty, negligence, or engaging in competition or
solicitations in competition with the Company and breaches of any
applicable employment agreement between the Company and the holder.
Options granted to employees under the Plan shall not be affected by any
change of duties or position so long as the holder continues to be a
regular employee of the Company or any of its current or future
subsidiaries. Any option agreement or any rules and regulations relating
to the Plan may contain such provisions as the Board of Directors or the
Committee, as the case may be, shall approve with reference to the
determination of the date employment terminates and the effect of any
leave of absence. Nothing in the Plan or in any option granted pursuant
to the Plan shall confer upon any employee any right to continue in the
employ of the Company or any of its subsidiaries or parent or affiliated
companies or interfere in any way with the right of the Company or any
such subsidiary or parent or affiliated companies to terminate such
employment at any time.
11. DEATH OR DISABILITY OF EMPLOYEE
(a) If an employee to whom an option has been granted under the Plan
shall die or become permanently disabled while employed by the Company or a
subsidiary or within 30 days after the termination of such employment (other
than termination for cause), such option may be exercised, to the extent
exercisable by the employee on the date of death or permanent disability, at
any time within one year after the date on which the employee died or became
permanently disabled, but not later than the date on which the option
terminates in accordance with its terms.
(b) Upon the death of an employee while an option held by such employee
is exercisable, such option may be exercised, to the extent exercisable by
the employee on the date of death, by the beneficiary specified by such
employee in writing to the Company prior to his death or, in case no such
beneficiary shall have been specified, by a legatee or legatees of the
employee under the employee's last will, or by the employee's personal
representatives or distributees. No transfer of an option by the optionee by
will or by the laws of descent and distribution shall be effective to bind
the Company unless the Company shall have been furnished with written notice
thereof and a copy of the will and such other evidence as the Company may
deem necessary to
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establish the validity of the transfer and the acceptance by the transferor
or transferees of the terms and conditions of such option.
12. ADJUSTMENTS UPON CHANGES IN CAPITALIZATION, ETC.
Notwithstanding any other provision of the Plan, the Board of Directors
or the Committee, as the case may be, may, at any time, make or
provide for such adjustments to the Plan, to the number and class of shares
issuable thereunder or to any outstanding options as it shall deem
appropriate to prevent dilution or enlargement of rights, including
adjustments in the event of changes in the outstanding Common Stock by reason
of stock dividends, split-ups, recapitalizations, mergers, consolidations,
combinations or exchanges of shares, separations, reorganizations,
liquidations and the like. In the event of any offer to holders of Common
Stock generally relating to the acquisition of their shares, the Board of
Directors or the Committee, as the case may be, may make such adjustment as
it deems equitable in respect of outstanding options and rights, including in
its discretion revision of outstanding options and rights so that they may be
exercisable for the consideration payable in the acquisition transaction.
Any such determination by the Board of Directors or the Committee, as the
case may be, shall be conclusive. Any fractional shares resulting from such
adjustments shall be eliminated.
13. EFFECTIVE DATE
The Plan shall become effective on November 1, 1995, subject to approval
by the stockholders of the Company on or before October 31, 1996.
14. AMENDMENTS AND TERMINATION
The Board of Directors may suspend, terminate, modify or amend the
Plan without stockholder approval, unless such approval is necessary or
appropriate under any Federal, state or other applicable law, rule or
regulation. No suspension, termination, modification or amendment of the
Plan may, without the consent of the employee to whom an option shall
theretofore have been granted, affect the rights of such employee under
such option.
15. MISCELLANEOUS
(a) As said term is used in the Plan, the "Fair Market Value" of a share
of Common Stock on any day means: (i) if the principal market for the Common
Stock is a national securities exchange or if the Common Stock is quoted on
the National Association of Securities Dealers Automated Quotation System
("NASDAQ"), the closing sales price of the Common Stock on such day as
reported by such exchange or NASDAQ, or on a consolidated tape reflecting
transactions on such exchange or NASDAQ; or (ii) if the principal market for
the Common Stock is not a national securities exchange and the Common Stock
is not quoted on NASDAQ, the mean between the highest bid and lowest asked
prices for the Common Stock on such day as reported by the National Quotation
Bureau, Inc.; provided that if clauses (i) and (ii) of this paragraph are all
inapplicable, or if no trades have been made or no quotes are available for
such day, the Fair Market Value of the Common Stock shall be determined by
the Board of Directors or the Committee, as the case may be, which
determination shall be conclusive as to the Fair Market Value of the Common
Stock.
(b) The Board of Directors or the Committee, as the case may be, may
require, as a condition to the exercise of any options granted under the
Plan, that to the extent required at the time of exercise, (i) the shares of
Common Stock reserved for purposes of the Plan shall be duly
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listed, upon official notice of issuance, upon stock exchange(s) or automated
quotation system on which the Common Stock is listed, (ii) a registration
statement under the Securities Act of 1933, as amended with respect to the
shares of Common Stock to be issued upon exercise shall be effective, and/or
(iii) the person exercising such option delivers to the Corporation such
documents, agreements and investment and other representations as the Board
of Directors or the Committee, as the case may be, shall determine to be in
the best interests of the Corporation. All certificates for shares of stock
delivered under the Plan shall be subject to such stop transfer orders and
other restrictions as the Board of Directors or the Committee, as the case
may be, may deem advisable under the rules, regulations, and other
requirements of the Securities and Exchange Commission, any stock exchange or
association upon which the Common Stock is then listed or traded, any
applicable federal or state securities law, and any applicable corporate law,
and the Board of Directors or the Committee, as the case may be, may cause a
legend or legends to be put on any such certificates to make appropriate
reference to such restrictions.
(c) During the term of the Plan, the Board of Directors or the
Committee, as the case may be, in its discretion, may offer one or more
option holders the opportunity to surrender any or all unexpired options for
cancellation or replacement. If any options are so surrendered, the Board of
Directors or the Committee, as the case may be, may then grant new
Non-qualified or Incentive Options to such holders for the same or different
numbers of shares at higher or lower exercise prices than the surrendered
options and for the same or a different exercise period. Such new options
shall otherwise be subject to the provisions of the Plan the same as any
other option.
(d) Not later than the date as of which an amount first becomes
includable in the gross income of the optionee for federal income tax
purposes with respect to any option under the Plan, the optionee shall pay to
the Company, or make arrangements satisfactory to the Board of Directors or
the Committee, as the case may be, regarding the payment of, any federal,
state and local taxes of any kind required by law to be withheld or paid with
respect to such amount. If permitted by the Board of Directors or the
Committee, as the case may be, tax withholding or payment obligations may be
settled with Common Stock, including Common Stock that is subject to the
option that gives rise to the withholding requirement. The obligations of
the Company under the Plan shall be conditional upon such payment or
arrangements and the Company or the optionee's employer (if not the Company)
shall, to the extent permitted by law, have the right to deduct any such
taxes from any payment of any kind otherwise due to the optionee from the
Company or any of its subsidiaries.
(e) The Plan and all options granted and actions taken thereunder shall
be governed by and construed in accordance with the laws of the State of
Delaware (without regard to choice of law provisions).
(f) Any option granted under the Plan shall not be deemed compensation
for purposes of computing benefits under any retirement plan of the Company
or any of its subsidiaries and shall not affect any benefits under any other
benefit plan now or subsequently in effect under which the availability or
amount of benefits is related to the level of compensation (unless required
by specific reference in any such other plan to awards under this Plan).
(g) A leave of absence, unless otherwise determined by the Board of
Directors or the Committee, as the case may be, prior to the commencement
thereof, shall not be considered a termination of employment. Any option
granted under the Plan shall not be affected by any change of employment, so
long as the holder continues to be an employee of the Company or any of its
subsidiaries.
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<PAGE>
(h) If any of the terms or provisions of the Plan conflict with the
requirements of Rule 16b-3 under the Securities Exchange Act of 1934, as in
effect from time to time, while the Plan is subject to such Rule, or with the
requirements of any other applicable law, rule or regulation, and with
respect to Incentive Options, Section 422 of the Code, then such terms or
provisions shall be deemed inoperative to the extent they so conflict with
the requirements of said Rule 16b-3 (if the Board of Directors or the
Committee, as the case may be, determines that the Plan should be in
compliance with such Rule) or any such other law, rule, or regulation, and
with respect to Incentive Options, Section 422 of the Code. With respect to
Incentive options, if this Plan does not contain any provision required to be
included herein under Section 422 of the Code, such provision shall be deemed
to be incorporated herein with the same force and effect as if such provision
had been set out at length herein.
(i) The Board of Directors or the Committee, as the case may be, may
terminate any option granted under the Plan if a written agreement relating
thereto is not executed and returned to the Corporation within 30 days after
such agreement has been delivered to the optionee for his or her execution.
16. AUTOMATIC GRANTS TO NONEMPLOYEE DIRECTORS
Each nonemployee director of the Company shall automatically be granted
options to purchase 10,000 shares of Common Stock for each full year that he
or she serves as a director of the Company. Such options will be
Non-Qualified Options; will vest and become exercisable as to 50 percent of
the shares of Common Stock subject to the option on the first anniversary
date of the grant and as to the remaining 50 percent on the second
anniversary date of the grant; will expire on the earlier of ten years from
the date the option was granted, upon expiration of the 1995 Stock Option
Plan, or three weeks after the optionee ceases to be a director of the
Company; and will have an exercise price equal to 100% of the Fair Market
Value of the Common Stock on the date of grant.
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Sound Source Interactive, Inc.
2985 E. Hillcrest Drive
Suite A
Westlake Village, CA 91362
THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS
The undersigned hereby appoints Vincent J. Bitetti and Ulrich E. Gottschling,
and each of them with full power of substitution, as his or her Proxies to
represent and vote, as designated below, all of the shares of the Common
Stock of Sound Source Interactive, Inc., registered in the name of the
undersigned on October 25, 1996, with the powers the undersigned would posses
if personally present at the 1996 Annual Meeting of Stockholders to be held
at the Century Plaza Hotel, 2025 Avenue of the Stars, Los Angeles, California
at 10:00 a.m. on December 9, 1996, and at any adjournment thereof, hereby
revoking any proxy or proxies previously given.
1. ELECTION OF DIRECTORS:
FOR all nominees listed below / / WITHHOLD AUTHORITY / /
(except as marked to the contrary below) to vote for all nominees listed below
(To WITHHOLD authority to vote for any individual nominee strike a line
through the nominee's name below)
Vincent J. Bitetti Ulrich E. Gottschling Ronald W. Hart Mark A. James
Ernest T. Klinger
2. Proposal to approve adoption of the Company's 1995 Stock Option Plan:
FOR / / AGAINST / / ABSTAIN / /
3. In their discretion, the appointed Proxies are authorized to vote upon
such other business as may properly come before the meeting or any
adjournment.
THIS PROXY, WHEN PROPERLY EXECUTED, WILL BE VOTED AS DIRECTED. IF NO
DIRECTION IS GIVEN, THE PROXY WILL BE VOTED "FOR" ALL NOMINEES FOR DIRECTOR,
"FOR" PROPOSAL #2 AND IN THE PROXY'S DISCRETION ON ANY OTHER MATTERS TO COME
BEFORE THE MEETING.
Dated: ______________________, 1996
------------------------------------
(Signature)
------------------------------------
(Second signature)
PLEASE DATE AND SIGN ABOVE exactly as
your name appears at left, indicating
where appropriate, official position or
representative capacity.
<PAGE>
[SOUND SOURCE LOGO]
1996 ANNUAL REPORT
<PAGE>
Dear Shareholder:
Let me extend a warm welcome and congratulations to all of our new
shareholders, long-time supporters and employees. Thanks to your support and
trust, we have been able to emerge as a public company. I am pleased to
report that on July 2, 1996 the Company's securities began trading publicly
through the NASDAQ SmallCap Market.
Fiscal 1996 was year of development and change for the Company, and one in
which we achieved many of the goals that we had set for ourselves. We
continued our history of developing high quality products, strengthened our
relationships with the motion picture and television studios, hired some
highly qualified creative talent, and began to rapidly expand the breadth of
distribution for our product lines. In short, we addressed many of the
issues facing the Company, and also positioned ourselves for future growth
and expansion.
Reflecting these goals, we have followed several methodical steps to align
the Company for future success. First we signed a distribution agreement
with Simon & Schuster Interactive Distribution Services in June of 1996. In
addition, in mid-July, we hired a software industry veteran to manage the
sales effort. Next, we effected our initial public offering on July 2, 1996.
This enabled us to repay our debt and secure additional working capital for
growth and development. Finally, we are continuing to diversify our product
line to include interactive video games and are adopting a strategy to expand
and enhance our entertainment utilities and educational products.
In July 1996, the Company formed two distinct divisions: entertainment and
education. The technology and proprietary 3D animation developed by the
entertainment division will be channeled into the education division, and we
know that it will greatly enhance the future look and feel of all our
products.
1996 RESULTS
For the fiscal year ended June 30, 1996, I am pleased to report that net
product sales increased 72% to $2,161,351, while overall net revenues
increased 5% to $2,264,633. This significant increase in net product sales
is attributable to the Company's release of seven new products, including
FREE WILLY 2-TM-, BABE A LITTLE PIG GOES A LONG WAY-TM- and THE ADVENTURES OF
BATMAN-TM- and ROBIN-TM- INTERACTIVE MOVIEBOOKS-TM-, and the STAR
WARS-Registered Trademark- and BABYLON 5-TM- LIMITED EDITION ENTERTAINMENT
UTILITIES-TM-. Cost of sales as a percentage of net product sales decreased
from 85% in fiscal 1995 to 64% in fiscal 1996.
In line with our expectations, the Company reported a net loss for fiscal
1996 of $4,474,976 or $2.44 per share. These results include a charge of
$1,409,375 for loan costs and interest expense related to debt financing, and
a charge of $663,421 to establish a reserve for bad debts associated with the
Company's former distributor.
<PAGE>
THE MARKET
The Consumer software business for education and entertainment oriented
properties is highly competitive and seasonal in nature. Currently, the
industry is experiencing a restructuring which involves developers,
publishers and retailers. However, through this restructuring, the installed
base of personal computers is expected to grow at a rate of approximately 20%
per year. We are taking an opportunistic approach to the industry and expect
to take advantage of these changes by strategic acquisitions and
relationships, product diversification, creative promotional campaigns, and
alternative revenue sources such as direct mail and the Internet.
1997 AND BEYOND
Simply put, our goal is to emerge as one of the foremost consumer software
publishers in the industry.
In order to accomplish this, our efforts are now focused on future licenses
and product diversification, including the development and production of our
first interactive video game. Tentatively titled RETURN TO THE ABYSS, the
game will be positioned as a sequel to the original Twentieth Century Fox
theatrical release -- THE ABYSS, which was directed by James Cameron. This
is the first time that a sequel has been created for a theatrical release in
a form other than a motion picture. The game is positioned as an
action/adventure/role playing game and will include state-of-the-art 3D
cinematic computer animation.
Furthermore, we will continue to update and enhance both our entertainment
and children's product lines to reflect the latest technological advances.
We will continue to produce compelling and entertaining products designed for
the whole family.
This letter would not be complete if I did not take the opportunity to thank
all of the major motion picture and television studios who have entrusted us
with their intellectual properties. Their support and cooperation has
enabled us to create quality educational and entertainment products for all
ages. We deeply appreciate their belief and confidence in our abilities and
look forward to continued, prosperous relationships. We are also grateful to
our employees for their dedication, hard work and perseverance.
It is with great pleasure that I present to you our first annual report. We
are looking forward to an exciting and rewarding 1997.
Sincerely,
Vincent J. Bitetti
CHAIRMAN OF THE BOARD AND
CHIEF EXECUTIVE OFFICER
October 28, 1996
<PAGE>
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
- ---- ACT OF 1934 (FEE REQUIRED)
FOR THE FISCAL YEAR ENDED JUNE 30, 1996
COMMISSION FILE NO. 0-28604
SOUND SOURCE INTERACTIVE, INC.
(NAME OF SMALL BUSINESS ISSUER IN ITS CHARTER)
Delaware 95-4264046
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2985 E. Hillcrest Drive, Suite A
Westlake Village, California 91362
(Address of principal executive offices) (Zip Code)
(805) 494-9996
(Issuer's telephone number
including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Title of each class: Name of each exchange
on which registered:
Common Stock, par value $.001
Redeemable Warrants NASDAQ SmallCap Market
Check whether the Issuer (1) filed all reports required to be filed by
Section 12 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the issuer was required
to file such reports), and (2) has been subject to such filing requirements
for the past 90 days. Yes /X/ No / /
Check if there is no disclosure of delinquent filers pursuant to Item 405
of Regulation S-B contained herein, and such disclosure will not be
contained, to the best of the Issuer's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form
10-KSB or any amendment to this Form 10-KSB. /X/
The Issuer's revenues for its most recent fiscal year were $2,264,633.
As of August 31, 1996, the aggregate market value of the shares of the
Issuer's voting stock held by nonaffiliates of the Issuer was approximately
$14,928,000, and the number of outstanding shares of the Issuer's common
stock, par value $.001, was 4,367,824.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Issuer's Proxy Statement to be filed with the Securities
and Exchange Commission within 120 days of the close of its fiscal year ended
June 30, 1996 are incorporated by reference into Part III of this Form 10-KSB.
- ------------------------------------------------------------------------------
- ------------------------------------------------------------------------------
<PAGE>
PART I
ITEM 1. DESCRIPTION OF BUSINESS AND PRODUCTS
The Company
Sound Source Interactive, Inc. (the "Company") is engaged primarily in
developing, publishing and marketing educational, interactive computer
software for children. INTERACTIVE MOVIEBOOKS-TM-, which combine animation
text, photos, sound clips and actual film footage of well recognized family
films and cartoon series, are the Company's major software products.
INTERACTIVE MOVIEBOOKS-TM- are developed and published by the Company on
compact disk-read only memory ("CD-ROM") for multimedia personal computers
("Multimedia PCs") as entertaining, interactive reading tools for young
children. The Company also produces a variety of entertainment computer
software utilities which incorporate screen savers, sound clips known as
AUDIOCLIPS-Registered Trademark- and other content based on licensed
entertainment properties. The new entertainment utilities are marketed as
limited edition serialized collector editions. The Company has developed
another line of children's products which it refers to as creativity centers.
This product line combines learning activities such as painting, drawing,
matching, puzzles and mazes within a framework of three distinct skill
levels. In July 1996, the Company created a "games" division, and in August
1996 signed an agreement with Twentieth Century Fox Licensing and
Merchandising to produce a game sequel to the 1989 theatrical release THE
ABYSS-TM-.
The Company's products are based on licensed content of major motion
pictures and television shows under agreement with major entertainment
studios including Viacom Consumer Products (as agent for Paramount Pictures
Corp.), Lucasfilm Ltd., Warner Bros. Consumer Products, CBS Entertainment,
MCA/Universal Merchandising, Inc., Carolco Pictures, Inc., DC Comics, MGM/UA
Merchandising, Inc. and others. The Company's license agreements for
existing products include BABE-TM-, LASSIE-TM-, THE LITTLE RASCALS-TM-, BLACK
BEAUTY-TM-, THE ADVENTURES OF BATMAN AND ROBIN-TM-, TERMINATOR 2: JUDGMENT
DAY-TM-, THE STAR WARS-TM- trilogy, FREE WILLY 2-TM-, THE SECRET GARDEN-TM-,
STAR TREK-TM-, THE TWILIGHT ZONE-TM-, I LOVE LUCY-TM- and other popular
titles. The Company also holds licenses for new products based on STAR TREK:
DEEP SPACE 9-TM-, STAR TREK: VOYAGER-TM-, ALL DOGS GO TO HEAVEN II-TM-, THE
LAND BEFORE TIME-TM-, DRAGONHEART-TM- and I LOVE LUCY-TM-. The Company is
continuing the negotiation of additional licenses for its INTERACTIVE
MOVIEBOOKS-TM-, entertainment utilities and creativity centers. Management
believes the Company is capable of continuing to obtain new licenses for
major motion pictures and television shows and developing new, high quality
software products using content from these entertainment properties.
The powerful capabilities and declining price of Multimedia PCs have
enabled them to draw acceptance as all purpose, functional educational and
entertainment products for home and school use. Industry sources state that
the installed base of Multimedia PCs exceeds 9,000,000 units. The
technological capabilities of Multimedia PCs have allowed the Company to
produce interactive software that is "user friendly" while maintaining what
management believes are high standards in design, sound quality,
three-dimensional sound effects and quality duplication of motion picture
footage. Management believes that the Company is well positioned to
participate in this market, not only through expansion of its existing
software products, but through development opportunities in other media
formats, such as interactive television, and the Internet.
The Company believes that as of August 31, 1996, its products were in
distribution to approximately 6,000 retail outlets. Retailers currently
selling the Company's products include Target, Tower Records, Sears,
Wal-Mart, Price/Costco, CompUSA, Best Buy, BJ's, Computer City, Egghead,
Electronics Boutique, Babbages, Software, Etc., Kmart, Barnes & Noble, Sam's
Club, Musicland and others.
On June 1, 1996 the Company entered into a Distribution Services
Agreement with Simon & Schuster Interactive Distribution Services
("SSIDS"). SSIDS is the consumer software distribution unit of Simon &
Schuster, Inc., the publishing operation of Viacom Inc. Pursuant to this new
distribution agreement, SSIDS will provide distribution, warehousing and
order fulfillment services for all of the Company's products (subject to
certain exceptions) throughout the United States and Canada. The
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Company's relationship with SSIDS is exclusive except as regards the rights
to distribute the Company's products in direct-to-the-customer programs
including direct mail, telemarketing and in-box coupon fulfillment, which are
nonexclusive.
The Company's objective is to be a leading publisher of high quality,
value priced, family- oriented software. To achieve this objective, the
Company intends to (i) focus primarily on developing products with
educational and entertainment value which are based on popular movies,
television series and comic book characters and are easy to use and install,
(ii) develop a broad line of products, upgrade successful products and
develop product line extensions and complementary products, (iii) leverage
studio relationships to develop cross-marketing promotional programs, (iv)
promote tradename recognition, (v) leverage its licensed content to develop
products intended for the game market, and (vi) pursue strategic alliances
and acquisitions.
The Company is located at 2985 East Hillcrest Drive, Suite A, Westlake
Village, California 91362. Its telephone number is (805) 494-9996. Its
facsimile number is (805) 379-3446.
INDUSTRY BACKGROUND
In recent years, the installed base of Multimedia PCs in households has
grown substantially as prices have declined significantly and as improvements
in computing power and capability have been achieved. There are a number of
factors driving the increased demand and use of Multimedia PCs in U.S. and
foreign households beyond the general impact of falling prices and increased
performance. Enabling technologies and standards, such as graphical user
interfaces and the Microsoft-Registered Trademark- Windows-Registered
Trademark- operating system, and the recent release of the Windows
'95-Registered Trademark- operating system, have made Multimedia PCs easier
to use for a broad range of applications, resulting in the transformation of
Multimedia PCs into general-purpose tools. In addition, today's Multimedia
PCs feature high-speed microprocessors, large amounts of memory,
high-resolution monitors and enhanced sound, speaker and graphics
capabilities. These advanced capabilities, along with the introduction of
CD-ROM multimedia technology, have allowed software developers to produce
more engaging software with advanced three-dimensional graphics, realistic
sound and full-motion video. The Company believes CD-ROM multimedia
technology will continue to impact the growth of the consumer software market
as software developers take advantage of the multimedia capabilities of this
more advanced hardware technology.
The resulting increased penetration of Multimedia PCs into domestic
households has created a large and growing mass market for consumer software
as many consumers wish to maximize the utility of their Multimedia PCs. The
distribution of consumer software has also expanded beyond traditional
software retailers and computer stores to include general mass merchandisers.
In response to these developments, increasing numbers of consumer
software products are being developed to address a broad range of consumer
interests and everyday tasks. The Company believes that consumers are more
frequently purchasing software on impulse in the same way that they often buy
books, music compact discs ("CDs") and motion picture videos. With the
increasing consummerization of the software market, the Company believes that
the prices for consumer software products may fall. If this occurs, the
distribution channels for consumer software could continue to expand to
include book and music stores, video outlets and supermarkets.
As consumer software becomes more of a mass market product, the Company
believes it will become increasingly important for consumer software
companies to have direct relationships with retailers to effectively market
their products to consumers. Competition for retail shelf space is also
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<PAGE>
likely to increase due to the proliferation of consumer software products and
companies. As a result, the Company believes that in order to be successful,
consumer software companies must have a consumer-driven focus, a broad
offering of category-leading products, close relationships with retailers, a
recognized brand name and a cost-efficient business model.
PRODUCTS
INTERACTIVE CD-ROM
The Company has created INTERACTIVE MOVIEBOOKS-TM- for children, which are
electronic storybooks with full motion video based on the licensed property.
INTERACTIVE MOVIEBOOKS-TM- are marketed as reading aids for young children.
Research studies involving literacy have shown that children learn to read by
repetitive reading -- usually with the aid of a parent or teacher. This
learning process begins at about 18 months of age and continues through the
first and second grades for many children. The targeted ages for INTERACTIVE
MOVIEBOOKS-TM- are three through ten. The Company has released nine of its
INTERACTIVE MOVIEBOOKS-TM- on CD-ROM. This product provides options for
automatic reading by the computer, user reading, a dictionary invoked by
"clicking" on a dictionary book icon, actual full motion video taken from
the motion picture that coincides with the text pages, high-quality sound,
art and animation as well as a quiz consisting of multiple choice questions
on a related topic to the story, reinforcement through a "jigsaw" puzzle
which can be printed, and a "bookmark" so the adventure can be stopped, put
away and restarted at the same point at a later date. More elaborate
activities in the INTERACTIVE MOVIEBOOK-TM- have been included in BABE-TM-, THE
LITTLE RASCALS-TM-, FREE WILLY 2-TM-, EXOSQUAD-TM-, THE ADVENTURES OF BATMAN
AND ROBIN-TM- and THE LAND BEFORE TIME-TM-, and will be further incorporated
in the next generation of products.
The Company first introduced its INTERACTIVE MOVIEBOOK-TM- product line
into the marketplace in August 1994 with the release of THE SECRET GARDEN-TM-
(Warner Bros.). The Company released BLACK BEAUTY-TM- (Warner Bros.) in
November 1994, Broadway Video's LASSIE-TM- (Broadway Video, a Paramount
Pictures release), in December 1994 and LITTLE RASCALS-TM- (Universal
Pictures) in June 1995. The Company released FREE WILLY 2-TM- (Warner Bros.)
in July 1995. During November 1995, three new INTERACTIVE MOVIEBOOKS-TM- were
completed and released: BABE-TM- (Universal Pictures), EXOSQUAD-TM-
(Universal Pictures) and THE ADVENTURES OF BATMAN & ROBIN-TM- (DC Comics).
These three products, however, did not receive widespread distribution until
the first calendar quarter of 1996. The Company released THE LAND BEFORE
TIME-TM- (MCA/Universal) in August 1996. All products are Windows
'95-Registered Trademark- compatible. Currently, the products are sold at a
suggested retail price of up to $30 each, a price point intended to generate
impulse purchases among consumers at the retail level.
The Company intends to introduce four to five new children's titles
annually in the future. Each is expected to experience its highest sales
prices and volumes within the 12 months following its introduction. Although
the products may continue to be sold after 12 months, they typically will be
sold on a discounted basis.
The Company has begun development of a game sequel to the 1989 theatrical
release THE ABYSS-TM-, under a license from Twentieth Century Fox Licensing
and Merchandising. The Company recently acquired a three-dimensional "game
engine" and purchased four Windows NT-Registered Trademark- workstations
equipped with SoftImage-R- three-dimensional rendering graphics software to
produce the product. The game, tentatively titled RETURN TO THE ABYSS, will
have a development cycle of 12 to 18 months.
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The following is a listing of the Company's INTERACTIVE MOVIEBOOK-TM-
products which are currently existing or planned for release, all of which
are on CD-ROM:
<TABLE>
<CAPTION>
MOVIEBOOK-TM- TITLE LICENSOR RELEASE DATE CURRENT PLATFORM
- -------------------- -------- ------------ ----------------
<S> <C> <C> <C>
THE SECRET GARDEN-TM- Warner Bros. August 1994 Windows-Registered Trademark- and
Windows '95-Registered Trademark-
BLACK BEAUTY-TM- Warner Bros. November 1994 Windows-Registered Trademark- and
Windows '95-Registered Trademark-
LASSIE-TM- Broadway Video December 1994 Windows-Registered Trademark- and
Windows '95-Registered Trademark-
THE LITTLE RASCALS-TM- Universal Pictures June 1995 Windows-Registered Trademark- and
Windows '95-Registered Trademark-
FREE WILLY 2-TM- Warner Bros. July 1995 Windows-Registered Trademark- and
Windows '95-Registered Trademark-
BABE-TM- Universal Pictures November 1995 Windows-Registered Trademark- and
Windows '95-Registered Trademark-
EXOSQUAD-TM- Universal Pictures November 1995 Windows-Registered Trademark- and
Windows '95-Registered Trademark-
THE ADVENTURES OF DC Comics November 1995 Windows-Registered Trademark- and
BATMAN AND ROBIN-TM- Windows '95-Registered Trademark-
THE LAND BEFORE TIME-TM- Universal Pictures August 1996 Windows-Registered Trademark- and
Windows '95-Registered Trademark-
ALL DOGS GO TO HEAVEN II-TM- MGM October 1996 Windows-Registered Trademark- and
Windows '95-Registered Trademark-
BATMAN AND ROBIN II-TM- DC Comics March 1997 Windows-Registered Trademark- and
Windows '95-Registered Trademark-
</TABLE>
The Company has developed a second line of interactive CD-ROM based
products which it refers to as creativity centers. This product line
combines learning activities such as painting, drawing, matching, puzzles and
images within a framework of three distinct skill levels. The Company
introduced its first creativity center product in June 1996, and plans to
introduce two or three new creativity centers annually thereafter.
The following creativity center products which have been or are planned
for release in 1996.
<TABLE>
<CAPTION>
CREATIVITY CENTER TITLE LICENSOR RELEASE DATE CURRENT PLATFORM
- ----------------------- -------- ------------ ----------------
<S> <C> <C> <C>
DRAGONHEART-TM- Universal Pictures June 1996 Macintosh-Registered Trademark-,
Windows-Registered Trademark- and
Windows '95-Registered Trademark-
THE LAND BEFORE TIME-TM- Universal Pictures March 1997 Macintosh-Registered Trademark-,
Windows-Registered Trademark- and
Windows '95-Registered Trademark-
</TABLE>
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ENTERTAINMENT UTILITIES
The Company was one of the first to license motion picture studio
properties to create entertainment utility software. The first product was
Star Trek AUDIOCLIPS-Registered Trademark- and the second was a sub-license
for a STAR TREK-TM- Screen Saver. The Company followed its STAR TREK-TM-
products with STAR WARS-TM-, THE WIZARD OF OZ-TM-, TERMINATOR 2: JUDGMENT
DAY-TM- and others. The Company's screen saver line-up now includes
TERMINATOR 2: JUDGMENT DAY-TM-, THE TWILIGHT ZONE-TM- and SATURDAY NIGHT
LIVE-TM-. Additionally, the sub-license for STAR TREK-TM-
AUDIOCLIPS-Registered Trademark- now extends to STAR TREK: THE NEXT
GENERATION-TM-, STAR TREK: THE MOTION PICTURES-TM- and a Stardate Desktop
Calendar.
Entertainment utility products may include AUDIOCLIPS-Registered
Trademark-, screen savers based on animation, video and still images, and
wallpaper, VISUALCLIPS-Registered Trademark-, jigsaw puzzles and other
content as applicable.
- LIMITED EDITION ENTERTAINMENT UTILITIES. The Company's new
entertainment computer software utilities incorporate screen savers,
AUDIOCLIPS-Registered Trademark- and other content based on entertainment
properties. The new entertainment utilities are marketed as limited
issue, serialized collector editions. For Christmas 1995, the Company
released a Limited Edition BABYLON 5-TM- (Warner Bros.) Entertainment
Utility which contains screen savers, desktop art and
AUDIOCLIPS-Registered Trademark-. Limited edition products are serialized
and retail at approximately $30 each. The Company expects the limited
edition products to replace stand alone screen savers and
AUDIOCLIPS-Registered Trademark- by Christmas of 1996. The Company
plans to release two to four limited edition entertainment utilities in
1997. The Company currently sells the following limited edition
entertainment utilities:
<TABLE>
<CAPTION>
TITLE LICENSOR RELEASE DATE CURRENT PLATFORM
- ----- -------- ------------ ----------------
<S> <C> <C> <C>
STAR WARS TRILOGY-TM- Lucasfilm, Ltd. July 1995 Macintosh-Registered Trademark-,
Windows-Registered Trademark- and
Windows '95-Registered Trademark-
BABYLON 5-TM- Warner Bros. November 1995 Windows-Registered Trademark- and
Windows '95-Registered Trademark-
TERMINATOR 2; Carolco Pictures July 1996 Windows-Registered Trademark- and
JUDGMENT DAY-TM- Windows '95-Registered Trademark-
STAR TREK: DEEP SPACE Paramount/Viacom August 1996 Windows-Registered Trademark- and
NINE-TM- Windows '95-Registered Trademark-
STAR TREK: VOYAGER-TM- Paramount/Viacom November 1996 Windows-Registered Trademark- and
Windows '95-Registered Trademark-
I LOVE LUCY-TM- CBS November 1996 Windows-Registered Trademark- and
Windows '95-Registered Trademark-
</TABLE>
- AUDIOCLIPS-Registered Trademark-. The Company's AUDIOCLIPS-Registered
Trademark- Desktop Diversion Utilities are audio computer software
utilities which utilize segments of dialogue, music or sound effects
from original soundtracks of major motion pictures and hit television
shows to provide complementary audio "cues" for certain computer
system functions. The AUDIOCLIPS-Registered Trademark- utilities are
packaged with default assignments to enable consumers to personalize
their computing environment. Thus, although AUDIOCLIPS-Registered
Trademark- are pre-programmed for use by the computer novice, the
technology enables the user to assign other sounds to the computer
function of their choice. AUDIOCLIPS-Registered Trademark- products
were first introduced into the marketplace in December 1991.
Currently, the products are sold at a suggested retail price of
approximately $15 each, a price point intended to generate impulse
purchases among
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<PAGE>
consumers at the retail level. The Company currently sells the
following AUDIOCLIPS-Registered Trademark- products:
<TABLE>
<CAPTION>
AUDIOCLIPS-Registered
Trademark- TITLE LICENSOR RELEASE DATE CURRENT PLATFORM
- ------------------- -------- ------------ ----------------
<S> <C> <C> <C>
TERMINATOR 2:
JUDGMENT DAY-TM- Carolco Pictures January 1993 Windows-Registered Trademark- and
Windows '95-Registered Trademark-
TOTAL RECALL-TM- Carolco Pictures February 1993 Windows-Registered Trademark- and
Windows '95-Registered Trademark-
STAR WARS-TM- Lucasfilm, Ltd. October 1992 Macintosh-Registered Trademark-
Windows-Registered Trademark- and
Windows '95-Registered Trademark-
STAR WARS-TM- Lucasfilm, Ltd. August 1993 Windows-Registered Trademark- and
Windows '95-Registered Trademark-
THE EMPIRE STRIKES BACK-TM- Lucasfilm, Ltd. August 1994 Windows-Registered Trademark- and
Windows '95-Registered Trademark-
RETURN OF THE JEDI-TM- Lucasfilm, Ltd. October 1994 Windows-Registered Trademark- and
Windows '95-Registered Trademark-
STAR TREK-TM- Paramount/Viacom March 1995 Windows-Registered Trademark- and
(original TV show) Windows '95-Registered Trademark-
STAR TREK: Paramount/Viacom March 1995 Windows-Registered Trademark- and
THE NEXT GENERATION-TM- Windows '95-Registered Trademark-
STAR TREK: Paramount/Viacom October 1994 Windows-Registered Trademark- and
THE MOTION PICTURES-TM- Windows '95-Registered Trademark-
</TABLE>
- SCREEN SAVERS. Originally developed as a utility to protect computer
monitors from image "burn-in," screen saver utilities have evolved
into desktop entertainment software. Market observers estimate the
screen saver market currently to exceed $80 million per annum. The
Company first introduced its screen saver product line into the
marketplace in August 1993 with the release of its TERMINATOR 2:
JUDGMENT DAY-TM- screen saver. In November 1994, the Company released
its THE TWILIGHT ZONE-TM- screen saver and SATURDAY NIGHT LIVE-TM-
screen saver.
PRODUCT DISTRIBUTION
On June 1, 1996 the Company entered into a Distribution Services
Agreement with Simon & Schuster Interactive Distribution Services ("SSIDS",
as previously defined). SSIDS is the consumer software distribution unit of
Simon & Schuster, Inc., the publishing operation of Viacom Inc. Pursuant to
this new distribution agreement, SSIDS will provide distribution, warehousing
and order fulfillment services for all of the Company's products throughout
the United States and Canada. The Company's relationship with SSIDS is
exclusive except as regards the rights to distribute the Company's products
in direct-to-the-customer programs including direct mail, telemarketing and
in-box coupon fulfillment, which are nonexclusive.
SSIDS will make a monthly payment to the Company in an amount equal to
its "gross revenues" during such month from the Company's products, less a
distribution fee and reserve for returns equal to stated percentages of the
gross revenues and less certain other items, including out-of-pocket costs
associated with inventory maintenance and order fulfillment. "Gross
revenues" are defined as amounts actually billed by SSIDS to its customers
for Company products sold by it. The payments by SSIDS will be due not later
than 75 days after the calendar month. Under the SSIDS distribution
agreement, SSIDS will be responsible for collection of accounts, whereas the
Company will be responsible for product returns. The Company intends to
maintain an appropriate reserve for
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<PAGE>
product returns based upon its prior experience and current market conditions
against which credits for actual returns will be applied.
SALES AND MARKETING
By offering a wide variety of products, the Company can provide retailers
with an assortment of titles in categories of interest to consumers. The
Company also supports its retailers by setting up special displays, end caps
and kiosks, executing targeted promotions and analyzing sales trends to help
build incremental sales. The Company is currently developing a variety of
cross-marketing promotional programs with its movie studio licensors and
other licensees of movie titles. These promotional programs may include
discount coupons for products in video cassettes, rebate coupons with action
figures, movie trailers in the Company's software products, and promotional
contests with various motion picture studios.
Drawing upon established consumer marketing techniques, the Company's
marketing department creates and executes high-impact merchandising programs
with the goal of maximizing each product's retail exposure. The Company
believes that its consumer-driven marketing, the high perceived value and
competitive price points of its products, and easily identifiable packaging
which emphasizes high-impact design and concise, nontechnical product
information lead to higher visibility and impulse purchases of its products
in retail stores.
The Company provides technical support by telephone at no additional
charge. The Company has installed a telephone system and a call handling
center to facilitate its response to customer inquiries. Customer feedback
is shared among other support representatives and made available to product
managers for development of product enhancements and upgrades.
Under the new SSIDS distribution agreement, the Company's direct retail
accounts will be serviced by the SSIDS sales force with direction and
assistance from the Company. The Company will work closely with SSIDS's to
assure that wholesale and retail accounts are adequately serviced and that
inventory levels are adequate and that merchandising programs are properly
executed. See "Product Distribution."
DEVELOPMENT
The Company develops a broad line of products in sustainable market
categories in which a leading market share can be obtained. The Company
depends on a flow of creative ideas to develop high-quality, value-priced
products. The Company believes that its efficient development model has
certain key advantages including consistent product quality, reliable
delivery schedules, cost containment and low investment risk.
The Company's product managers oversee the development of various
products from conception through completion, and control the content, design,
scope and development schedule. New product ideas are evaluated with each
studio partner based upon upcoming theatrical releases, detailed market
research on the subject matter, the type and demographics of the target
consumer, and the existence and characteristics of competitive products. The
Company seeks to design new products which incorporate all of the important
functions and features of the leading competitive products. Once a product is
approved for development, a detailed design specification is created that
includes the product's features and a user interface that is consistent with
other Company products. Whenever possible, the software is designed to
incorporate technology used in existing Company products in an effort to
shorten the development cycle and improve quality and consistency. The
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<PAGE>
overall product, including documentation, is designed to meet a manufacturing
specification that will meet the Company's margin requirements at consumer
price points.
The product managers then execute the development project with a team
that includes programmers, sound engineers, artists, animators, designers,
writers and testers. The Company's internal development efforts are focused
primarily on product design and features, consistent user interfaces, and
product quality consistency. The Company supplements its internal product
development resources by utilizing existing technologies and externally
developed programming when such utilization can result in a more efficient
method of creating a higher quality product. Using this method, the Company
maintains internal control over the creative and market-driven aspects of
product development while using external resources to shorten development
time and lower development risks. Development costs associated with
externally licensed technology are generally paid by royalties based on net
sales, which lowers the Company's investment risk. The Company's agreements
with its external developers typically grant the Company an exclusive
worldwide license to use the developers' software. The agreements typically
have three-year terms, with renewal provisions upon mutual agreement of the
parties. The Company has recently decided fully to develop some of its
products in-house.
The Company currently is the licensee under technology licenses with
Apple Computer, Inc., Iterated Systems, Inc., Qsound Labs, Inc., Rock Ridge
Enterprises, EchoMedia, Inc. and Rhode Island Soft Systems, Inc. The Company
utilizes technology provided by these licensors to develop and operate
several of its products. With the exception of the Apple Computer license,
there are alternative products for each of the technologies now licensed by
the Company. Therefore, the Company believes that it could readily obtain
licenses to comparable products from other sources at comparable costs.
Products under development are extensively tested by the quality
assurance department, and must be approved by the licensor before being
released for production. The department tests for bugs, functionality,
ease-of-use and compatibility with the many popular Multimedia PC
configurations that are available to consumers.
Product managers are also responsible for reviewing customer feedback,
competitive products, product performance and market positioning in order to
introduce upgrades that keep abreast of consumer tastes and trends. The
Company has increased its development of new CD-ROM products to address the
shift to CD-ROM-based products.
OPERATIONS
The Company controls all purchasing, inventory, scheduling, order
processing and accounting functions related to its operations, with all
production and warehousing performed by independent contractors in accordance
with the Company's specifications. The Company intends to invest in
management information systems and other capital equipment which it believes
are necessary to achieve operational efficiencies and support increasing
sales volumes.
The Company prepares master software disks, user manuals and packaging
designs. Disk and CD-ROM duplication, printing of documentation and
packaging, as well as the assembly of purchased components and the shipment
of finished products, are performed by third parties in accordance with the
Company's specifications. The Company has multiple sources for all
components, with assembly and shipping currently performed by two independent
fulfillment houses. To date, the Company has not experienced any material
difficulties or delays in the production and assembly of its products.
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<PAGE>
COMPETITION
The market for the Company's consumer software products is intensely and
increasingly competitive. The Company's competitors range from small
companies with limited resources to large companies with substantially
greater financial, technical and marketing resources than those of the
Company. Existing consumer software companies may broaden their product
lines to compete with the Company's licensed products, and potential new
competitors, including computer hardware and software manufacturers,
diversified media companies and book publishing companies, may enter or
increase their focus on the consumer software market, resulting in greater
competition for the Company.
Only a small percentage of products introduced in the consumer software
market achieve any degree of sustained market acceptance. Principal
competitive factors in marketing consumer software include product features,
quality, reliability, tradename and licensed title recognition, ease-of-use,
merchandising, access to distribution channels and retail shelf space,
marketing, price, and the availability and quality of support services. The
Company believes that it continues to compete effectively in these areas,
particularly in the areas of quality, brand recognition, ease-of-use,
merchandising, access to distribution channels and retail shelf space and
price. To the extent that competitors achieve performance, price or other
selling advantages, the Company could be adversely affected. There can be no
assurance that the Company will have the resources required to respond to
market or technological changes or to compete successfully in the future. In
addition, increasing competition in the consumer software market may cause
prices to fall, which could adversely affect the Company's business,
operating results and financial condition.
The Company considers Microsoft Corp., Broderbund, Inc., Knowledge
Adventure, Disney, Maxis, Davidson, GT Interactive Software Corp., 7th Level,
Inc. and A.D.A.M. Software, Inc. its chief competitors in the interactive
entertainment CD-ROM market. The Company considers Microsoft, Inc. and
Berkeley Systems its chief competitors in the entertainment utility software
market. Microsoft offers screen savers and generic sounds, as well as
licensed sounds from the MGM/Turner film library. The Company considers
Berkeley Systems its chief competitor in the screen saver market. The
Company developed the concept and provided the introductions that led to the
development of the Star Trek series of screen savers by Berkeley Systems.
The Company has received over $300,000 in earnings from this sublicense,
which continues until 1997. The Company notes that there are a number of
other smaller entertainment utility publishers competing in this market. For
the fiscal year ended June 30, 1996, $9,213 was received by the Company in
earnings from this sub-license, which terminates on August 31, 1997. The
Company notes that there are a number of other smaller entertainment utility
publishers competing in this market.
The Company has entered into license agreements with Viacom Consumer
Products (as agent for Paramount Pictures Corp.), Lucasfilm Ltd., Warner
Bros. Consumer Products, CBS Entertainment, MCA/Universal Merchandising,
Inc., Carolco Pictures, Inc., DC Comics, MGM/UA Merchandising, Inc. and
others. Several of the major motion picture studios now have captive
interactive software divisions. As these types of software become better
known in the marketplace, these profit centers may begin to vie for their
studio's product. Management believes that Disney, Lucasfilm, Fox and
Paramount/Viacom are currently the most active studios in publishing their
own product to create software packages. Universal Pictures, Sony Pictures
and Warner Bros. each have announced the formation of divisions to publish
software products using their own license content.
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<PAGE>
PROPRIETARY RIGHTS AND LICENSES
The Company regards its software as proprietary and relies primarily on a
combination of trademark, copyright and trade secret laws, employee and third
party nondisclosure agreements and other methods to protect its proprietary
rights. All of the Company's new products are CD-ROM based, and hence are
difficult to copy. During the fiscal year ended June 30, 1996, the Company
was unaware of any of its products' unauthorized copying.
The Company's products are based upon licensed content of major motion
pictures and television shows under license and/or development agreements
with major entertainment studios. All of such license and development
agreements to which the Company currently is a party are for fixed terms
which will expire over the next one to five years. The Company anticipates
that the licensor under each agreement will extend its terms, although no
licensor is required to extend any license, provided that the Company is in
compliance with all requirements of each license, including most
significantly that the Company have satisfied the applicable minimum royalty
guarantees.
EMPLOYEES
As of August 31, 1996, the Company had 31 full-time employees, including
five employees in sales and marketing, 15 employees in development and
customer support, six employees in administration and finance, two employees
in licensing and three employees in production and shipping. None of the
Company's employees are represented by a labor union or are subject to a
collective bargaining agreement.
EXECUTIVE OFFICERS
The executive officers of the Company, their ages and their positions
with the Company as of June 30, 1996, are as follows:
NAME AGE POSITION
---- --- --------
Vincent J. Bitetti 41 Chairman of the Board,
Chief Executive Officer
and Director
Eric H. Winston 49 President, Chief Operating Officer
and Director
Ulrich E. Gottschling 38 Chief Financial Officer, Treasurer,
Secretary and Director
VINCENT J. BITETTI founded Sound Source Interactive, Inc., a California
corporation (the "Subsidiary"), in 1989 and served as the President of the
Subsidiary from its formation. Since the Company acquired the Subsidiary in
1994, Mr. Bitetti has served as the Chairman of the Board and Chief Executive
Officer and as a director of the Company and the Subsidiary. Prior to
founding the Subsidiary, from 1986 to 1988 Mr. Bitetti was President of
Fantastic Planet Consultants, a sound and musical instrument design
consulting company. Mr. Bitetti is a published music composer and lyricist.
From 1986 to 1993, Mr. Bitetti was a consultant to manufacturers of keyboard
synthesizers in the music industry. Mr. Bitetti developed the concepts for
the Company's INTERACTIVE MOVIEBOOKS-TM-, AUDIOCLIPS-Registered Trademark-,
VISUALCLIPS-Registered Trademark-, limited edition and creativity center
products.
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<PAGE>
ERIC H. (RICK) WINSTON has served as President and director of the
Company and the Subsidiary since April 1994, and Chief Operating Officer of
the Company and the Subsidiary since October 1995. Prior to joining the
Company, Mr. Winston was President of E.H. Winston & Associates, a business
consulting firm which he established in 1991. Mr. Winston was President and
Chief Executive Officer of Computer Data Information Systems, Inc. from 1985
to 1989, when it was acquired by NYNEX. As part of that acquisition, Mr.
Winston was retained as Vice President and General Manager of The DATAGROUP,
a NYNEX subsidiary, and remained with The DATAGROUP until 1991 when he
departed to start E.H. Winston & Associates.
ULRICH E. GOTTSCHLING was appointed as Chief Financial Officer, Treasurer
and director of the Company on October 9, 1995, and as Secretary of the
Company on November 17, 1995. Prior to joining the Company, Mr. Gottschling
was employed from June 1991 through September 1995 as a certified public
accountant with Corbin & Wertz, the Company's independent auditors. From
1987 through May 1991, he was employed as a certified public accountant by
Deloitte & Touche. From 1980 through 1986, Mr. Gottschling held various
management positions with Westin Hotels and Marriott Corporation.
ITEM 2. DESCRIPTION OF PROPERTY.
The Company leases approximately 7,315 square feet of office and
warehousing space in Westlake Village, Ventura County, California under a
lease which expires on February 28, 1997. The Company leases an additional
1,915 square feet of warehouse space in an adjoining building under a
month-to-month arrangement. The Company currently expects that these
facilities will be sufficient for its needs at least through the term of the
leases. The Company may lease additional adjacent space as its needs
require, which it believes will be available on acceptable terms.
ITEM 3. LEGAL MATTERS.
The Company and its officers and directors are, and in the future the
Company and/or its officers and directors may be, involved in suits and
actions incidental to the Company's business. The Company does not believe
that the resolution of any of the current suits or actions will result in any
material adverse effect on the financial condition or operations of the
Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Pursuant to a written consent of the Company's majority stockholder,
Vincent J. Bitetti, dated May 15, 1996, the Company adopted Amended and
Restated Bylaws. On such date no class of the Company's equity securities
was registered under the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), and consequently the solicitation of such written consent
was not subject to the requirements of Section 14 of the Exchange Act. The
written consent was effectuated by Mr. Bitetti as the beneficial owner of
1,557,901 shares of the Company's outstanding Common Stock, of which a total
of 1,808,291 shares then were outstanding. No other votes were cast for or
against the matter in question.
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<PAGE>
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's Common Stock and Redeemable Warrants have been traded on
the NASDAQ SmallCap Market under the symbols "SSII" and "SSIIW,"
respectively, since July 2, 1996, and were not traded on any market or
exchange prior to that date. Therefore, no information is available as to
the range of sales prices for these securities for any period prior to July
2, 1996.
As of August 31, 1996, there were approximately 125 holders of record of
the Common Stock and 16 holders of record of the Redeemable Warrants. Most
such securities are held in street name by nominees who hold stock
certificates for an unknown number of beneficial owners.
The Company has never paid cash dividends on its Common Stock. The
Company currently intends to retain any earnings for use in its operations
and does not anticipate payment of cash dividends in the foreseeable future.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
OVERVIEW
The Company derives substantially all of its revenues from sales of its
retail consumer software and original equipment manufacturer ("OEM") versions
of its retail consumer software. The Company designs, develops, markets and
supports a broad line of consumer software products. The Company focuses
primarily on nonviolent, family-oriented products with educational and
entertainment value, which are easy to use and install, using popular movies,
television series and comic book characters.
In June 1995, the Company entered into a Sales and Distribution Agreement
with Acclaim Distribution, Inc., a subsidiary of Acclaim Entertainment, Inc.
(collectively, "Acclaim") a distributor of entertainment software and related
products. The Company had no sales to or through Acclaim during its fiscal
year ended June 30, 1995. During the fiscal year ended June 30, 1996, of the
Company's net sales of $2,264,633 a total of $1,889,750 were generated by
Acclaim. Under the terms of this agreement, Acclaim was the exclusive
distributor of the Company's products on a worldwide basis, subject to
certain limited exceptions. The Company was not satisfied with the
distribution of its products through Acclaim, and determined to terminate the
Acclaim distribution agreement in March 1996. The Company and Acclaim
terminated the distribution agreement as of April 1, 1996. To date, the
Company has received a net payment of $912,134 from Acclaim pursuant to the
distribution agreement, which exceeded the net account receivable reflected
in the financial statements included in the registration statement pertaining
to the Company's initial public offering. The Company, however, believes
that further amounts are due from Acclaim, and Acclaim and the Company are in
discussions regarding a final accounting to the Company together with payment
of the amounts due to the Company under the distribution agreement. Acclaim
was obligated to notify its accounts that it will not accept returns of any
of the Company's software products after June 30, 1996.
Effective June 1, 1996 the Company entered into a Distribution Services
Agreement with SSIDS. Pursuant to this new distribution agreement, SSIDS
will provide distribution, warehousing and order fulfillment services for all
of the Company's products (subject to certain exceptions) throughout the
United States and Canada. The Company's relationship with SSIDS will be
exclusive except as
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regards the rights to distribute the Company's product in
direct-to-the-customer programs including direct mail, telemarketing and
in-box coupon fulfillment, which are nonexclusive.
Net sales consist of gross sales net of allowances for returns, credit
losses and other adjustments. The Company adjusts its allowance for returns
as it deems appropriate. The Company could be forced to accept substantial
product returns or other concessions to maintain its relationships with
retailers and distributors and its access to distributor channels. The
Company is also exposed to the risk of returns of defective, shelf-worn and
damaged products from retailers and distributors.
Costs of sales consist primarily of product cost, freight charges,
royalties to outside programmers and content providers, and an inventory
provision for damaged and obsolete products. Product costs consist of the
costs to purchase the underlying materials and print both boxes and manuals,
media costs (disks and CD-ROMs) and fulfillment (assembly and shipping).
From the Company's inception through October 24, 1995, the Company sold
synthesizer sound libraries. In July 1995, the Company's Board of Directors
approved a formal plan to license the proprietary assets related to such
revenues in exchange for royalties. The Results of Operations discussion and
analysis which follows includes only the continuing operations of the
Company, which is primarily comprised of software sales. The Company
sustained losses from these discontinued synthesizer operations of $143,106
in fiscal 1995, including an estimated loss of $32,000 during the phase-out
period. No additional losses from the discontinued operations were recorded
during fiscal 1996.
RESULTS OF OPERATIONS
FISCAL YEAR ENDED JUNE 30, 1995 COMPARED TO FISCAL YEAR ENDED JUNE 30, 1996
NET SALES. Net Sales from continuing operations increased by 5.1 percent
from $2,154,926 for the fiscal year ended June 30, 1995 (fiscal 1995) to
$2,264,633 for the fiscal year ended June 30, 1996 (fiscal 1996). In fiscal
1996, the Company determined to concentrate its focus on development of its
educational and entertainment utility interactive CD-ROM software and to
reduce its development work for third parties. Consequently, total retail
sales of the Company's software products increased by 72.2 percent from
$1,255,230 in fiscal 1995 to $2,161,351 in fiscal 1996. However, the Company
had no development revenues during fiscal 1996 as compared with $343,250 for
fiscal 1995. Revenues from OEM sales declined from $479,675 for fiscal 1995
to $70,895 for fiscal 1996, reflecting a one-time agreement with Acer that
produced significant revenues in calendar 1994 but not in calendar 1995. In
addition, the Company's royalty fees declined from $76,771 for fiscal 1995 to
$32,387 for fiscal 1996. The higher royalty revenues for the fiscal year
ended June 30, 1995 resulted primarily from product introductions
incorporating content sublicensed by the Company that were not repeated in
the fiscal year ended June 30, 1996. This decline in royalty revenues also
reflected the Company's current strategy of focusing on developing all
product licenses itself rather than sublicensing them to third parties.
During fiscal 1996, of the Company's net sales of $2,264,633 a total of
$1,889,750 were generated by Acclaim. None of the Company's net sales of
$2,154,926 during the fiscal 1995 were generated by Acclaim. As described
above, the Company terminated its exclusive distribution agreement with
Acclaim as of April 30, 1996 and entered into a new distribution agreement
with SSIDS as of June 1, 1996.
COST OF SALES. Cost of Sales increased by 28.9 percent from $1,072,691
for fiscal 1995 to $1,382,999 for fiscal 1996, representing 49.8 percent and
61.1 percent of net sales, respectively,
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and 85.5 percent and 64.0 percent of product sales, respectively. This
decrease is attributable to the above noted 72.2 percent increase in software
product sales partially offset by decreased production costs resulting from
the Company's switch from floppy disk to CD-ROM media for a majority of its
products, decreased per unit costs due to larger quantity purchases,
decreased royalty costs, and diminishing inventory writedowns and writeoffs.
MARKETING AND SALES. Marketing and sales expenses increased by 104.0
percent from $516,886 for fiscal 1995 to $1,054,602 for fiscal 1996, and
increased as a percentage of net sales from 24.0 percent to 46.7 percent,
respectively. These increases were primarily due to increased marketing
activities to promote the Company's products and brand name among retail
purchasers, and increased personnel costs.
GENERAL AND ADMINISTRATIVE. General and administrative expenses
decreased by 12.2 percent from $1,743,023 for fiscal 1995 to $1,530,434 for
fiscal 1996, and decreased as a percentage of net sales from 80.9 percent to
67.6 percent, respectively. The increase is primarily attributable to costs
incurred by the Company during fiscal year 1996 related to the Company's
initial public offering and two private placements and increases in executive
salaries related to the addition of a Chief Financial Officer, partially
offset by decreased noncash compensation incurred in connection with issuance
of Common Stock and Common Stock options. A total of $733,165 of the general
and administrative expenses for fiscal 1995 relates to a noncash charge to
earnings in connection with the vesting of stock options granted to
employees, determined as the difference between the fair market value of the
date of grant and the exercise price. No such charge was incurred during
fiscal year 1996.
DEVELOPMENT. Development expenses increased by 89.7 percent from
$378,471 for fiscal 1995 to $717,994 for fiscal year 1996, and increased as a
percentage of net sales from 17.6 percent to 31.7 percent, respectively.
These increases were primarily attributable to costs related to product
upgrades and new product development activities. The Company believes that
development expenses will increase in dollar amount in the future as the
Company continues to expand its development activities.
TAX PROVISION. The current period income tax provision is comprised of
minimum State of California Franchise Taxes of $1,600. There is no provision
for Federal income taxes as the Company has a loss in fiscal 1995 and 1996,
respectively.
OTHER. Other income (expense) increased from $6,691 for fiscal 1995 to
$(2,051,980) for fiscal 1996, and increased as a percentage of net sales from
.3 percent to (90.6) percent, respectively. This increase is primarily
comprised of amortization of deferred loan costs of $1,035,200 and interest
expense of $374,175 both of which relate to private placements of the
Company's debt securities, and an allowance for doubtful accounts receivable
from Acclaim of $663,421 during fiscal 1996.
FISCAL YEAR ENDED JUNE 30, 1994 COMPARED TO FISCAL YEAR ENDED JUNE 30, 1995
NET SALES. Net sales from continuing operations increased by 28 percent
from $1,685,871 for fiscal 1994 to $2,154,296 for fiscal 1995. Retail
software sales decreased by 5 percent from $1,313,890 for fiscal 1994 to
$1,255,230 for fiscal 1995 due principally to discounting and pricing
declines for the Company's software products. Development revenues increased
by 205 percent from $112,520 for fiscal 1994 to $343,250 for fiscal 1995,
primarily as a result of an agreement to develop INTERACTIVE MOVIEBOOKS-TM-
under a contract with a motion picture studio. OEM sales increased from
$5,500 for fiscal 1994 to $479,675 for fiscal 1995. This increase in OEM
sales resulted
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principally from sales pursuant to a software bundling agreement with a PC
manufacturer. Royalty fees decreased by 70 percent from $253,961 for fiscal
1994 to $76,771 for fiscal 1995. The decline in royalty revenues reflected
the Company's strategy of focusing on developing all product licenses itself
rather than sublicensing them to third parties.
The Company has established a reserve for returns that it believes to be
adequate based upon historical return data and its analysis of current
customer inventory levels and sell through rates.
COST OF SALES. Costs of sales decreased by 9 percent from $1,180,803
for fiscal 1994 to $1,072,691 for fiscal 1995, and decreased as a percentage
of net sales from 70 percent to 50 percent, respectively. This percentage
decrease was principally attributable to the substantially lower costs
associated with the sale of the single "golden master" for certain of the
Company's products sold to a PC manufacturer under an OEM bundling agreement
in the first 6 months of 1995, partially offset by a change in the product
mix to higher priced items and a decrease in OEM sales.
MARKETING AND SALES. Marketing and sales expenses increased by 45
percent from $356,381 for fiscal 1994 to $516,886 for fiscal 1995, and
increased as a percentage of net sales from 21 percent to 24 percent,
respectively. These increases were primarily due to increased marketing
activities to promote the Company's products and brand name, and an increase
in personnel.
GENERAL AND ADMINISTRATIVE. General and administrative expenses
decreased by 53 percent from $3,821,728 for fiscal 1994 to $1,783,023 for
fiscal 1995, and decreased as a percentage of net sales from 227 percent to
83 percent, respectively. The decrease was primarily due to a decrease in
noncash compensation in connection with Common Stock issued for services
provided, partially offset by increased staffing and associated overhead
expenses necessary to manage and support the Company's growth. A total of
$2,992,862 of the fiscal 1994 general and administrative expenses and
$733,165 of the fiscal 1995 general and administrative expenses relates to
noncash charges to earnings in connection with the vesting of stock options
granted to employees, determined as the difference between the fair market
value on the date of grant and the exercise price.
DEVELOPMENT. Development expenses increased by 225 percent from
$116,559 for fiscal 1994 to $378,471 for fiscal 1995, and increased as a
percentage of net sales from 7 percent to 18 percent, respectively. These
increases were primarily attributable to costs relating to product upgrade
and new product development activities. The Company developed its first four
INTERACTIVE MOVIEBOOKS-TM- in fiscal 1995.
TAX PROVISION. The income tax provision for fiscal 1994 and fiscal 1995
is comprised of minimum State of California Franchise Taxes of $1,600. There
is no provision for Federal income taxes as the Company has a current year
loss and has a net operating loss carryforward.
QUARTERLY RESULTS OF OPERATIONS
The Company has experienced, and may continue to experience,
fluctuations in operating results due to a variety of factors, including the
size and rate of growth of the consumer software market, market acceptance of
the Company's products and those of its competitors, development and
promotional expenses relating to the introduction of new products or new
versions of existing products, product returns, changes in pricing policies
by the Company and its competitors, the accuracy of retailers' forecasts of
consumer demand, the timing of the receipt of orders from major customers,
and account cancellations or delays in shipment. The Company's expense
levels are based, in part, on its expectations as to future sales and, as a
result, operating results could be
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disproportionately affected by a reduction in sales or a failure to meet the
Company's sales expectations.
SEASONALITY
The consumer software business traditionally has been seasonal.
Typically, net sales are the highest during the fourth calendar quarter and
decline sequentially in the first and second calendar quarters. The seasonal
pattern is due primarily to the increased demand for consumer software during
the year-end holiday buying season. The Company expects its net sales and
operating results to continue to reflect seasonality. Nevertheless,
management believes that in the future its results may be less subject to
seasonal fluctuations because its products will be marketed in connection
with the releases of major motion pictures and home videos, which occur
throughout the year.
LIQUIDITY AND CAPITAL RESOURCES
Since its formation, the Company has financed its operations and capital
expenditures primarily with cash provided by operating activities, securities
issuances and financing arrangements. As of the fiscal year ended June 30,
1996, the Company had negative working capital of $(5,373,974) and cash
equivalents of $181,985.
On July 1, 1996, pursuant to its initial public offering, the Company
issued 2,400,000 shares of common stock at $4.00 per share and 1,200,000
redeemable warrants (the "Redeemable Warrants") at $.25 per warrant. Net
proceeds totalled $7,973,305, net of offering costs of $1,926,695. On August
14, 1996, the Company's underwriters for the initial public offering
exercised a portion of their "over-allotment" option, pursuant to the
underwriting agreement, which resulted in the Company issuing an additional
160,000 shares of common stock at $4.00 per share and 171,775 Redeemable
Warrants at $.25 per warrant. Net proceeds totalled $594,161, net of offering
costs of $88,783.
On July 1, 1996, the Company repaid certain notes payable aggregating
$4,987,500 plus accrued interest of $373,753. On July 7, 1996, the
Company issued 2,016,657 Redeemable Warrants in connection with the
conversion of the note payable to ASSI, Inc., a related party, of $500,000,
plus accrued interest of $4,164.
The Company invested approximately $47,855 during fiscal 1995 and
approximately $129,456 during fiscal 1996 for capital equipment to expand
into new product lines and to address potential capacity constraints created
by the Company's growing unit sales volumes. From time to time, the Company
evaluates acquisitions of products, businesses and technologies that are
complementary to the Company's business.
Management expects that in the future, cash in excess of current
requirements will be invested in investment-grade, interest-bearing
securities. To date, the Company has not invested in derivative securities
or any other financial instruments that involve a high degree of complexity
or risk, and management does not intend to invest in these types of
securities or financial instruments in the future.
NEW ACCOUNTING STANDARDS
In October 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS No. 123"). SFAS No. 123 establishes a method of
accounting for stock compensation plans based on fair value of grants made
under such plans on the date of grant using certain option-pricing models.
SFAS No. 123 allows companies to continue to account for their stock option
plans in accordance with APB opinion 25 "Accounting for Stock Issued to
Employees," which provides for an intrinsic valuation model that recognizes
only the difference between the fair market value of a company's stock and
the price paid to acquire the stock under the stock compensation plan.
However, SFAS No. 123 encourages the adoption of the fair value accounting
method. Companies electing not to follow the new fair value based method are
required to provide expanded footnote disclosures, including pro forma net
income and earnings per share, determined as if the company had applied the
new method. SFAS No. 123 is required to be adopted prospectively beginning
January 1, 1996. The Company plans to use the intrinsic valuation model and
provide footnote disclosure with respect to the fair value of options for
fiscal years beginning after January 1, 1996.
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ITEM 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III
Items 10, 11 and 12 of Part III of this Form 10-KSB are omitted because
the Company intends to file with the Securities and Exchange Commission,
within 120 days of the close of its fiscal year ended June 30, 1996, a
definitive Proxy Statement containing information pursuant to Regulation 14A
of the Exchange Act, and that such information shall be deemed incorporated
herein by reference from the date of filing of such document.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
EXH.
NO. DESCRIPTION OF EXHIBITS
---- -----------------------
3.1 Second Restated Certificate of Incorporation of the
Registrant. [Filed as Exhibit 3.1 to the Company's
Registration Statement No. 33-80827 (the "Registration
Statement") and incorporated herein by reference.]
3.2 Amended and Restated Bylaws of the Registrant. [Filed as
Exhibit 3.2 to the Registration Statement and incorporated
herein by reference.]
4.1 Specimen Common Stock Certificate. [Filed as Exhibit 4.1 to
the Registration Statement and incorporated herein by
reference.]
4.2 Form of Warrant Agreement and Warrant. [Filed as Exhibit 4.2
to the Registration Statement and incorporated herein by
reference.]
4.3 Form of Representative's Warrant Agreement and Warrant. [Filed
as Exhibit 4.3 to the Registration Statement and incorporated
herein by reference.]
4.4 Warrant dated April 30, 1996 issued to ASSI, Inc. [Filed as
Exhibit 4.4 to the Registration Statement and incorporated
herein by reference.]
9.1 Stockholder Voting Agreement, dated as of April 30, 1996,
among ASSI, Inc., Vincent J. Bitetti and Eric H. Winston.
[Filed as Exhibit 9.1 to the Registration Statement and
incorporated herein by reference.]
9.2 Irrevocable Proxy of Vincent J. Bitetti to ASSI, Inc., dated
April 30, 1996. [Filed as Exhibit 9.2 to the Registration
Statement and incorporated herein by reference.]
9.3 Irrevocable Proxy of Eric H. Winston to ASSI, Inc., dated
April 30, 1996. [Filed as Exhibit 9.3 to the Registration
Statement and incorporated herein by reference.]
9.4 Irrevocable Proxy of ASSI, Inc. to Vincent J. Bitetti, dated
April 30, 1996. [Filed as Exhibit 9.4 to the Registration
Statement and incorporated herein by reference.]
9.5 Irrevocable Proxy and Voting Agreement of Martin Meyer to
Vincent J. Bitetti, dated May 4, 1994. [Filed as Exhibit 9.5
to the Registration Statement and incorporated herein by
reference.]
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10.1 Second Amended and Restated Employment Agreement of Vincent
J. Bitetti dated as of April 30, 1996. [Filed as Exhibit
10.1 to the Registration Statement and incorporated herein
by reference.]
10.2 Second Amended and Restated Employment Agreement of Eric H.
Winston dated as of April 30, 1996. [Filed as Exhibit 10.2
to the Registration Statement and incorporated herein by
reference.]
10.3 Employment Agreement of Ulrich E. Gottschling, as amended.
[Filed as Exhibit 10.3 to the Registration Statement and
incorporated herein by reference.]
10.4 Sound Source Interactive, Inc. 1992 Stock Option Plan. [Filed
as Exhibit 10.4 to the Registration Statement and incorporated
herein by reference.]
10.5 Sound Source Interactive, Inc. and 1995 Stock Option Plan.
Filed herewith.
10.6 Sales and Distribution Agreement, dated as of June 15, 1995,
between the Registrant and Acclaim Distribution, Inc. [Filed
as Exhibit 10.13 to the Registration Statement and
incorporated herein by reference.]
10.7 Retail License Agreement, dated June 16, 1994, between Warner
Bros. Consumer Products and "Sound Source Interactive,"
pertaining to the motion picture, "Willy 2." [Filed as
Exhibit 10.14 to the Registration Statement and incorporated
herein by reference.]
10.8 Retail License Agreement, dated July 7, 1995, between Warner
Bros. Consumer Products and "Sound Source Interactive,"
pertaining to the television series, "Babylon 5." [Filed
as Exhibit 10.15 to the Registration Statement and
incorporated herein by reference.]
10.9 Retail License Agreement, dated June 16, 1994, between Warner
Bros. Consumer Products and "Sound Source Interactive,"
pertaining to the motion picture, "The Secret Garden."
[Filed as Exhibit 10.16 to the Registration Statement and
incorporated herein by reference.]
10.10 Retail License Agreement, dated June 16, 1994, between Warner
Bros. Consumer Products and "Sound Source Interactive,"
pertaining to the motion picture, "Black Beauty." [Filed as
Exhibit 10.17 to the Registration Statement and incorporated
herein by reference.]
10.11 Merchandising License Agreement, dated March 7, 1995, between
Sony Signature, Inc., as agent for Columbia Pictures
Industries, Inc., and the Subsidiary, pertaining to the
motion picture, "Close Encounters of the Third Kind."
[Filed as Exhibit 10.18 to the Registration Statement and
incorporated herein by reference.]
10.12 CD-ROM Development Agreement, dated August 30, 1994, between
Fox Electronic Publishing, Inc., doing business as Fox
Interactive, and "Sound Source Interactive." [Filed as
Exhibit 10.19 to the Registration Statement and incorporated
herein by reference.]
10.13 (a) Merchandising Licensing Agreement, dated December 5, 1994,
between MCA/Universal Merchandising, Inc. and "Sound Source
Interactive," pertaining to the motion picture, "The Little
Rascals." [Filed as Exhibit 10.20(a) to the Registration
Statement and incorporated herein by reference.]
(b) Multimedia Rights License, dated June 14, 1995, between
The Harry Fox Agency, Inc. and "Sound Source Interactive,"
pertaining to the motion picture, "The Little Rascals."
[Filed as Exhibit 10.20(b) to the Registration Statement and
incorporated herein by reference.]
(c) Letter of Agreement, dated June 28, 1995, between Roy
Shield Music Company and "Sound Source Interactive,"
pertaining to the motion picture, "The Little Rascals."
[Filed as Exhibit 10.20(c) to the Registration Statement and
incorporated herein by reference.]
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<PAGE>
(d) Multi Media Rights License, dated July 27, 1995, between
MCA, Inc. and "Sound Source Interactive," pertaining to the
motion picture, "The Little Rascals." [Filed as Exhibit
10.20(d) to the Registration Statement and incorporated
herein by reference.]
10.14 Merchandising Licensing Agreement, dated March 16, 1995,
between MCA/Universal Merchandising, Inc. and "Sound Source
Interactive," pertaining to the animated television series,
"ExoSquad." [Filed as Exhibit 10.21 to the Registration
Statement and incorporated herein by reference.]
10.15 Merchandising Licensing Agreement, dated August 10, 1995,
between MCA/Universal Merchandising, Inc. and "Sound Source
Interactive," pertaining to the motion picture, "Babe."
[Filed as Exhibit 10.22 to the Registration Statement and
incorporated herein by reference.]
10.16 (a) License Agreement, dated October 1, 1994, between
Lucasfilm Ltd. ("LFL") and "Sound Source Interactive,"
pertaining to AUDIOCLIPS-C- of sound effects, dialogue and
movie soundtracks for the motion pictures, "Star Wars,"
"The Empire Strikes Back," and "Return of the Jedi."
[Filed as Exhibit 10.23(a) to the Registration Statement and
incorporated herein by reference.]
(b) License Agreement, dated October 1, 1994, between LFL and
"Sound Source Interactive," pertaining to VISUALCLIPS-C- of
film/video cues for the motion pictures, "Star Wars," "The
Empire Strikes Back," and "Return of the Jedi." [Filed as
Exhibit 10.23(b) to the Registration Statement and
incorporated herein by reference.]
(c) Soundtrack License Agreement, dated October 1, 1994,
between LFL and "Sound Source Interactive," pertaining to the
use of the soundtrack of the "Star Wars Films" (as defined
therein). [Filed as Exhibit 10.23(c) to the Registration
Statement and incorporated herein by reference.]
(d) Film Footage License, dated October 1, 1994, between LFL
and "Sound Source Interactive," pertaining to the use of the
film footage of the "Star Wars Films" (as defined therein).
[Filed as Exhibit 10.23(d) to the Registration Statement and
incorporated herein by reference.]
(e) Letter of Intent and Star Wars Classic License Agreement,
dated September 15, 1995, between LFL and "Sound Source
Interactive, Inc.," pertaining to the grant of a license for
sales in Canada. [Filed as Exhibit 10.23(e) to the
Registration Statement and incorporated herein by reference.]
(f) Addendum to the agreement dated October 28, 1992, between
Horatio Productions and the Subsidiary, pertaining to the use
of preexisting dialogue of the Darth Vader character. [Filed
as Exhibit 10.23(f) to the Registration Statement and
incorporated herein by reference.]
10.17 Merchandising License Agreement, dated July 8, 1994, between
Viacom Consumer Products, as agent for Paramount Pictures
Corporation, and "Sound Source Interactive, Inc.," pertaining
to the television series, "Star Trek: The Original Series,"
the first six motion pictures based thereon and the
television series, "Star Trek: The Next Generation." [Filed
as Exhibit 10.24 to the Registration Statement and
incorporated herein by reference.]
10.18 (a) License Agreement, dated as of July 10, 1995, between DC
Comics and "Sound Source Interactive," pertaining to the
animated television series initially entitled "Batman: The
Animated Series" and thereafter entitled, "The Adventures
of Batman and Robin." [Filed as Exhibit 10.25(a) to the
Registration Statement and incorporated herein by reference.]
(b) Interactive/Multimedia Adherence Letter, dated
November 10, 1995, between the Screen Actors Guild and
"Sound Source Interactive," pertaining to the animated
television series initially entitled "Batman: The
Animated Series" and thereafter
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<PAGE>
entitled, "The Adventures of Batman and Robin." [Filed as
Exhibit 10.25(b) to the Registration Statement and
incorporated herein by reference.]
10.19 Licensing Agreement, dated as of June 14, 1994 among
CBS Entertainment ("CBS"), Rod Serling Trust and "Sound
Source Interactive," pertaining to the television series,
"The Twilight Zone." [Filed as Exhibit 10.26 to the
Registration Statement and incorporated herein by reference.]
10.20 Merchandising License Agreement, dated as of October
30, 1992, among Carolco Pictures Inc., Carolco
International N.V. and "Sound Source Unlimited, Inc.,"
pertaining to the motion picture, "Total Recall. [Filed as
Exhibit 10.27 to the Registration Statement and incorporated
herein by reference.]
10.21 Merchandising License Agreement, dated as of October
30, 1992, among Carolco Pictures Inc., Carolco
International N.V. and "Sound Source Unlimited, Inc.,"
pertaining to the motion picture, "Terminator 2:
Judgment Day." [Filed as Exhibit 10.28 to the Registration
Statement and incorporated herein by reference.]
10.22 License Agreement, dated as of September 20, 1994,
between Palladium Limited Partnership and "Sound Source
Interactive," pertaining to the motion picture, "Lassie."
[Filed as Exhibit 10.29 to the Registration Statement and
incorporated herein by reference.]
10.23 License Agreement, dated as of September 20, 1994,
between Broadway Video Entertainment and "Sound Source
Interactive," pertaining to the television series,
"Saturday Night Live." [Filed as Exhibit 10.30 to the
Registration Statement and incorporated herein by reference.]
10.24 Merchandising License Agreement, dated as of October
12, 1995, between DESILU, TOO, CBS and "Sound Source
Interactive," pertaining to the television series, "I
Love Lucy." [Filed as Exhibit 10.31 to the Registration
Statement and incorporated herein by reference.]
10.25 Memorandum of Understanding, dated May 26, 1994,
between Brian Leader, doing business as Sentient Software,
and "Sound Source Interactive, Inc.," pertaining to
program development and licensing agreements related to
INTERACTIVE MOVIEBOOKS-TM-. [Filed as Exhibit 10.32 to the
Registration Statement and incorporated herein by reference.]
10.26 (a) Royalty Programming Contract, dated July 12,
1993, between Rhode Island Soft Systems (""RISS") and the
Subsidiary, pertaining to screen saver modules. [Filed as
Exhibit 10.33(a) to the Registration Statement and
incorporated herein by reference.]
(b) Amendment to Royalty Programming Contract, dated
September 12, 1994, between RISS and the Subsidiary. [Filed
as Exhibit 10.33(b) to the Registration Statement and
incorporated herein by reference.]
(c) Agreement, dated April 12, 1995, between RISS and
"Sound Source Interactive," pertaining to INTERACTIVE
MOVIEBOOKS-TM-. [Filed as Exhibit 10.33(c) to the
Registration Statement and incorporated herein by reference.]
(d) Letter of Intent, dated August 24, 1995, between RISS
and "Sound Source Interactive," pertaining to
INTERACTIVE MOVIEBOOKS-TM-. [Filed as Exhibit 10.33(d) to the
Registration Statement and incorporated herein by reference.]
10.27 Merchandising License Agreement, dated September 1,
1995, between Greytsounds Sound Development and "Sound
Source Interactive," pertaining to Registrant's Sound
Library. [Filed as Exhibit 10.34 to the Registration
Statement and incorporated herein by reference.]
10.28 Indemnification Agreement, dated as of January 1, 1996,
between the Registrant and Vincent J. Bitetti. [Filed as
Exhibit 10.35 to the Registration Statement and
incorporated herein by reference.]
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10.29 Indemnification Agreement, dated as of January 1,
1996, between the Registrant and Eric H. Winston.
[Filed as Exhibit 10.36 to the Registration Statement and
incorporated herein by reference.]
10.30 Indemnification Agreement, dated as of January 1,
1996, between the Registrant and Ulrich Gottschling.
[Filed as Exhibit 10.37 to the Registration Statement and
incorporated herein by reference.]
10.31 Merchandising License Agreement, dated October 24,
1995, between MCA/Universal Merchandising, Inc. and
"Sound Source Interactive," pertaining to the motion picture,
"Dragonheart." [Filed as Exhibit 10.38 to the Registration
Statement and incorporated herein by reference.]
10.32 Merchandising License Agreement, dated January 10,
1996, between MCA/Universal Merchandising, Inc. and
"Sound Source Interactive," pertaining to the motion
pictures, "The Land Before Time" (I, II and III). [Filed as
Exhibit 10.39 to the Registration Statement and incorporated
herein by reference.]
10.33 Agreement, dated March 18, 1996, between Musicians'
Union and "Sound Source Interactive," pertaining to the
use of music from the motion pictures, "The Land Before
Time" (I, II and III). [Filed as Exhibit 10.40 to the
Registration Statement and incorporated herein by reference.]
10.34 License Agreement, dated February 27, 1996, between
MGM/UA Merchandising, Inc. and Subsidiary, pertaining to
the motion picture, "All Dogs Go To Heaven 2." [Filed as
Exhibit 10.41 to the Registration Statement and incorporated
herein by reference.]
10.35 Agreement, dated January 4, 1996, between Universal
Studios Florida and "Sound Source Interactive,"
pertaining to the "Universal Studios Florida T2
Screensaver Sweepstakes." [Filed as Exhibit 10.42 to the
Registration Statement and incorporated herein by reference.]
10.36 Agreement, dated January 24, 1996, between Warner
Bros. Television and "Sound Source Interactive,"
pertaining to the "Babylon 5 Contest." [Filed as Exhibit
10.43 to the Registration Statement and incorporated herein
by reference.]
10.38 Consulting Agreement, dated as of April 30, 1996,
between the Company and ASSI, Inc. [Filed as Exhibit 10.45
to the Registration Statement and incorporated herein by
reference.]
10.39 Share Purchase Agreement, dated April 3, 1995,
between Eric Winston and Vincent Bitetti. [Filed as Exhibit
10.46 to the Registration Statement and incorporated herein
by reference.]
10.40 Distribution Services Agreement, dated June 1, 1996,
between the Registrant and Simon & Schuster Interactive
Distribution Services. [Filed as Exhibit 10.47 to the
Registration Statement and incorporated herein by reference.]
10.41 Note Purchase Agreement, dated as of May 30, 1996,
between the Registrant and ASSI, Inc. [Filed as Exhibit
10.48 to the Registration Statement and incorporated herein
by reference.]
10.42 Convertible Promissory Note, dated May 30, 1996,
issued by the Company to ASSI, Inc. [Filed as Exhibit 10.49
to the Registration Statement and incorporated herein by
reference.]
10.43 Merchandising License Agreement, dated July 22,
1996, between Twentieth Century Fox Licensing and
Merchandising, a unit of Fox, Inc., and Sound Source
Interactive, Inc., a California corporation pertaining to
the motion picture "The Abyss." Filed herewith.
21.1 Subsidiary of the Registrant. [Filed as Exhibit 21.1 to
the Registration Statement and incorporated herein by
reference.]
23.1 Consent of Corbin & Wertz. Filed herewith.
27.1 Financial Data Schedule. Filed herewith.
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(b) Reports on Form 8-K.
None.
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SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of
1934, as amended (the "Exchange Act"), the issuer has caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
Date: September 30, 1996 SOUND SOURCE INTERACTIVE, INC.
By /s/ VINCENT J. BITETTI
___________________________________
Vincent J. Bitetti, Chairman of the
Board and Chief Executive Officer
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the issuer in the capacities and on the
dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- --------- ----- -----
<S> <C> <C>
/s/ VINCENT J. BITETTI
______________________
Vincent J. Bitetti Chairman of the Board and September 30, 1996
Chief Executive Officer (principal
executive officer)
/s/ ERIC H. WINSTON
___________________
Eric H. Winston President and Chief Operating September 30, 1996
Officer
/s/ ULRICH E. GOTTSCHLING
_________________________
Ulrich E. Gottschling Chief Financial Officer, Treasurer September 30, 1996
and Secretary (principal financial
and accounting officer)
/s/ RONALD W. HART
_______________________
Ronald W. Hart Director September 29, 1996
/s/ MARK A. JAMES
_______________________
Mark A. James Director September 26, 1996
/s/ ERNEST T. KLINGER
_____________________
Ernest T. Klinger Director September 24, 1996
</TABLE>
No annual report or proxy materials have been sent to security holders.
An annual report for the Company's fiscal year ended June 30, 1996 will be
forwarded to stockholders.
-24-
<PAGE>
SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY
CONSOLIDATED FINANCIAL STATEMENTS
For The Years Ended June 30, 1995 and 1996
with
INDEPENDENT AUDITORS' REPORT THEREON
<PAGE>
INDEPENDENT AUDITORS' REPORT
Board of Directors
Sound Source Interactive, Inc.
We have audited the accompanying consolidated balance sheet of Sound Source
Interactive, Inc. (a Delaware corporation) and subsidiary (collectively
referred to as the "Company") as of June 30, 1996 and the related
consolidated statements of operations, stockholders' deficit and cash flows
for each of the years in the two-year period then ended. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Sound
Source Interactive, Inc. and subsidiary as of June 30, 1996, and the results
of their operations and their cash flows for each of the years in the
two-year period then ended in conformity with generally accepted accounting
principles.
See Note 1 to the consolidated financial statements regarding the Company's
historical losses and distributor relationships.
CORBIN & WERTZ
Irvine, California
September 16, 1996
<PAGE>
SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
June 30, 1996
<TABLE>
<S> <C>
ASSETS (Note 4)
Current assets:
Cash and cash equivalents $ 181,985
Accounts receivable, net of allowance for doubtful
accounts of $703,421 (Notes 6, 14 and 15) 912,904
Inventories, net of valuation allowance of
$201,499 (Note 2) 262,657
Prepaid royalties 628,676
Deferred offering costs (Note 15) 620,904
Prepaid expenses and other 15,864
---------
Total current assets 2,622,990
Property and equipment, net of accumulated
depreciation of $129,954 (Note 3) 177,067
Other assets 12,900
---------
$ 2,812,957
=========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Notes payable (Note 4) $ 4,987,500
Accrued interest (Notes 4 and 5) 367,695
Accounts payable and accrued expenses (Note 8) 664,736
Accrued legal fees 347,710
Accrued compensation and related taxes 74,901
Note payable to related party (Note 5) 500,000
Accrued royalties 542,804
Short-term advance (Note 6) 400,000
Deferred revenue (Note 7) 84,360
Current portion of capital lease obligations
(Note 8) 27,058
---------
Total current liabilities 7,996,964
---------
Capital lease obligations, net of current
portion (Note 8) 13,811
---------
Total liabilities 8,010,775
---------
Commitments and contingencies (Note 8)
Stockholders' deficit (Notes 4, 5, 9, 10, 11 and 15):
Common stock, $.001 par value; 20,000,000
shares authorized; 1,807,824 shares issued
and outstanding 1,808
Warrants 263,350
Additional paid-in capital 5,124,576
Accumulated deficit (10,587,552)
---------
Total stockholders' deficit (5,197,818)
---------
$ 2,812,957
=========
</TABLE>
See independent auditors' report and accompanying
notes to consolidated financial statements
F-2
<PAGE>
CONSOLIDATED STATEMENTS OF OPERATIONS
For Each Of The Years In The
Two-Year Period Ended June 30, 1996
<TABLE>
<CAPTION>
1995 1996
----------- -----------
<S> <C> <C>
Revenues (Notes 14 and 15):
Product sales $ 1,255,230 $ 2,161,351
Development fees 343,250 ---
Original equipment manufacturing 479,675 70,895
Royalties (Note 7) 76,771 32,387
----------- -----------
Net revenues 2,154,926 2,264,633
Cost of sales 1,072,691 1,382,999
----------- -----------
Gross profit 1,082,235 881,634
----------- -----------
Operating costs and expenses:
Marketing and sales (Note 8) 516,886 1,054,602
Compensation in connection with
common stock and common stock
options issued for services
rendered (Note 11) 733,165 ---
Other general and administrative
(Note 8) 1,009,858 1,530,434
Reserve for bad debts 40,000 663,421
Research and development (Note 8) 378,471 717,994
----------- -----------
Total operating costs and expenses 2,678,380 3,966,451
----------- -----------
Operating loss (1,596,145) (3,084,817)
Interest income 16,994 35,430
Interest expense (Notes 4, 5 and 8) (7,045) (374,175)
Amortization of deferred loan costs
(Note 4) --- (1,035,200)
Other expense, net (3,258) (14,614)
----------- -----------
Loss before provision for income
taxes (1,589,454) (4,473,376)
Provision for income taxes (Note 13) 1,600 1,600
----------- -----------
Loss from continuing operations (1,591,054) (4,474,976)
----------- -----------
Discontinued operations (Note 12):
Loss from operations of discontinued
music division (111,106) ---
Estimated operating loss and loss on
disposal of discontinued music
division during phase-out period (32,000) ---
----------- -----------
Loss from discontinued operations (143,106) ---
----------- -----------
Net loss $ (1,734,160) $ (4,474,976)
=========== ===========
Net loss per common share:
Loss from continuing operations $ (0.85) $ (2.44)
=========== ===========
Loss from discontinued operations (0.08) ---
=========== ===========
Net loss per common share $ (0.93) $ (2.44)
=========== ===========
Weighted average number of common
shares outstanding 1,862,908 1,837,759
=========== ===========
</TABLE>
See independent auditors' report and accompanying
notes to consolidated financial statements
F-3
<PAGE>
SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
For Each Of The Years In The Two-Year
Period Ended June 30, 1996
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL
-------------- PAID-IN ACCUMULATED
SHARES AMOUNT WARRANTS CAPITAL DEFICIT TOTAL
-------- ------- -------- ---------- ----------- ------------
<S> <C>
Balances, July 1, 1994 1,753,533 $ 1,754 $ --- $3,685,108 $(4,378,416) $ (691,554)
Issuance of common stock in connection
with private offering, net of offering
costs of $61,759 (Note 9) 59,238 59 706,048 706,107
Shares issued for services performed
in connection with private offering
(Note 9) 42,227 42 504,644 504,686
Offering costs (Note 9) (504,686) (504,686)
Issuance of stock options for services
(Note 11) 733,165 733,165
Issuance of common stock in connection
with exercise of options (Note 11) 4,184 4 246 250
Net loss (1,734,160) (1,734,160)
---------- ------- ------- --------- ---------- ------------
Balances, June 30, 1995 1,859,182 1,859 --- 5,124,525 (6,112,576) (986,192)
Issuance of warrants in connection with
private offerings (Note 4) 263,350 263,350
Cancellation of shares in connection with
settlement (Notes 8 and 9) (15,120) (15) 15
Cancellation of shares for which the Company
had not received valid consideration
(Note 9) (36,238) (36) 36
Net loss (4,474,976) (4,474,976)
---------- ------- ------- --------- ---------- ------------
Balances, June 30, 1996 1,807,824 $ 1,808 $263,350 $5,124,576 $(10,587,552) $ 5,197,818
========== ======= ======= ========= =========== ==========
</TABLE>
See independent auditors' report and accompanying
notes to consolidated financial statements
F-4
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
For Each Of The Years In The
Two-Year Period Ended June 30, 1996
<TABLE>
<CAPTION>
1995 1996
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Net loss from continuing operations $ (1,591,054) $ (4,474,976)
Adjustments to reconcile net loss
to net cash used by operating
activities:
Depreciation and amortization 27,541 45,230
Allowance for sales returns (8,732) (64,250)
Allowance for bad debt reserve (56,566) 663,421
Allowance for inventories --- 201,499
Common stock and stock options
issued for services rendered 733,165 ---
Changes in operating assets and
liabilities:
Accounts receivable 66,352 (1,451,247)
Inventories (99,576) (313,836)
Prepaid royalties 1,537 (147,264)
Prepaid expenses and other --- (15,864)
Accounts payable and accrued
expenses (206,037) 210,241
Accrued legal fees 80,351 267,359
Accrued compensation and related
taxes 92,394 (169,138)
Accrued interest --- 367,695
Commissions payable 114,786 (159,593)
Accrued royalties (20,697) 291
Deferred revenue (8,795) 20,360
------------ ------------
Net cash used by continuing operations (875,331) (5,020,072)
------------ ------------
Net loss from discontinued operations (143,106) ---
Reserve for estimated loss on disposal 32,000 ---
Depreciation 8,878 ---
Changes in operating assets and
liabilities of discontinued operations:
Accounts receivable (2,471) ---
Inventories 1,351 ---
Accounts payable and accrued expenses 3,098 ---
Accrued royalties 3,415 ---
Commissions payable 12,498 ---
------------ ------------
Net cash used by discontinued operations (84,337) ---
------------ ------------
Cash flows from investing activities of
continuing operations:
Purchases of property and equipment (38,876) (90,985)
Other assets --- (9,840)
------------ ------------
Net cash used in investing activities (38,876) (100,825)
Cash flows from investing activities of
continued operations -
Purchases of property and equipment (6,665) ---
------------ ------------
</TABLE>
Continued
F-5
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
For Each Of The Years In The
Two-Year Period Ended June 30, 1996
<TABLE>
<CAPTION>
1995 1996
------------ -----------
<S> <C> <C>
Cash flows from financing activities:
Proceeds from issuance of common stock 684,107 ---
Proceeds from issuance of warrants --- 263,350
Proceeds from issuance of notes payable --- 5,306,700
Repayments of notes payable --- (319,200)
Notes payable to officers 13,500 (13,500)
Note payable to related party --- 500,000
Payments on note payable (19,587)
Deferred offering costs --- (620,904)
Payments on capital lease obligations (13,678) (27,294)
Short-term advance 400,000 ---
------------ -----------
Net cash provided by financing activities 1,064,342 5,089,152
------------ -----------
Net change in cash and cash equivalents 59,133 (31,745)
Cash and cash equivalents,
beginning of period 154,597 213,730
------------ -----------
Cash and cash equivalents,
end of period $ 213,730 $ 181,985
============ ===========
Supplemental disclosure of cash flow
information -
Cash paid during the year for:
Interest $ 9,742 $ 6,480
============ ===========
Income taxes $ 1,600 $ 1,600
============ ===========
</TABLE>
See the accompanying notes to consolidated financial statements for
supplemental disclosure of noncash investing and financing activities.
See independent auditors' report and accompanying
notes to consolidated financial statements
F-6
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For Each Of The Years In The
Two-Year Period Ended June 30, 1996
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
Sound Source Interactive, Inc., (a California corporation) was incorporated
on March 8, 1990, under the name Sound Source Unlimited, Inc.
("SSI-California"). On May 16, 1994, SSI-California consummated a
stock-for-stock exchange with Basic Science Associates, Inc. ("BSA"), a
publicly-held Delaware corporation. As part of the exchange, BSA issued
1,474,232 shares of its common stock and 1,000,000 shares of its Series A
preferred stock (see Note 10) in exchange for all of the outstanding shares
of SSI-California. The exchange has been accounted as a reverse acquisition
because stockholders of SSI-California maintained control of the surviving
entity, BSA. Accordingly, for financial reporting purposes, the shares
issued by BSA are considered outstanding since the date of incorporation of
SSI-California, and the 99,992 shares of common stock retained by the
stockholders of BSA are reflected as consideration issued to consummate the
stock-for-stock exchange. No value was ascribed to the shares of common
stock retained by the stockholders of BSA since as of the date of the
exchange, BSA had nominal assets and stockholders' equity and was an
inactive company. Concurrent with the stock-for-stock exchange, BSA
changed its name to Sound Source Interactive, Inc. (a Delaware corporation)
("SSI-Delaware").
SSI-Delaware, through its wholly-owned subsidiary,
SSI-California (collectively called the "Company"), is in the business of
developing, publishing and distributing entertainment software,
specializing in interactive educational software, entertainment computer
software utilities and sound clips for customers primarily in North America.
HIHSTORICAL LOSSES AND DISTRIBUTOR RELATIONSHIPS
As shown in the accompanying consolidated financial
statements, the Company has incurred net losses of $1,734,160 and
$4,474,976 for the years ended June 30, 1995 and 1996, respectively. The
Company has not historically generated sufficient cash flows to fund
operations due in part to its problems with its major distributor, Acclaim
Entertainment, Inc. ("Acclaim") (see Notes 14 and 15). The Company has
entered into a new distributor agreement effective June 1, 1996 (see Note
14). The success of this new relationship is, to date, unproven. The
Company has had to rely on debt and equity financings to fund operations.
The Company effected an initial public offering on July 1, 1996 and raised
proceeds to repay certain of its debt and to fund its working capital
requirements (see Note 15). The future success of the Company is largely
dependent upon its new distributor relationship and the Company's ability
to generate revenues sufficient to fund operations.
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of
the SSI-Delaware and its wholly-owned subsidiary SSI-California. All
significant intercompany transactions and balances have been eliminated in
consolidation.
Continued
F-7
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
For Each Of The Years In The
Two-Year Period Ended June 30, 1996
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
DISCONTINUED OPERATIONS
In July 1995, the Company approved a formal plan to license the rights to
its music division (which developed and sold sound patches for electronic
keyboards and synthesizers) and sold the related inventory and property and
equipment to an unrelated third party (see Note 12). Accordingly, the
Company has classified such as discontinued operations in the accompanying
consolidated financial statements for both years presented.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the periods reported. Actual results could materially differ from
those estimates.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The consolidated financial statements contain financial instruments whereby
the fair value of the financial instruments could be different than those
recorded on a historical basis in the accompanying consolidated financial
statements. The Company's financial instruments consist of cash and cash
equivalents, accounts receivable, notes payable, accounts payable, note
payable to related party and short-term advance. The carrying amounts of
the Company's financial instruments approximated their fair values at June
30, 1996.
CONCENTRATION OF CREDIT RISK
The Company at times maintains cash balances at certain financial
institutions in excess of the federally insured deposits.
The Company performs periodic credit evaluations of its customers and
maintains allowances for potential credit losses and returns. The Company
estimates credit losses and returns based on management's evaluation of
historical experience and current industry trends. Although the Company
expects to collect amounts due, actual collections may differ from the
estimated amounts. The Company is subject to rapid changes in technology and
shifts in consumer demand which could result in product returns which differ
from estimates.
As of June 30, 1996, reserves for credit losses totalled $703,421.
Reserves for sales returns were not deemed necessary by management of the
Company. Such reserves relate solely to Acclaim (see Notes 6, 14 and 15).
One customer accounted for 18% of consolidated total revenues for the year
ended June 30, 1995. Acclaim accounted for 83% of consolidated total
revenues for the year ended June 30, 1996. The Company's accounts
receivable at June 30, 1996 are primarily from Acclaim (see Notes 6, 14 and
15).
No one company accounted for more than 10% of consolidated purchases for
the year ended June 30, 1995. The Company purchased certain products from
two companies, which accounted for approximately 49% and 37%, respectively,
of consolidated purchases for the year ending June 30, 1996. Accounts
payable to two companies accounted for 11% and 11%, respectively, of
consolidated accounts payable as of June 30, 1996.
Continued
F-8
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
For Each Of The Years In The
Two-Year Period Ended June 30, 1996
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
RISKS AND UNCERTAINTIES
TECHNOLOGICAL OBSOLESCENCE
The entertainment software industry is characterized by rapid technological
advancement and change. Should demand for the Company's products prove to
be significantly less than anticipated, the ultimate realizable value of
such products could be substantially less than the amount shown in the
consolidated balance sheet. Included in the accompanying consolidated
balance sheet is inventories at a carrying value of $262,657 as of June 30,
1996, which represents management's estimate of its net realizable value.
Such value is based on forecasts for sales of such inventories.
LICENSES
The Company's products are based upon the licensed content of major motion
pictures and television shows and/or development agreements with major
entertainment studios. All of such license and development agreements to
which the Company currently is a party are for fixed terms which will
expire over the next one to five years. Although no licensor is required
to extend any license, the Company anticipates that the licensor under each
agreement will extend its terms, provided that the Company is in compliance
with all requirements of each license, including most significantly that
the Company has satisfied the applicable minimum royalty guarantees. In
the event that any licensor fails to renew its license agreement, then the
subject license will terminate and the Company will no longer be entitled
to sell the licensed product. The loss of one or more of the licenses
could have a material adverse effect on the Company's revenues and
operating results. There can be no assurance that the Company will satisfy
its performance obligations under any license or development agreement or,
that even if such requirements are satisfied, all material licenses will be
renewed. Generally, the terms of a license agreement state that, upon any
bankruptcy or liquidation of the Company, licensing rights revert to the
license holder.
DISTRIBUTION
As discussed in Note 14, the Company entered into a distribution agreement
which is exclusive except for sales in the direct-to-the-customer programs,
as defined. The term of the agreement is for two years. The Company will
be substantially dependent upon such distributor for the marketing and
selling of its products throughout North America during the term of this
agreement. The distributor, however, will not be obligated to sell any
specified minimum quantity of the Company's products. There can be no
assurance as to the volume of product sales that may be achieved by the
distributor. Because the Company's rights to market and sell its products
are limited, the Company's ability to realize cash flow necessary to fund
its ongoing operations and to achieve profitability will be largely
dependent upon the success of the distributor in marketing and selling the
Company's products.
SEASONALITY
Traditionally, the consumer software business has been seasonal.
Typically, net revenues are highest during the fourth calendar quarter and
decline sequentially in the first three calendar quarters. The seasonal
pattern is due primarily to the increased demand for consumer software
during the holiday season. The Company expects its net sales and operating
results to reflect such seasonality.
Continued
F-9
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
For Each Of The Years In The
Two-Year Period Ended June 30, 1996
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with a remaining
maturity of 90 days or less when purchased to be cash equivalents.
INVENTORIES
Inventories, which consist primarily of software media, manuals and related
packaging materials, are stated at the lower of cost or market with cost
determined on a first-in, first-out (FIFO) basis.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost less accumulated depreciation.
Property and equipment are depreciated using the straight-line method over
the estimated useful lives of the related assets, generally ranging from
five to seven years. Repairs and maintenance are charged to expense as
incurred; replacements and betterments are capitalized.
Depreciation expense related to continuing operations totalled $27,541 and
$45,230 for the years ended June 30, 1995 and 1996, respectively and is
included in other general and administrative expense in the accompanying
consolidated statements of operations.
DEFERRED OFFERING COSTS
Deferred offering costs represent costs associated with the Company's
Initial Public Offering ("IPO"). Deferred offering costs will be recorded
as a reduction of proceeds upon completion of the IPO (see Note 15).
REVENUE RECOGNITION
Direct-to-the-customer sales are recognized at the time the products are
shipped, in accordance with the provisions of Statement of Position 91-1,
"SOFTWARE REVENUE RECOGNITION". While the Company has no obligations to
perform future services subsequent to shipment, the Company provides
telephone customer support as an accommodation to purchasers of its
products for a limited time. Costs associated with this effort are expensed
as incurred and charged to cost of sales in the accompanying consolidated
statements of operations.
Through June 30, 1996, the Company recognized revenue, net of distribution
fees, for product shipped to Acclaim on the date that Acclaim purchased
such product and shipped it to their customers. Acclaim is obligated to
pay the Company on the earlier of the month following the date of receipt
of payment by it or 120 days following the end of the month that the
product was shipped. The Company is responsible for product returns
through June 30, 1996, and records a reserve for returns based on
management's evaluation of historical experience and current industry
trends, as discussed above (see Notes 6, 14 and 15).
Continued
F-10
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
For Each Of The Years In The
Two-Year Period Ended June 30, 1996
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
ROYALTIES
The Company enters into license agreements with movie studios, actors and
sound developers for recognizable movie and television properties which
require the Company to pay royalties to such movie studios, actors and
sound developers. The license agreements generally require the Company to
pay a percentage of sales of the products but no less than a specified
amount (the minimum guaranteed royalty). The Company records the minimum
guaranteed royalty as a liability and a related asset at the time the
agreement is consummated. The liability is extinguished as payments are
made to the license holders and the asset is amortized on a straight-line
basis over the expected number of units to be sold. Royalty liabilities
are recognized upon the sale of the related product. Royalty liabilities
in excess of the minimum guaranteed amount are recorded when such amounts
are earned by the license holders. Royalties for the years ended June 30,
1995 and 1996 amounted to $325,981 and $535,065, respectively, and are
included in cost of sales on the accompanying consolidated statements of
operations.
The Company assesses the recoverability of royalty assets by determining
whether the amortization of the minimum guarantee will be recovered through
anticipated sales on a per unit basis. Any amounts not expected to be
recovered are charged to operations in the period assessed by management.
For the years ended June 30, 1995 and 1996, management made such an
assessment and charged $66,559 and $99,798, respectively, to cost of sales
on the accompanying consolidated statements of operations.
SOFTWARE DEVELOPMENT COSTS
In accordance with Statement of Financial Accounting Standards No. 86,
"ACCOUNTING FOR THE COST OF CAPITALIZED SOFTWARE TO BE SOLD, LEASED OR
OTHERWISE MARKETED," ("SFAS No. 86"), the Company examines its software
development costs after technological feasibility has been established to
determine if capitalization is required. Through June 30, 1996, all
software development costs have been expensed.
INCOME TAXES
The Company accounts for income taxes under Statement of Financial
Accounting Standards No. 109, "ACCOUNTING FOR INCOMES TAXES" ("SFAS No.
109"), which requires that deferred income taxes be recognized for the tax
consequences in future years of differences between the tax basis of assets
and liabilities and their financial reporting basis at rates based on
enacted tax laws and statutory tax rates applicable to the periods in which
the differences are expected to affect taxable income.
Valuation allowances are established when necessary to reduce deferred tax
assets to the amount expected to be realized. Current income tax expense
represents the tax payable for the period. The deferred income tax expense
(benefit) represents the change during the period in the balance of
deferred taxes (see Note 13).
STOCK SPLIT
In September, 1995, the Company effectuated a 1-for-5.976 reverse stock
split of issued and outstanding common shares and common shares reserved
for options in connection with the August 1995 private placement (see Note
4). The accompanying consolidated financial statements have been adjusted
to reflect the reverse stock split for all periods presented.
Continued
F-11
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
For Each Of The Years In The
Two-Year Period Ended June 30, 1996
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
NET LOSS PER COMMON SHARE
Net loss per common share is computed by dividing net loss by the weighted
average number of shares of common stock and common stock equivalents
outstanding during the respective period. Common stock equivalents include
shares issuable upon the exercise of the Company's stock options. For the
years ended June 30, 1995 and 1996, common stock equivalents were excluded
from the computation of loss per common share because the effect of
including such in the computation would have been anti-dilutive (see Notes
4, 5, 11 and 15), except as discussed below.
Pursuant to Securities and Exchange Commission Staff Bulletin No. 83,
common shares issued for consideration below an assumed initial public
offering price ($4.00 per share) and stock options granted (see Note 11)
with exercise prices below the IPO price during the twelve-month period
preceding the date of the filing of the Registration Statement have been
included in the calculation of common share equivalents, using the treasury
stock method, as if they were outstanding for all periods presented,
including loss years where the impact is anti-dilutive.
The only securities issued within twelve months of the Registration
Statement which effect the computation of the weighted average common shares
are vested options to purchase 100,000 shares granted at $3.40 per share
(see Note 11).
The computations of the weighted average common shares and equivalents
outstanding follows:
<TABLE>
<CAPTION>
1995 1996
---------- ----------
<S> <C> <C>
Weighted average common shares
outstanding during the period 1,847,908 1,822,759
Incremental shares assumed to be
outstanding related to stock
options granted 15,000 15,000
---------- ----------
Weighted average common shares and
equivalents outstanding 1,862,908 1,837,759
========== ==========
</TABLE>
RECLASSIFICATIONS
Certain reclassifications have been made to the 1995 amounts to conform
with the 1996 presentation.
NOTE 2 - INVENTORIES
Inventories consisted of the following as of June 30, 1996:
<TABLE>
<S> <C>
Finished goods $ 159,151
Raw materials (components) 103,506
----------
$ 262,657
==========
</TABLE>
Continued
F-12
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
For Each Of The Years In The
Two-Year Period Ended June 30, 1996
NOTE 3 - PROPERTY AND EQUIPMENT
Property and equipment consisted of the following as of June 30, 1996:
<TABLE>
<S> <C>
Studio computers and equipment $ 246,107
Office furniture and equipment 60,914
----------
307,021
Less accumulated depreciation (129,954)
----------
$ 177,067
==========
</TABLE>
As of June 30, 1996, the Company had a total cost of $86,723 of assets
under capital leases (see Note 8).
NOTE 4 - NOTES PAYABLE
1995 BRIDGE FINANCING
During June through August 1995, the Company offered up to $700,000 of
Units (the "1995 Bridge Financing"), each consisting of $9,975 in principal
amount of the Company's 10% Secured Promissory Notes (the "Bridge Notes")
and warrants to purchase 586 shares of the Company's common stock (the
"Bridge Warrants"). Pursuant to this offering, the Company sold 32 Units
for net proceeds to the Company of $278,400, net of costs of $41,600.
A total of 18,747 Bridge Warrants were issued in connection therewith.
The dealer/manager received 20,918 Bridge Warrants for $50 as partial
consideration for services in connection with this offering. Upon completion
of the IPO the Bridge Warrants were automatically converted into Redeemable
Warrants (see Note 15).
The principal and accrued interest on the Bridge Notes was due and payable
in full on August 15, 1995. The Company did not repay the Bridge Notes
upon their maturity. During the pendency of any such default, the Bridge
Note holders were entitled to receive a penalty of two percent per month in
addition to the interest otherwise payable on the Bridge Notes. These
notes, plus accrued interest, were repaid in full during September 1995 in
connection with the 1995 Private Placement, discussed below.
1995 PRIVATE PLACEMENT
In August 1995, the Company engaged two dealer/managers to assist in a
private placement (the "1995 Private Placement") to sell a minimum of
$1,000,000 of Units to a maximum of $5,000,000 of Units, each consisting of
$95,000 in principal amount of the Company's 10% Secured Promissory Notes
(the "Private Notes") due on the earlier of September 1, 1996 or the
completion by the Company of an IPO, and 100,000 warrants (the "Private
Warrants") to purchase one share of the Company's common stock. A total of
5,250,000 Private Warrants were issued in connection therewith (see below).
As of June 30, 1996, the Company had sold 52.5 units for net
proceeds of $4,256,400, of which $262,500 represents the Private Warrants,
net of costs of $993,600. Included in accrued interest on the accompanying
consolidated balance sheet as of June 30, 1996 is accrued interest of
$364,188 related to this private placement. In connection with this
offering, the Company issued 400,000 Private Warrants as partial
consideration for services provided by a dealer/manager (see below).
The obligations of the Company under the Private Notes were secured by a
security interest in all the assets of the Company, including a pledge of
all of the issued and outstanding capital stock of its Subsidiary. A
portion of the net proceeds of this private placement were utilized to
retire all of the outstanding indebtedness of the 1995 Bridge Financing,
discussed above. The Private Notes plus accrued interest, were repaid in full
during July 1996 in connection with the Company's IPO (see Note 15).
Continued
F-13
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
For Each Of The Years In The
Two-Year Period Ended June 30, 1996
NOTE 4 - NOTES PAYABLE, CONTINUED
Upon completion of the IPO, the Private Warrants were converted into Redeemable
Warrants (see Note 15).
NOTE 5 - RELATED PARTY TRANSACTIONS
PRIOR NOTES PAYABLE
During the year ended June 30, 1995, the Company repaid a note due to a
stockholder amounting to $19,587. The Company also repaid a $22,000 note
in 1995 due to an affiliate of a stockholder through issuance of shares.
During 1996, the Company repaid $13,500 of short-term non-interest bearing
advances to certain officers of the Company.
NOTE PAYABLE TO RELATED PARTY
On May 30, 1996, ASSI, Inc., a shareholder, loaned the Company $500,000
(the "ASSI Convertible Loan"). The ASSI Convertible Loan bore interest at
8% per annum and principal and accrued interest was due on the earlier of
September 1, 1996 or the completion of the Company's IPO. Upon the closing
of the Company's IPO, ASSI, Inc. had the option to convert all or part of
the ASSI Convertible Loan plus accrued interest into warrants to purchase
common stock at a conversion price of $.25 per warrant (the "ASSI Loan
Warrants").
On July 7, 1996, in connection with the Company's IPO, ASSI, Inc. exercised
the conversion option to convert this note, plus accrued interest, into
warrants to purchase common stock at the conversion price of $.25 per
warrant. The ASSI Loan Warrants have the same terms as the Redeemable
Warrants except as discussed below (see Note 15).
ASSI WARRANTS
On April 30, 1996, in consideration of certain financial and personnel
consulting service provided to the Company in 1996, including advising the
Company regarding capital raising alternatives and executive recruiting,
the Company has entered into an agreement to issue to ASSI, Inc. warrants
to purchase 2,000,000 shares of common stock at an exercise price of $4.40
per share (the "ASSI Warrants"). The terms of the ASSI Warrants and the ASSI
Loan Warrants are identical to those of the Redeemable Warrants issued in
connection with the IPO (see Note 15), except that they will become
exercisable October 1, 1996, they will not be mandatorily redeemable by the
Company and they will be subject to separate registration rights, including
one demand registration right and unlimited piggyback registration rights for
as long as they are held by ASSI, Inc. or one of its affiliates. Upon a
transfer of the ASSI Warrants or ASSI Loan Warrants to any nonaffiliate of
ASSI, Inc., the terms of such transferred ASSI Warrants and ASSI Loan
Warrants will become identical to those of the Redeemable Warrants. The
demand registration rights will expire on August 31, 2001. Until and unless
exercised, the holders of the ASSI Warrants and ASSI Loan Warrants will have
no voting, dividend or other rights as shareholders of the Company.
NOTE 6 - SHORT-TERM ADVANCE
In June 1995, the Company entered into a five-year sales and distribution
agreement (the "Agreement") with a subsidiary of Acclaim, a distributor of
entertainment software. Under the terms of the Agreement, Acclaim was
responsible for the distribution of the Company's products on a world-wide
basis to retail accounts. The Company retained the rights to certain
direct distribution, such as direct mail and infomercials.
Continued
F-14
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
For Each Of The Years In The
Two-Year Period Ended June 30, 1996
NOTE 6 - SHORT-TERM ADVANCE, CONTINUED
In conjunction with the signing of the Agreement, the Company received a
non-interest bearing advance from Acclaim in the amount of $400,000. The
advance was due in twelve monthly installments of $33,333 each, commencing
no later than 90 days subsequent to first billing by the Company. The
installments were to be deducted from amounts due the Company from Acclaim
related to product sales.
Effective April 1, 1996, such Agreement was terminated. In connection
therewith, the advance was deducted from the final amounts due the Company,
as reported by Acclaim (see Notes 14 and 15).
NOTE 7 - DEFERRED REVENUE
In August 1994, the Company entered into a contract to develop computer
software for Fox Interactive, a division of Fox, Inc. In exchange, the
Company received nonrefundable advances based upon the attainment of
certain milestones. The Company recognizes these advances into revenues
based upon the percentage of completion method. As of June 30, 1996, the
Company had received $24,000 of advances in excess of earnings and has
therefore recorded such amount as deferred revenue in the accompanying
consolidated balance sheet.
The Company has entered into various agreements with computer manufacturers
to sell and distribute certain of the Company's products. In exchange, the
Company receives royalties and advances against expected royalties. As of
June 30, 1996, the Company received $48,360 of advances in excess of
royalties earned. As of June 30, 1996, the Company received $12,000 of
advance royalties in connection with the licensing of the music division
(see Note 12). Accordingly, the Company has recorded such amounts as
deferred revenues on the accompanying June 30, 1996 consolidated balance
sheet.
NOTE 8 - COMMITMENTS AND CONTINGENCIES
EMPLOYMENT CONTRACTS
The Company has entered into employment contracts with five of its
employees, including three officers, which expire on various dates through
September 1998 and provide for certain expense allowances.
In April 1996, effective March 31, 1996, the Company modified the
employment contracts of two officers. Such modifications reduced the
annual base compensation by a specified amount. Upon the Company achieving
specified sales levels, the annual base compensation is increased by the
amount of the specified reduction. The Company also modified the
employment contract of a third officer in March 1996 to change the number
and vesting period of options previously granted and to grant additional
options (see Note 11).
Future minimum base salaries, by year and in the aggregate, after giving
effect to the modification of two of the contracts, consist of the
following as of June 30, 1996:
<TABLE>
<CAPTION>
Years Ending
June 30,
-----------
<S> <C>
1997 $ 508,625
1998 332,083
1999 62,500
----------
$ 903,208
==========
</TABLE>
Continued
F-15
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
For Each Of The Years In The
Two-Year Period Ended June 30, 1996
NOTE 8 - COMMITMENTS AND CONTINGENCIES, CONTINUED
Certain of the employment contracts provided for commissions based on net
revenues. Commissions under employment contracts for the years ended June
30, 1995 and 1996, related to continuing operations amounted to $132,078
and $66,067, respectively, and are included in marketing and sales costs in
the accompanying consolidated statements of operations. As of June 30,
1996, all such amounts have been paid. Effective November 1995,
commissions are no longer paid under any of the employment contracts.
OPERATING LEASES
The Company leases its facilities and certain equipment under noncancelable
operating leases which expire at various dates through February 1997.
The facility lease expense is being recognized on a straight-line basis
over the term of the related lease. The excess of the expense recognized
over the cost paid is included in accounts payable and accrued expenses in
the accompanying consolidated balance sheet.
Future minimum lease payments as of June 30, 1996, due through June 30,
1997 under such leases total $56,273.
Rent expense under operating lease agreements totalled $94,006 and $89,192
for the years ended June 30, 1995 and 1996, respectively, and is included
in other general and administrative expenses on the accompanying
consolidated statements of operations.
CAPITAL LEASES
The Company leases certain equipment and computers under capital lease
obligations with interest rates ranging from 14.19% to 35.08% per annum.
Aggregate monthly principal and interest payments total $3,306 as of June
30, 1996.
Future minimum lease payments, by year and in the aggregate, under capital
leases for equipment and computers with initial or remaining terms of one
year or more, consist of the following as of June 30, 1996:
<TABLE>
<CAPTION>
YEARS ENDING
JUNE 30,
------------
<S> <C>
1997 $ 31,438
1998 14,068
1999 4,196
----------
49,702
Less amount representing interest (8,833)
----------
Present value of net minimum lease
payments 40,869
Less current portion (27,058)
----------
$ 13,811
==========
</TABLE>
Interest expense under capital lease obligations amounted to $7,045 and
$10,500 for the years ended June 30, 1995 and 1996, respectively.
Continued
F-16
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
For Each Of The Years In The
Two-Year Period Ended June 30, 1996
NOTE 8 - COMMITMENTS AND CONTINGENCIES, CONTINUED
CONSULTING AGREEMENT
On October 16, 1995, the Company entered into a one year binding letter of
intent with a consultant whereby for consulting services the Company would
pay a minimum $39,000 per year plus royalties up to 3%, as defined, on
products as specified. Through June 30, 1996, the Company paid a total of
$73,340 under this agreement. During the year ended June 30, 1996, $39,581
is included in marketing and sales expense and $33,759 is included in cost
of sales on the accompanying consolidated statements of operations.
DEVELOPMENT CONTRACTS
Periodically, the Company enters into certain agreements with software
developers whereby for specified development services, the Company will pay
a fixed fee and/or a percentage of sales of the product developed. As of
June 30, 1996, the Company was party to two such contracts. No amounts
were paid under such agreements during the year ended June 30, 1995. For
the year ended June 30, 1996, the Company paid a total of $146,416 under
such agreements. Of such amounts, $113,125 is included in research and
development and $33,291 is included in cost of sales in the accompanying
consolidated statements of operations.
LITIGATION
In July 1995, a stockholder of the Company filed a complaint in the United
States District Court for the District of Washington, naming, among others,
the Company and its subsidiary, and Bentley Richards Investments (the
"Placement Agent") claiming federal and state securities violations, breach
of contract, and negligent misrepresentation related to the 1994 Private
Placement (see Note 9). The complaint sought rescission of all monies paid
to the Company and unspecified amounts of punitive damages, attorney's fees
and costs, prejudgment and postjudgment interest and cost of suit.
In September 1995, the stockholder entered into a settlement agreement
whereby the stockholder dismissed all defendants, including the Company and
its subsidiary, upon delivery of certain shares of the Company's common
stock owned by the Placement Agent and its affiliates. A portion of these
shares have been distributed to the 1994 Private Placement holders and the
balance has been canceled (see Note 9). Pursuant to the settlement, the
Placement Agent's options also were canceled. The Company was not required
to pay any consideration as a part of the settlement. The Company has been
dismissed with prejudice from the complaint.
In August 1996, the Company and certain officers were named in a suit filed
by a former officer of the Company with the Superior Court of California,
East County District. The former officer alleges breach of an employment
contract and is seeking monetary restitution and punitive damages in an
unspecified amount. Management of the Company believes such claim has no
merit. No provision for loss has been made to the accompanying consolidated
financial statements for any loss which may arise from the result of this
matter.
Continued
F-17
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
For Each Of The Years In The
Two-Year Period Ended June 30, 1996
NOTE 9 - COMMON STOCK
During the fiscal year 1994, the Company engaged an agent (the "Placement
Agent") to sell a private placement of up to 125,502 shares of its common
stock at $13.00 per share (the "1994 Private Placement"). Through June 30,
1994, the Company issued 55,639 shares of its common stock for $665,000 in
cash, net of offering costs of $58,312.
During the fiscal year 1995, the Company issued an additional 59,238 shares
of its common stock in exchange for $706,107 in cash, net of costs of
$61,759.
In accordance with the terms of the 1994 Private Placement, the Company
agreed to compensate the Placement Agent with up to 81,997 shares of its
common stock and an option to purchase up to 60,241 shares of its common
stock at a price equal to the closing bid price of the common stock on the
first day of trading following the stock-for-stock exchange (see Note 1).
For the years ended June 30, 1994 and 1995, the Placement Agent earned
39,770 and 42,227 shares valued at $475,315 and $504,686, respectively.
During September 1995, the Placement Agent notified the Company that all
shares held by the Placement Agent or its affiliates, or held in escrow for
the benefit of the Placement Agent or its affiliates, representing and
aggregate of 108,769 shares of the Company's common stock, will be
distributed to the holders of the 1994 Private Placement shares. In
addition, 15,120 shares were returned to the Company for retirement (see
Note 8).
CANCELLATION OF SHARES
In fiscal 1996, it has been determined by the Company that 36,238 shares of
common stock were improperly issued in 1992 due to the fact no
consideration was received. Accordingly, such common shares were canceled
effective June 30, 1996.
STOCKHOLDER PRIVATE PLACEMENT
Concurrent with the 1995 Private Placement (see Note 4), the Company's major
stockholder conducted a private placement of up to 200,000 shares of common
stock, held by such stockholder, at a purchase price of $5.00 per share.
Through June 30, 1996, the stockholder had sold 107,500 shares of common
stock. On July 1, 1996 in connection with the Company's IPO, such shares of
common stock purchased in this private placement were registered with the
Securities and Exchange Commission (see Note 15).
NOTE 10 - SERIES A PREFERRED STOCK
In connection with the Company's reverse acquisition of BSA (see Note 1) on
May 16, 1994, the Company issued to its major stockholder 1,000,000 shares
of Series A preferred stock, par value of $.001. The Series A preferred
stockholder was entitled to vote as a single class with the holders of the
Company's common stock on all matters coming before the Company's
stockholders for a vote. The holder of the Series A preferred stock was
entitled to ten votes per share whereas the holders of common stock are
entitled to only one vote per share. The holder was entitled to a
liquidation preference of $.001 per share, provided the holder would not
share any liquidating distribution except to the extent of such preference.
The Company did not ascribe any value to the preferred shares.
Continued
F-18
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
For Each Of The Years In The
Two-Year Period Ended June 30, 1996
NOTE 10 - SERIES A PREFERRED STOCK, CONTINUED
Prior to June 30, 1994, the 1,000,000 shares of Series A preferred stock
were converted into 83,669 shares of the Company's common stock with an
ascribed value of $645,000.
In fiscal 1996, the Company amended its articles of incorporation and
deleted the authorization to issue Series A preferred stock.
NOTE 11 - STOCK OPTIONS
THE 1992 STOCK OPTION PLAN
The Company adopted the 1992 Stock Option Plan (the "1992 Plan") in May,
1992, authorizing the issuance of up to 2,000,000 shares of common stock to
employees, officers and directors and to employees of companies who do
business with the Company.
Any shares which are subject to an award but are not used because the terms
and conditions of the award are not met, or any shares which are used by
participants to pay all or part of the purchase price of any option may
again be used for awards under the Plan. However, shares with respect to
which a stock appreciation right (see below) has been exercised may not
again be made subject to an award.
At the discretion of a committee comprised of directors, officers and key
employees of the Company and its subsidiaries or employees of companies
with which the Company does business may become participants in the Plan
upon receiving grants in the form of stock options or restricted stock.
Stock options may be granted as non-qualified stock options or incentive
stock options, upon stockholder approval as defined, but incentive stock
options may not be granted at a price less than 100% of the fair market
value of the stock as of the date of grant (110% as to any 10% stockholder
at the time of grant); non-qualified stock options may not be granted at a
price not less than 85% of fair market value of the stock as of the date of
grant. Restricted stock may not be granted under the Plan in connection
with incentive stock options.
Stock options granted under the 1992 Plan may include the right to acquire
an Accelerated Ownership Non-Qualified Stock Option ("AO"). All options
granted to date have included the AO feature. If an option grant contains
the AO feature and if a participant pays all or part of the purchase price
of the option with shares of the Company's common stock, then upon exercise
of the option the participant is granted an AO to purchase, at the fair
market value as of the date of the AO grant, the number of shares of common
stock of the Company equal to the sum of the number of whole shares used by
the participant in payment of the purchase price and the number of whole
shares, if any, withheld by the Company as payment for withholding taxes.
An AO may be exercised between the date of grant and the date of
expiration, which will be the same as the date of expiration of the option
to which the AO is related.
Stock appreciation rights and/or restricted stock may be granted in
conjunction with, or may be unrelated to stock options. A stock
appreciation right entitles a participant to receive a payment, in cash or
common stock or a combination thereof, in an amount equal to the excess of
fair market value of the stock at the time of exercise over the fair market
value of the date of grant. Stock appreciation rights may be exercised
during a period of time fixed by the Committee.
Continued
F-19
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
For Each Of The Years In The
Two-Year Period Ended June 30, 1996
NOTE 11 - STOCK OPTIONS, CONTINUED
Restricted stock requires the recipient to continue in service as an
officer, director, employee or consultant for a fixed period of time for
ownership of the shares to vest. If restricted shares or stock
appreciation rights are issued in tandem with options, the restricted stock
or stock appreciation right is canceled upon exercise of the option and the
option will likewise terminate upon vesting of the restricted shares.
On April 6, 1994, the Company issued a non-qualified stock option outside
of the Plan to an officer of the Company to purchase an aggregate of
251,004 shares of the Company's common stock for $.06 per share and
subsequently in fiscal 1994 an option was granted to the officer to
purchase 41,834 shares of the Company's common stock for $.06 per share.
All stock options issued to the officer were immediately vested and are
exercisable for a period of up to four years after termination of
employment from the Company. During the year ended June 30, 1995, a
portion of the difference between the fair market value of the common stock
underlying the options at the date of grant and the exercise price was
included in operating costs and expenses in the accompanying consolidated
statement of operations.
On April 6, 1994, the Company issued options to purchase 199,130 shares of
the Company's common stock at $.06 per share to employees of the Company
and to certain consultants. During the year ended June 30, 1995, a portion
of the difference between the fair market value of the common stock
underlying the options at the date of grant and the exercise price was
included in operating costs and expenses in the accompanying consolidated
statement of operations. These options had an original vesting period of
four years. In September 1995, the Company modified the vesting period to
50% vested on the first year anniversary from the date of grant, 25% on the
third year anniversary and 25% on the fourth year anniversary from the date
of grant.
For the year ended June 30, 1995, an aggregate of $733,165 was charged to
operating costs and expenses for the options vested during the year, as
discussed in the preceding two paragraphs.
On September 5, 1995, in connection with the resignation of an officer of the
Company, 12,550 options were canceled in accordance with the 1992 Plan and
the officer's employment contract. In connection with the resignation of
such officer, 4,184 options were exercised effective June 30, 1995.
On October 9, 1995, the Company granted 100,000 options to an
employee/officer with an exercise price of $5.00, the fair market value of
the common stock as determined by the Company. The options vested
immediately and expire 10 years from the date of grant. On March 31, 1996,
the employee/officer agreed to the termination of his existing 100,000
share option in consideration for the Company's agreement to grant to him a
new 200,000 share option pursuant to the 1992 Plan. Such
option will be vested and exercisable upon the date of its grant as to
100,000 shares at a purchase price of $3.40 per share, and will become
vested and exercisable as to 100,000 shares ratably between June 30, 1996
and September 30, 1997 at a purchase price of $4.00 per share. The
employee/officer's employment agreement further provides that following the
voluntary or involuntary termination of his employment by the Company, the
employee/officer is entitled to a single demand registration right with
respect to the common stock held by or issuable to him pursuant to his
option agreement.
On September 22, 1995, the Board of Directors resolved that no additional
shares shall be issued under the 1992 Plan, with the exception of the
options discussed in the preceding paragraph.
Continued
F-20
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
For Each Of The Years In The
Two-Year Period Ended June 30, 1996
NOTE 11 - STOCK OPTIONS, CONTINUED
THE 1995 STOCK OPTION PLAN
On October 9, 1995, the Company adopted the 1995 stock option plan (the
"1995 Plan") effective November 1, 1995. On May 15, 1996, the Company
adopted the Company's restated 1995 stock option plan whereby the Company
can grant up to 500,000 options for shares of the Company's common stock.
Options under the 1995 Plan may be granted in the form of incentive stock
options as provided in section 422 of the Internal Revenue Code, as
amended, or in the form of non-qualified stock options (the "Options").
The 1995 Plan terminates October 31, 2005 and shall be administered by a
committee appointed by the Board of Directors of the Company.
Incentive stock options shall be limited to persons who are employees of
the Company and may not be granted at a price less than 100% of the fair
value of the stock as of the date of grant (110% as to any 10% stockholder
at the time of grant).
The term of each Option shall not be more than 10 years from the date of
grant (5 years for any 10% stockholder). Vesting of the Options is
determinable by the Committee on a case-by-case basis and the Options are
not exercisable unless the holder is currently employed with the Company.
Upon termination of an employee, the holder has 30 days to exercise any
Options held.
On July 2, 1996, the Company granted options to purchase 13,610 shares of
the Company's common stock at $4.00 per share to employees of the Company
(see Note 15).
The following table summarizes option transactions during the years ended
June 30, 1995 and 1996 under both of the aforementioned plans:
<TABLE>
<CAPTION>
NUMBER PRICE
OF SHARES PER SHARE
--------- ------------
<S> <C> <C>
Balances at July 1, 1994 491,968 $0.06
Granted -- --
Exercised (4,184) $0.06
Canceled (12,550) $0.06
---------- -----------
Balances at June 30, 1995 475,234 $0.06
Granted 300,000 $3.40-$5.00
Exercised -- --
Canceled (100,000) $5.00
---------- -----------
Balances at June 30, 1996 675,234 $0.06-$4.00
========== ===========
Vested as of June 30, 1996 500,703
==========
</TABLE>
The Financial Accounting Standards Board has issued Statement of Financial
Accounting Standards No. 123, "ACCOUNTING FOR STOCK BASED COMPENSATION"
("Statement No. 123"). Statement No. 123 is primarily a disclosure
standard for the Company because the Company will continue to account for
employee stock options under Accounting Principles Board Opinion No. 25.
The disclosure requirements for the Company required by Statement No. 123
will be effective for financial statements issued after fiscal year 1996.
Continued
F-21
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
For Each Of The Years In The
Two-Year Period Ended June 30, 1996
NOTE 12 - DISCONTINUED OPERATIONS
In July 1995, the Company approved a formal plan to license certain
proprietary assets to Greytsounds Sound Development ("GSD") in exchange for
royalties, as defined. Effective November 1, 1995 (commencement of a
license agreement with GSD), $15,000 was paid to the Company representing
advance royalties. As of June 30, 1996, $12,000 of such advance royalties
are included in deferred revenue on the accompanying consolidated balance
sheet. GSD also is to guarantee $50,000 of royalties over the license term
of two years. The license agreement is exclusive and worldwide.
The proprietary assets licensed to GSD include the Company's musical
instrument sound library, all music related inventory and all music related
fixed assets owned and leased by the Company.
As of June 30, 1996 no assets or liabilities of the music division are
included in the accompanying consolidated balance sheet.
The following summarizes the results of operations for the discontinued
operations for the year ended June 30, 1995:
<TABLE>
<S> <C>
Revenues $ 220,937
Costs and expenses (332,043)
---------
Loss from operations $ (111,106)
=========
</TABLE>
NOTE 13 - INCOME TAXES
The provision for income taxes from continuing operations for the years
ended June 30, 1995 and 1996 is comprised of minimum state taxes only.
A reconciliation of the provision for income taxes from continuing
operations with expected income tax benefit computed by applying the
federal statutory income tax rate to loss before provision for income taxes
for the years ended June 30, 1995 and 1996 is as follows:
<TABLE>
<CAPTION>
1995 1996
$ % $ %
--------- ----- ---------- -----
<S> <C> <C> <C> <C>
Income tax benefit computed at
Federal statutory tax rate $(513,486) (34.0)% $(1,520,948) (34.0)%
State and local taxes 1,600 - 1,600 -
Expenses not deductible for
income tax purposes 252,173 15.9 3,774 -
Change in the beginning-of-the-
period balance of the valuation
allowance for deferred tax
assets allocated to income tax
benefit 261,313 18.1 1,517,174 34.0
-------- ----- ---------- -----
$ 1,600 - % $ 1,600 - %
======== ===== ========== =====
</TABLE>
Continued
F-22
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
For Each Of The Years In The
Two-Year Period Ended June 30, 1996
NOTE 13 - INCOME TAXES, CONTINUED
The components of the net deferred tax asset recorded in the accompanying
balance sheet as of June 30, 1996 is as follows:
<TABLE>
<S> <C>
Reserves, principally due to allowances for
sales returns and obsolete inventory $ 363,213
Accrued liabilities, principally due to accrual for
financial reporting purposes 1,811,583
Net operating loss carryforwards 2,129,913
Less valuation allowance (4,304,709)
----------
$ ---
==========
</TABLE>
The valuation allowance increased $1,456,540 during the
year ended June 30, 1996.
At June 30, 1996, the Company had federal and state net operating loss
carryforwards of approximately $5,742,000 and $2,864,000, respectively,
available to offset future taxable federal and state income. The
federal and state carryforwards amounts expire in varying amounts
through 2012 and 2001, respectively.
Due to the change in ownership provisions of the Tax Reform Act of 1986,
net operating loss carryforwards for federal income tax reporting
purposes are subject to annual limitations. Should a change of
ownership occur, net operating loss carryforwards may be limited as to
use in future years.
NOTE 14 - DISTRIBUTION AGREEMENTS
ACCLAIM TERMINATION AGREEMENT
Effective April 1, 1996, the Company and Acclaim entered into an
agreement to terminate the distribution agreement (the "Termination
Agreement"). On or before June 30, 1996, Acclaim was to render a final
accounting to the Company together with payment of the balances of any
amounts due to the Company under the distribution agreement. The final
accounting was not received by June 30, 1995 (see Note 15). Pursuant to
the terms of the Termination Agreement, Acclaim was obligated to notify
its accounts that it will not accept returns of any of the Company's
software products after June 30, 1996.
SIMON & SCHUSTER DISTRIBUTION AGREEMENT
On June 1, 1996, the Company entered into a two year distribution services
agreement with Simon & Schuster Interactive Distribution Services ("SSIDS"),
which became effective July 1, 1996. SSIDS is the consumer software
distribution unit of Simon & Schuster, Inc., the publishing operations of
Viacom, Inc. Pursuant to this new distribution agreement, SSIDS will provide
distribution, warehousing and order fulfillment services for all of the
Company's products (subject to certain exceptions) throughout the United
States and Canada. The Company's relationship with SSIDS will be exclusive
except as regards the rights to distribute the Company's products in
direct-to-the-customer programs including direct mail, telemarketing and
in-box coupon fulfillment, which will be nonexclusive.
Continued
F-23
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
For Each Of The Years In The
Two-Year Period Ended June 30, 1996
NOTE 14 - DISTRIBUTION AGREEMENTS, CONTINUED
The Company will recognize revenue, net of distribution fees, for
product shipped to SSIDS on the date that SSIDS purchases such product
and ships it to their customers. Pursuant to the agreement, SSIDS will
make a monthly payment to the Company in the amount equal to its gross
revenues, as defined, during such month from the Company's products, less a
distribution fee and reserve for returns equal to stated percentages of
the gross revenues and less certain other items, including out-of-pocket
costs associated with inventory maintenance and order fulfillment. The
payments will be due not later than 75 days after the calendar month in
question. Under the agreement with SSIDS, SSIDS will be responsible for
collection of accounts receivable and the Company will remain
liable for product returns. The Company intends to maintain a reserve
of 15 percent of gross revenues for product returns.
The Company may experience a loss of sales momentum as a result of the
transition from utilizing Acclaim to SSIDS as its exclusive distributor.
NOTE 15 - SUBSEQUENT EVENTS
INITIAL PUBLIC OFFERING ("IPO")
On July 1, 1996, the Company issued 2,400,000 shares of common stock at
$4.00 per share and 1,200,000 redeemable warrants (the "Redeemable
Warrants") at $.25 per warrant. Net proceeds totalled $7,973,305, net
of offering costs of $1,926,695. On August 14, 1996, the underwriters
exercised a portion of their "over-allotment" option, pursuant to the
underwriting agreement, which resulted in the Company issuing an
additional 160,000 shares of common stock at $4.00 per share and 171,775
redeemable warrants at $.25 per warrant. Net proceeds totalled $594,161,
net of offering costs of $88,783.
Through June 30, 1996, in connection with the IPO, the Company has
incurred offering costs totalling $620,904. Such costs have been
capitalized on the accompanying consolidated balance sheet as of June
30, 1996 and will be offset against the aforementioned proceeds in
fiscal 1997.
Each Redeemable Warrant entitles the holder to purchase one share of
Common Stock at $4.40 per share, subject to adjustment as defined,
expiring December 31, 2001. In the event that the Redeemable Warrants
are called for redemption, they will be exercisable for 30 days
preceding the applicable redemption date. Commencing one year after
July 1, 1996, the Redeemable Warrants will be subject to redemption at
$.25 per Redeemable Warrant if the average closing bid price of the
common stock equals or exceeds $5.60 per share for any 20 trading days
within a period of 30 consecutive trading days ending on the fifth
trading day prior to the date of the notice of redemption.
In connection with the registration of the shares of common stock and
Redeemable Warrants discussed above, the Company registered 107,500
shares of common stock registered for the account of certain selling
stockholders (see Note 9).
The Company has also, in connection with the IPO, given the underwriter
a warrant, for $50, which entitles the underwriter to purchase 240,000
shares of common stock at $5.80 per share.
On July 7, 1996, in connection with the IPO, the Company repaid notes
payable issued with the 1995 Private Placement (see Note 4) aggregating
$4,987,500 plus accrued interest of $373,753.
On July 7, 1996, in connection with the IPO, the Company issued
2,016,657 redeemable warrants in connection with the conversion of the
note payable to related party (see Note 5) of $500,000, plus accrued
interest of $4,164.
Continued
F-24
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
For Each Of The Years In The
Two-Year Period Ended June 30, 1996
NOTE 15 - SUBSEQUENT EVENTS, CONTINUED
The following pro forma condensed consolidated balance sheet as of June 30,
1996 gives effect to the Company's IPO, as discussed above, the repayment of
notes payable and related accrued interest (see Note 4) and the conversion of
the note payable to related party (see Note 5).
<TABLE>
<CAPTION>
HISTORICAL PRO FORMA
AS OF AS OF
ASSETS JUNE 30, 1996 ADJUSTMENTS JUNE 30, 1996
- ------ ------------- ----------- -------------
<S> <C> <C> <C>
Cash and cash equivalents $ 181,985 $ 3,833,175 $4,015,160
Accounts receivable, net 912,904 912,904
Inventories, net 262,657 262,657
Prepaid royalties 628,676 628,676
Deferred offering costs 620,904 (620,904) --
Prepaid expenses and other 15,864 15,864
-------------- ----------- -------------
Total current assets 2,622,990 3,212,271 5,835,261
Property and equipment,
net 177,067 177,067
Other 12,900 12,900
-------------- ----------- -------------
$ 2,812,957 $ 3,212,271 $6,025,228
============== =========== =============
LIABILITIES AND HISTORICAL PRO FORMA
STOCKHOLDERS' EQUITY AS OF AS OF
(DEFICIT) JUNE 30, 1996 ADJUSTMENTS JUNE 30, 1996
- -------------------- ------------- ----------- -------------
<S> <C> <C> <C>
Notes payable $ 4,987,500 $(4,987,500) $ --
Accrued interest 367,695 (367,695) --
Accounts payable and
accrued expenses 664,936 664,936
Accrued legal fees 347,710 347,710
Note payable to related
party 500,000 (500,000) --
Accrued royalties 542,804 542,804
Short-term advance 400,000 400,000
Other current
liabilities 186,319 186,319
-------------- ----------- -------------
Total current
liabilities 7,996,964 (5,855,195) 2,141,769
-------------- ----------- -------------
Capital lease obligation,
net of current portion 13,811 13,811
-------------- ----------- -------------
Total liabilities 8,010,775 (5,855,195) 2,155,580
-------------- ----------- -------------
Total stockholders'
equity (deficit) (5,197,818) 9,067,466 3,869,648
-------------- ----------- -------------
$ 2,812,957 $ 3,212,271 $6,025,228
============== =========== =============
</TABLE>
Continued
F-25
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
For Each Of The Years In The
Two-Year Period Ended June 30, 1996
NOTE 15 - SUBSEQUENT EVENTS, CONTINUED
OPTIONS
On July 2, 1996, the Company agreed to grant 13,610 options under the
1995 stock option plan to non-executive employees at an exercise price
of $4.00 per share. The options vested 25% upon the date of grant and
will vest 25% on June 30, 1997 and 1998, respectively. The options
expire 10 years from date of grant (see Note 11).
ACCLAIM TERMINATION AGREEMENT
In July 1996, Acclaim submitted certain information to the Company
together with payment of $256,067, and a promissory note with a
principal amount of $256,067, maturing August 26, 1996 and bearing
interest at 10% per annum. Such represented the balances of all amounts
due to the Company under the distribution agreement, as determined by
Acclaim. Included in the information provided by Acclaim it was noted
that the Company is not obligated to repay the short-term advance
totaling $400,000 (see Note 6).
On August 28, 1996, the Company received $256,067 plus accrued interest
of $2,175 pursuant to the terms of the promissory note discussed above.
As of June 30, 1996, the Company has recorded an additional $703,421 in
accounts receivable from Acclaim, which has been fully reserved for (see
Note 1), due to disputes and discrepancies in the information as
reported by Acclaim.
F-26
<PAGE>
CORPORATE INFORMATION
DIRECTORS STOCK LISTINGS
Vincent J. Bitetti The Company's common stock and
Chairman of the Board and redeemable warrants are traded on the
Chief Executive Officer NASDAQ SmallCap Market under the
Sound Source Interactive, Inc. symbols SSII and SSIIW, respectively.
Ulrich E. Gottschling
Chief Financial Officer, REGISTRAR AND TRANSFER AGENT
Treasurer and Secretary
Sound Source Interactive, Inc. Corporate Stock Transfer, Inc.
370 17th Street, Suite 2250
Ronald W. Hart Denver, Colorado 30202-4614
Independent Consultant
Mark A. James ANNUAL MEETING
Partner, James, Driggs & Walsh and
Member, Nevada State Senate The 1996 Annual Meeting of
Stockholders will be held on December 9,
Ernest T. Klinger 1996 at 10:00 a.m. local time, at the
Chief Financial Officer, Century Plaza Hotel, 2025 Avenue of the
Arden Group, Inc. Stars, Los Angeles, California.
OFFICERS STOCKHOLDER INQUIRIES; STOCKHOLDERS
REPORT
Vincent J. Bitetti
Chairman of the Board and Additional copies of this Annual
Chief Executive Officer Report and Form 10-KSB filed with the
Securities and Exchange Commission
Ulrich E. Gottschling (excluding exhibits) can be obtained
Chief Financial Officer without charge by writing to or calling:
Secretary and Treasurer
Donna Sava
Sound Source Interactive, Inc.
INDEPENDENT ACCOUNTANTS 2985 East Hillcrest Drive
Suite A
Corbin & Wertz Westlake Village, California 91362
Irvine, California (805) 494-9996
COUNSEL
McDermott, Will & Emery
Washington, D.C.
