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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.
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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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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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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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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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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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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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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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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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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.]
-19-
<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
-20-
<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.]
-21-
<PAGE>
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.
-22-
<PAGE>
(b) Reports on Form 8-K.
None.
-23-
<PAGE>
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>
Exhibit 10.5
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
<PAGE>
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.
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
-2-
<PAGE>
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.
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)
-3-
<PAGE>
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.
-4-
<PAGE>
(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.
-5-
<PAGE>
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 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
-6-
<PAGE>
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 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
-7-
<PAGE>
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
-8-
<PAGE>
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 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.
-9-
<PAGE>
(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.
(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
-10-
<PAGE>
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 NON-EMPLOYEE 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 shall be
Non-Qualified Options, shall have a term of ten years from the date of grant,
shall be fully vested and exercisable on their date of grant and shall have
an exercise price equal to 100% of the Fair Market Value of the Common Stock
on the date of grant.
<PAGE>
[FOX LOGO] P.O. Box 900
Beverly Hills, California 90213-0900
Phone 310 369 1000 - Fax 310 369 4241
MERCHANDISING LICENSE AGREEMENT
No. 6033
Agreement dated as of March 27, 1996, between Twentieth Century Fox Licensing
and Merchandising, a unit of Fox Inc. ("Fox"), as Administrator for Twentieth
Century Fox Film Corporation ("Trademark Licensor"), and Sound Source
Interactive, a California corporation ("Licensee").
SCHEDULE
A. "PROPRIETARY SUBJECT MATTER": The "Proprietary Subject Matter" shall
consist of: (1) artwork depicting one or more of the characters and other
distinctive creative elements appearing in the theatrical motion picture
entitled "THE ABYSS" (the "Property"); (2) the title logo of the Property
("Trademark"); and (3) video and audio footage from the Property, subject to
the provisions of Section K.1. below.
B. "LICENSED ARTICLES": The "Licensed Articles" shall consist of a CD-ROM
"puzzle" video game utilizing the Proprietary Subject Matter currently
entitled "Return to The Abyss" (i.e., a 3-D rendered adventure/exploratory
video game with original storyline involving the use of strategies with
escalating levels of gameplay, to be designed and marketed as a "sequel" in
game form to the Proprietary Subject Matter) for the MAC/PC format/platform;
provided, however, that if Licensee achieves sales in such format in excess
of 100,000 units within the first year of the Term following the Latest
Commencement Date, then the Licensed Articles shall be developed for Sony
Playstation and Sega Saturn formats/platforms.
C. "DISTRIBUTION OUTLETS": The term "Distribution Outlets" shall mean the
market(s) in which Licensee is authorized to sell and/or distribute the
Licensed Articles and shall include all markets in which Licensee usually and
customarily distributes its products (including direct mail channels).
D. "TERM":
1. "TERM": The "Term" will commence on July 1, 1996 and expire on
June 30, 2001.
2. "EARLIEST COMMENCEMENT DATE": The "Earliest Commencement Date", which
means the date before which Licensee shall not sell or offer to sell any
Licensed Articles to the public (or permit any third party to do so), is
June 1, 1997.
3. "LATEST COMMENCEMENT DATE": Subject to the limitations and conditions
contained in Paragraphs 2. and 11. of the Standard Terms and Conditions
attached hereto, Licensee agrees to commence in good faith to manufacture,
distribute and sell Licensed Articles in the MAC/PC format on or before
June 1, 1998 and in the Sony Playstation and Sega Saturn formats within one
year thereafter ("Latest Commencement Date").
E. "LICENSED TERRITORY": The "Licensed Territory" is the entire world.
F. "ROYALTY": The "Royalty" is 8% of 100% of Net Sales.<PAGE>
K1616V04.JMF 07-01-96
Merchandising License Agreement #6033
"THE ABYSS" - Sound Source Interactive -1-
A NEWS CORPORATION COMPANY
<PAGE>
G. "ADVANCE"/"GUARANTEE": Licensee shall pay Fox a minimum Royalty
hereunder of US$45,000 ("Guarantee"), which sum shall be due and payable in
accordance with the following schedule (to the extent not previously paid
pursuant to Section F. above).
1. $10,000 ("Advance"), payable upon signature of this Agreement by
Licensee;
2. $10,000 on or before December 31, 1997;
3. $10,000 on or before June 30, 1998;
4. $10,000 on or before September 30, 1998; and
5. $5,000 on or before December 31, 1998.
H. "PRODUCT LIABILITY INSURANCE": The amount of bodily injury coverage
under product liability insurance is US$1,000,000.
I. "TRADEMARK AND COPYRIGHT NOTICES":
TM and - 1997 [or year of publication] Twentieth Century Fox Film Corporation
All rights reserved
J. "SERVICE OF PROCESS": Licensee appoints Ulrich Gottschling, whose
address in California is 2985 E. Hillcrest Drive., Suite "A", Westlake
Village, CA 91362, to accept service of process on Licensee's behalf. If no
name or address is filled in above or if said person has moved or for any
reason cannot be validly served, then Licensee appoints the Secretary of
State of the State of California to accept service of process on Licensee's
behalf.
K. "SPECIAL PROVISIONS":
1. AUDIO/VIDEO FOOTAGE: Licensee shall be solely responsible for any
and all third party payments that may arise out of the approved use of
the music, character voices and/or sound effects form the Property in
connection with the Licensed Articles, including without limitation any
third party royalties, mechanical fees, residuals, publishing fees,
license fees, reuse fees or other guild-related payments. In addition,
Licensee shall pay Fox a separate royalty of $750 with respect to each
minute of video footage from the Property incorporated in the Licensed
Article. Further, Licensee shall pay directly to the attention of Mary
Jo Mennella, Vice President of Music Publishing, Twentieth Century Fox
Film Corporation, at the letterhead address, a separate, additional
royalty at the rates set forth below with respect to each Licensed
Article sold containing original music composed for the Property.
SELLING PRICE ROYALTY RATE
------------- ------------
$0-24.99 5CENTS per unit
$25-$49.99 10CENTS per unit
$50-$75* 15CENTS per unit
*Rate to be negotiated on an individual basis if over $75
2. ABBREVIATED VERSIONS: Licensee shall have the right to produce an
abbreviated, on-line version of the Licensed Article, incorporating not
more than 15% of the total content thereof, for transmission via
electronic on-line internet services for the purpose of promoting the
sale of Licensed Articles. In addition, Licensee shall have the right
to produce and distribute a limited edition of an abbreviated version of
the
K1616V04.JMF 07-01-96
Merchandising License Agreement #6033
"THE ABYSS" - Sound Source Interactive -2-
A NEWS CORPORATION COMPANY
<PAGE>
Licensed Article in the MAC/PC format, incorporating not more than 30%
of the total content thereof, for sale at retail. Such abbreviated
versions shall be subject to the prior approval of Fox in accordance
with the provisions of Paragraph 10. of the Standard Terms and
Conditions attached hereto.
3. Trade Show Exhibition: Approved prototypes of the Licensed
Articles will be prominently exhibited by Licensee at the 1998
Electronic Entertainment Exposition trade convention known as "E3".
4. Reversion of Rights: Notwithstanding anything to the contrary
contained herein, if Licensee fails to commence in good faith to sell
and distribute commercial quantities of the Licensed Articles in any
format/platform in any country(ies) of the Licensed Territory within 6
months following the initial shipment for sale of such format/platform
in the United States or anytime thereafter discontinues the sale and
distribution of commercial quantities of Licensed Articles in any
format/platform in any country(ies) of the Licensed Territory for a
period of 3 consecutive months, then the rights granted herein with
respect to such unexploited format/platform and/or country(ies) of the
Licensed Territory, as applicable, shall automatically revert to Fox.
= = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = =
By signing in the spaces provided below, the parties have agreed to all of
the terms and conditions contained in the above Schedule and the attached
Standard Terms and Conditions. This Agreement shall consist of the above
Schedule, the attached Standard Terms and Conditions and any rider making
specific reference to this Agreement attached hereto and separately signed by
authorized representatives of Licensee, Fox and Trademark Licensor.
SOUND SOURCE INTERACTIVE TWENTIETH CENTURY FOX LICENSING AND
("Licensee") MERCHANDISING, A UNIT OF FOX INC. ("FOX")
AS ADMINISTRATOR FOR TWENTIETH
CENTURY FOX FILM CORPORATION
("Trademark Licensor")
By /s/Vincent J. Bitetti
------------------------------------
Its CEO
By /s/ [Signature illegible]
------------------------------------
Its Senior Vice President
Date: 7/7/96
--------------------------------
Date: 7/22/96
--------------------------------
K1616V04.JMF 07-01-96
Merchandising License Agreement #6033
"THE ABYSS" - Sound Source Interactive -3-
A NEWS CORPORATION COMPANY
<PAGE>
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
Sound Source Interactive, Inc.
We hereby consent to the incorporation by reference in Registration
Statements No. 333-11481 and No. 333-11483 on Form S-8 of our report dated
September 16, 1996 appearing in your Annual Report on Form 10-KSB of
Sound Source Interactive, Inc. for the years ended June 30, 1996 and 1995.
CORBIN & WERTZ
Irvine, California
September 26, 1996
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM SOUND SOURCE
INTERACTIVE, INC. AND SUBSIDIARY FOR THE PERIOD JULY 1, 1995 TO JUNE 30, 1996
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUN-30-1996
<PERIOD-START> JUL-01-1995
<PERIOD-END> JUN-30-1996
<CASH> 181,985
<SECURITIES> 0
<RECEIVABLES> 1,616,325
<ALLOWANCES> (703,421)
<INVENTORY> 262,657
<CURRENT-ASSETS> 2,622,990
<PP&E> 307,021
<DEPRECIATION> (129,954)
<TOTAL-ASSETS> 2,812,957
<CURRENT-LIABILITIES> 7,996,964
<BONDS> 4,987,500
0
0
<COMMON> 5,126,384
<OTHER-SE> 263,350
<TOTAL-LIABILITY-AND-EQUITY> 2,812,957
<SALES> 2,264,633
<TOTAL-REVENUES> 2,264,633
<CGS> 1,382,999
<TOTAL-COSTS> 1,382,999
<OTHER-EXPENSES> 4,377,414
<LOSS-PROVISION> 663,421
<INTEREST-EXPENSE> 374,175
<INCOME-PRETAX> (4,473,376)
<INCOME-TAX> 1,600
<INCOME-CONTINUING> (4,474,976)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (4,474,976)
<EPS-PRIMARY> (2.44)
<EPS-DILUTED> (2.44)
</TABLE>
