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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, 1997
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.)
26115 Mureau Road, Suite B
Calabasas, California 91302
(Address of principal executive offices) (Zip Code)
(818) 878-0505
(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.
[x] [_]
Yes 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 $4,596,806.
As of August 31, 1997, the aggregate market value of the shares of the
Issuer's voting stock held by nonaffiliates of the Issuer was approximately
$3,571,217, and the number of outstanding shares of the Issuer's common stock,
par value $.001, was 4,409,099.
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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 30,1997 are incorporated by reference into Part III of this Form 10-KSB.
===============================================================================
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PART I
ITEM 1. DESCRIPTION OF BUSINESS.
THE COMPANY
Sound Source Interactive, Inc. (the "Company"), which was incorporated on
March 8, 1990, is engaged primarily in developing, publishing and marketing of
interactive computer software. The Company "produces products in two categories;
Children's Entertainment and Adult Entertainment. Children's Entertainment
consists principally of children's edutainment products including Interactive
MovieBooks(TM), Activity Centers and Learning Adventures for children" ages
three to twelve. These products include animation, text, photos, sound clips and
actual film footage of well-recognized family films and television series. Adult
Entertainment consists of two categories: Entertainment Utilities and Games.
Entertainment Utilities incorporate screen savers, sound clips, and other
content, including mini-arcade games, into a desktop diversion. These products
are based on licensed entertainment properties and are marketed as limited
edition serialized collector editions. In July, 1996, the Company created a
"Games" division and currently has under development two games and has purchased
the rights to two other games that are at or near completion.
The Company's objective is to be a leading publisher of high quality,
competitively priced, consumer-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.
Many of 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.), Twentieth Century Fox Licensing, New Line Cinema, Harvey Entertainment,
Warner Bros. Consumer Products, 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: A Little Pig Goes A Long
Way(TM), The Little Rascals(TM), All Dogs Go to Heaven II(TM), The Land Before
Time(TM), Babylon 5(TM), Hercules(TM) and Xena(TM), The Adventures of Batman and
Robin(TM), Terminator 2(TM): Judgment Day(TM), Free Willy 2(TM), Star Trek(TM),
Star Trek: Deep Space Nine(TM), Star Trek: Voyager(TM), DragonHeart(TM), I Love
Lucy(TM) and other popular titles. The Company also holds licenses for new
products based on Casper A Spirited Beginning(TM), Lost In Space(TM), An
American Tail(TM), The Land Before Time(TM), The Abyss(TM), Free Willy 3(TM) and
The Lost World Jarassic Park(TM). The Company is continuing the negotiation of
additional licenses for its children's products, entertainment utilities and
games. 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 Company believes that as of August 31, 1997, its products were in
distribution to approximately 8,000 retail outlets. Retailers currently selling
one or more of the Company's products include Toys R Us, Office Depot, Office
Max, Staples, Future Shops, Egghead, Tower Records, CompUSA, Best Buy, BJ's,
Computer City, Electronics Boutique, Babbages, Etc., Kmart, Barnes & Noble,
Sam's Club, Spencer Gifts, Dapy Stores and others.
On June 1, 1996 the Company entered into a Distribution Services Agreement
with Simon & Schuster Interactive Distribution Services ("SSIDS") which expires
on May 31, 1998. SSIDS is the consumer software distribution unit of Simon &
Schuster, Inc., the publishing operation of Viacom Inc. Pursuant to this
distribution agreement, SSIDS provides distribution, warehousing and order
fulfillment
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services for all of the Company's products (subject to certain exceptions)
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. During the year ended June 30,
1997, net sales to and through SSIDS approximated $2,982,285, or 64.9% of the
Company's total net revenues.
The Company is located at 26115 Mureau Road, Suite B, Calabasas,
California, 91302. Its telephone number is (818) 878-0505. Its facsimile
number is (818) 878-0007.
INDUSTRY BACKGROUND
In recent years, the installed base of Multimedia PCs in households has
grown as prices have declined 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(R) Windows(R) operating system, and the release of the Windows '95(R)
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. See Part I, Item 1,
"Description of Business Risk Factors Forward-Looking Statements."
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
consumerization 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 the demand for consumer software products increased in the early and mid
1990's, many companies entered into the business believing that their respective
products were better and, would be more widely accepted and purchased by
consumers, and that the demand for consumer products would continue to increase
at dramatic rates. As many of these software development companies began
introducing products, demand for retail shelf space became increasingly more
difficult to obtain and more expensive. Given these various factors, and a
shift in consumer purchasing toward licensed content for children's products,
many software development companies encountered severe financial difficulties.
As a result of this, numerous software development companies either
significantly reduced their development and sales activities, were acquired by
other larger software development companies such as Good Times Interactive or
CUC International, or have ceased doing business. As of the summer of 1997,
there is still a glut of new products being introduced to the retailers by
software development companies and even though demand continues to be
increasing, shelf space is still very difficult to obtain, consolidation
continues as companies attempt to obtain a competitive advantage, and the shift
toward licensed products for children appears to be continuing.
As consumer software moves into the mass-market channel, the Company
believes it will become increasingly important for consumer software companies
to have direct relationships with
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retailers to effectively market their products to consumers. 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.
In an effort to incrementally increase the Company's revenues, as well as
create new revenue sources, the Company is active in searching for new ways to
market the Company's products. Included in these non-traditional methods is the
placement of coupons in videos, coupons in complimentary products, "unlockable"
discs, and enhanced upsell programs.
PRODUCTS
CHILDREN'S ENTERTAINMENT
The Company has created Interactive StoryBooks that it markets as
MovieBooks(TM) for children as they contain full motion video based on the
licensed property. Interactive MovieBooks(TM) are marketed as reading aids for
young children, generally for ages three through six. The Company has released
ten of its Interactive MovieBooks(TM) on CD-ROM. This product category 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
topic related 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. The latest versions of these
products have been enhanced to contain educationally oriented games in addition
to the above noted features. 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.
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The following is a listing of the Company's Interactive MovieBook(TM)
products, which currently exist, or are planned for release, all of which are on
CD-ROM:
<TABLE>
<CAPTION>
TITLE LICENSOR RELEASE DATE CURRENT PLATFORM
- ---------------------------- ------------------ ------------------ ---------------------
<S> <C> <C> <C>
The Secret Garden(TM) Warner Bros. August 1994 Windows(R) and
Windows '95(R)
Black Beauty(TM) Warner Bros. November 1994 Windows(R) and
Windows '95(R)
The Little Rascals(TM) Universal Pictures June 1995 Windows(R) and
Windows '95(R)
Free Willy 2(TM) Warner Bros. July 1995 Windows(R) and
Windows '95(R)
Babe(TM) Universal Pictures November 1995 Windows(R) and
Windows '95(R)
ExoSquad(TM) Universal Pictures November 1995 Windows(R) and
Windows '95(R)
The Adventures of DC Comics November 1995 Windows(R) and
Batman and Robin(TM) Windows '95(R)
The Land Before Time(TM) Universal August 1996 Windows(R) and
Pictures Windows '95(R)
All Dogs Go To Heaven II(TM) MGM October 1996 Windows(R) and
Windows '95(R)
An American Tail(TM) Universal Pictures October 1998 Windows(R) and
Windows '95(R)
Lost In Space(TM) New Line Cinema March 1998 Windows(R) and
Windows '95(R)
</TABLE>
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The Company has developed a second line of children's entertainment
products, which it refers to as activity centers and/or learning adventures.
This product line contains activities that teach young children logic, language
skills, arithmetic and reading comprehension, along with developmental
challenges such as multiple choice questions, rhyme and meter basics while
entertaining and captivating the players. The activity centers are designed for
children ages three through eight, whereas the learning adventures are more
educationally based and are designed for children ages six through twelve.
The following is a listing of the Company's products of this type, which
currently exist or are planned for release, all of which are on CD-ROM:
<TABLE>
<CAPTION>
TITLE LICENSOR RELEASE DATE CURRENT PLATFORM
- ---------------------------- ------------------ ------------------ ---------------------
<S> <C> <C> <C>
Dragonheart Creativity Universal Pictures June 1996 Macintosh(R),
Center(TM) Windows(R) and
Windows '95(R)
The Land Before Time Universal Pictures March 1997 Macintosh(R),
Activity Center(TM) Windows(R) and
Windows '95(R)
Hercules and Xena Learning Universal Pictures May 1997 Macintosh(R),
Adventure(TM) Windows(R) and
Windows '95(R)
Casper(TM) A Spirited Harvey September 1997 Macintosh(R),
Beginning Activity Center Entertainment Windows(R) and
Windows '95(R)
The Land Before Time Math Universal Pictures December 1997 Macintosh(R),
Adventure(TM) Windows(R) and
Windows '95(R)
Free Willy 3 Activity Warner Bros. November 1997 Macintosh(R),
Center(TM) Windows(R) and
Windows '95(R)
Lost In Space Learning New Line Cinema October 1998 Macintosh(R),
Adventure(TM) Windows(R) and
Windows '95(R)
The Land Before Time Universal Pictures June 1998 Macintosh(R),
Kindergarten Adventure(TM) Windows(R) and
Windows '95(R)
</TABLE>
ADULT ENTERTAINMENT
The Company's entertainment computer software utilities, which it refers to
as Limited Edition Entertainment Utilities(TM), incorporate screen savers, sound
clips and other content, including mini arcade games, into a desktop diversion.
The entertainment utilities are based on licensed entertainment properties and
are marketed as limited edition, serialized collector editions. The Company
currently plans to release two to four limited edition entertainment utilities
for the next several years, depending on availability of quality licenses. The
Company currently sells or plans to sell the following limited edition
entertainment utilities:
<TABLE>
<CAPTION>
TITLE LICENSOR RELEASE DATE CURRENT PLATFORM
- ---------------------------- ------------------ ------------------ ---------------------
<S> <C> <C> <C>
Babylon 5(TM) Warner Bros. November 1995 Windows(R) and
Windows '95(R)
Terminator 2; Carolco Pictures July 1996 Windows(R) and
Judgment Day(TM) Windows '95(R)
</TABLE>
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<TABLE>
<CAPTION>
TITLE LICENSOR RELEASE DATE CURRENT PLATFORM
- ---------------------------- ------------------ ------------------ ---------------------
<S> <C> <C> <C>
Star Trek: Deep Space Paramount/ August 1996 Windows(R) and
Nine(TM) Viacom Windows '95(R)
Star Trek: Voyager(TM) Paramount/ November 1996 Windows(R) and
Viacom Windows '95(R)
I Love Lucy(TM) CBS November 1996 Windows(R) and
Windows '95(R)
Babylon 5 Volume II - Warner Bros. May 1997 Windows(R) and
Shadow Wars(TM) Windows '95(R)
The Lost World Universal Pictures October 1997 Windows(R) and
Jurassic Park(TM) Windows '95(R)
Lost In Space(TM) New Line Cinema March 1998 Windows(R) and
Windows '95(R)
Star Trek: Voyager Vol II(TM) Paramount/ July 1998 Windows(R) and
Viacom Windows '95(R)
</TABLE>
During July, 1996, the Company created a Game division and began
development of a PC game sequel to the 1989 theatrical release The Abyss(TM),
under a license from Twentieth Century Fox Licensing and Merchandising. In order
to develop the game, the Company acquired a three-dimensional ray casting "game
engine" and purchased four Windows NT(R) workstations equipped with SoftImage(R)
three-dimensional rendering software. Additionally, the Company began internal
development of an additional game, acquired the rights to one completed game
developed by Intracorp Entertainment and acquired the rights to a game then
under development by Rhode Island Soft Systems. The Company plans to sell the
following games:
<TABLE>
<CAPTION>
TITLE LICENSOR RELEASE DATE CURRENT PLATFORM
- ---------------------------- ------------------ ------------------ ---------------------
<S> <C> <C> <C>
Final Conflict(TM) Rhode Island October 1997 Windows(R) and
Soft Systems Windows '95(R)
Harpoon II Collection(TM) Intracorp January 1998 Windows(R) and
Entertainment Windows '95(R)
Star Trek: The Game Paramount/ October 1997 Macintosh(R),
Show(TM) Viacom Windows(R) and
Windows '95(R)
The Abyss: Incident at Twentieth Century March 1998 Windows '95(R)
Europa(TM) Fox Licensing
</TABLE>
PRODUCT DISTRIBUTION
NORTH AMERICAN RETAIL
On June 1, 1996 the Company entered into a Distribution Services Agreement
with Simon & Schuster Interactive Distribution Services ("SSIDS", as previously
defined) which expires on May 31, 1998. SSIDS is the consumer software
distribution unit of Simon & Schuster, Inc., the publishing operation of Viacom
Inc. Pursuant to this distribution agreement, SSIDS provides 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 with regard to 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
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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 are due not later than 75 days after each calendar month end.
Under the SSIDS distribution agreement, SSIDS will be responsible for collection
of accounts, whereas the Company is responsible for product returns. The Company
maintains a reserve for product returns based upon its prior experience and
current market conditions against which credits for actual returns are applied.
Such reserve is netted against revenues as reported by SSIDS. See Part I, Item
1, "Description of Business--Risk Factors--Product Distribution" and ,
"Description of Business--Risk Factors--Product Returns."
INTERNATIONAL RETAIL
The Company utilizes several international distributors to actively promote
and sell the Company's non-localized products throughout most of the English
speaking countries and non-English speaking countries, including France,
Germany, Spain and Brazil. Additionally, the Company has entered into a
republishing agreement with IONA Software, Ltd. of Dublin, Ireland to translate
certain of the Company's products into as many as fourteen different languages
for sale in up to 35 countries. Under the terms of this agreement, the Company
is paid a republishing fee on each product sold. All costs of localization of
the product, product boxes and collateral materials, as well as all costs or
replication, marketing, warehousing and fulfillment, are borne by IONA. The
success of this localization will be dependent upon the international appeal of
certain of the Company's products, the ability of IONA to successfully localize
the products and the ability of the Company to continue to obtain licenses with
worldwide appeal.
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 videocassettes, movie trailers in the Company's software
products, and promotional contests with various motion picture studios. The
Company believes that a significant amount of revenues during the upcoming
fiscal year could be generated through the Company's involvement in cross-
promotional efforts with other studio licensees and direct mail programs.
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. 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 SSIDS distribution agreement, the SSIDS sales force, with
direction and assistance from the Company, services the Company's direct retail
accounts. The Company works closely with SSIDS to assure that wholesale and
retail accounts are adequately serviced, that inventory levels are adequate and
that merchandising programs are properly executed. See "Product Distribution."
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DEVELOPMENT
The Company seeks to develop a broad line of products in sustainable market
categories in which a significant 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 controlled capital 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 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
partially 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 to continue to develop some of its products in-house.
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.
In order to supplement the Company's internal development activities, the
Company has begun to acquire products developed by unrelated third parties.
Through August 31, 1997, the Company has acquired three games from two outside
companies. The Company anticipates that as opportunities to acquire products
become available, the Company will evaluate its current and future product mix
to determine if the acquisition of an additional title will provide a benefit to
the Company. Under the terms of the current agreements, the Company generally
provides either funds to complete development of the product or an advance
against future royalties. In either case, such advances are recouped by the
Company against royalties owed to the developer upon sales of the completed
products.
The Company currently is the licensee under technology licenses with Apple
Computer, 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
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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.
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 continue to invest in
additional management information systems and other capital equipment, which it
believes to be 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 several independent fulfillment
houses. To date, the Company has not experienced any material difficulties or
delays in the production and assembly of its products.
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 toy companies, may
enter or increase their focus on the consumer software market, resulting in
greater competition for the Company. See Part I, Item 1, "Description of
Business--Risk Factors--Competition."
Only a small percentage of products introduced in the consumer software
market achieve any degree of or have sustained market acceptance. Principal
competitive factors in marketing consumer software include product features,
quality, reliability, trade name 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.
The Company considers Microsoft Corp., Broderbund, Inc., Knowledge
Adventure, Disney, Davidson + Associates, Virgin Interactive and GT Interactive
Software Corp. its chief competitors in the interactive entertainment CD-ROM
market.
The Company has entered into license agreements with Viacom Consumer
Products (as agent for Paramount Pictures Corp.), Warner Bros. Consumer
Products, New Line Cinema, Twentieth Century Fox, Harvey 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, MGM/UA, Lucasfilm Ltd., Fox
and Paramount/Viacom are currently the most active studios in publishing their
own product to create software packages
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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 recent products are CD-ROM based, and hence are
difficult to copy. During the fiscal years ended June 30, 1997, 1996 and 1995,
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 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 has satisfied the
applicable minimum royalty guarantees, the Licensor can not prematurely cancel a
license.
EMPLOYEES
As of August 31, 1997, the Company had 32 full-time employees, including
six employees in sales and marketing, 19 employees in development and customer
support, five employees in administration and finance and two employees in
licensing. None of the Company's employees are represented by a labor union or
are subject to a collective bargaining agreement. From time to time the Company
will engage consultants and independent contractors of which there were two as
of August 31, 1997.
RISK FACTORS
EMPLOYMENT OF VINCENT J. BITETTI - Vincent J. Bitetti, Chairman of the
Board and Chief Executive Officer of the Company is employed under an employment
agreement which expires on September 15, 1998. The Company's success depends to
a significant extent on the performance and continued service of its senior
management and certain key employees. In particular, the loss of the services of
Vincent Bitetti could have a material adverse effect on the Company. In addition
to his duties as Chairman of the Board and Chief Executive Officer, Mr. Bitetti
is the executive producer for all Company products, he conceptualizes, reviews
and "green lights" all title development, and has led the negotiations for all
studio license and promotional/partnership agreements.
PRODUCT DISTRIBUTION - On June 1, 1996 the Company entered into a
Distribution Services Agreement with Simon & Schuster Interactive Distribution
Services ("SSIDS" as previously defined) which expires on May 31, 1998. SSIDS
is the consumer software distribution unit of Simon & Schuster, Inc., the
publishing operation of Viacom Inc. Pursuant to this distribution agreement,
SSIDS provides 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 is exclusive except
with regard to 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 Distribution Services Agreement is for
a term of two years. The Company is substantially dependent upon SSIDS for the
distribution of its products throughout the United States and Canada during the
term of the agreement. SSIDS, however, is not 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 SSIDS. Because the Company's
rights to market it products through channels other than SSIDS are limited, the
Company's ability to realize the cash flow necessary to fund its ongoing
operations and to achieve profitability will be largely dependent upon the
success of SSIDS in marketing its products. Additionally, as the agreement
expires on May 31, 1998, and SSIDS is not obligated to renew the agreement,
there is no assurance that subsequent to May 31, 1998, the Company will have a
distributor in place to distribute the Company's products to the North American
retail channel.
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<PAGE>
PRODUCT RETURNS - Under the SSIDS distribution services agreement, SSIDS is
responsible for collection of accounts and the Company is responsible for
product returns. The Company maintains a reserve for product returns based upon
its prior experience and current market conditions, which approximates 15
percent of gross revenues, against which credits for actual returns are applied.
Such reserve is netted against revenues as reported by SSIDS. Although the
Company believes that these reserves are adequate, there can be no assurance
that its actual losses due to returns will not exceed the reserved amount.
COMPETITION - The market for the Company's consumer software products is
intensely and increasingly competitive. Existing consumer software companies
may broaden their product lines to compete with the Company's products, and
potential new competitors may enter or increase their focus on the consumer
software market, resulting in even greater competition for the Company. Many of
the companies with which the Company currently competes, including Microsoft
Corp., Broderbund, Inc., Knowledge Adventure, Disney, Davidson + Associates,
Virgin Interactive, and GT Interactive Software Corp., have greater financial,
technical, marketing, sales and customer support resources, as well as greater
name recognition and better access to consumers, than the Company. To the
extent that competitors achieve performance, price or other selling advantages,
the Company could be materially adversely affected. There can be no assurance
that the Company will have the resources required to respond effectively 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 may materially adversely affect the Company's business,
operating results and financial condition.
CONTROL OF THE COMPANY BY OFFICERS AND DIRECTORS AND ASSI, INC. - As of
August 31, 1997, the Company had 4,409,099 outstanding shares of Common Stock.
Vincent Bitetti, who is the Company's largest shareholder, owned of record
1,234,684 shares (28.0 percent) of the outstanding Common Stock; and ASSI, Inc.
owned of record 40,000 shares of Common Stock and presently exercisable ASSI
Warrants to purchase an additional 4,816,657 shares of Common Stock. Therefore,
ASSI, Inc. beneficially owned 4,856,657 shares of Common Stock, representing
approximately 52.6 percent of the outstanding Common Stock assuming exercise in
full of the ASSI Warrants but no other outstanding warrants and options (31.3
percent assuming exercise in full of all the other outstanding Redeemable
Warrants (as hereinafter defined), but no other outstanding warrants and
options). Louis Habash of Las Vegas, Nevada, is the ultimate beneficial owner
of all of the Common Stock and ASSI Warrants owned by ASSI, Inc.
POSSIBLE NEED FOR ADDITIONAL FINANCING - The Company heretofore has been
substantially dependent on the net proceeds of its securities offerings,
including its initial public offering, to fund its working capital requirements.
As of June 30, 1997, the Company has working capital of $851,290 and cash and
cash equivalents of $590,459. The Company has experienced a significant
increase in growth during the year ended June 30, 1997, as compared to the prior
fiscal year. The Company incurred a loss from operations of $2,668,520 for the
year ended June 30, 1997. In order to fund its increased growth, the Company
may require additional financing to fund its growth and to meet all of its
obligations in a timely manner. Effective September 1997, the Company entered
into a factoring agreement with Silicon Valley Financial Services, a division of
Silicon Valley Bank. The factoring agreement provides up to $1,500,000 of the
Company's qualified gross domestic accounts receivable, as defined in the
agreement. The credit is secured by all the assets of the Company and matures
one year from the date of the agreement. See Part II, Item 6, "Management's
Discussion and Analysis of Financial Condition and Results of Operations
Liquidity."
QUALIFICATION REQUIREMENTS FOR NASDAQ SECURITIES; RISK OF LOW PRICED
SECURITIES - Effective August 22, 1997 new rules governing the listing of
securities in the Nasdaq SmallCap Market, where the Company's Redeemable
Warrants and Common Stock are both listed, became effective. Under these rules,
for the Company's securities to continue to be listed, (I) the Company must have
either (A) net tangible assets (defined as total assets, excluding goodwill,
minus total liabilities) of at least
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<PAGE>
$2,000,000, (B) a market capitalization of at least $35,000,000 or (C) net
income in its latest fiscal year or in two of its last three fiscal years of at
least $500,000, (ii) a public float (defined as shares not held directly or
indirectly by any officer, director or ten percent or greater stockholder of the
Company) of at least 500,000 shares having a market value of at least
$1,000,000, (iii) a minimum bid price of at least $1, (iv) at least two market
makers, and (v) at least 300 stockholders that each own 100 or more shares. If
the bid price for the Common Stock falls below $1 for 30 days, it has 90 days to
come back into compliance (by closing at or above $1 for ten consecutive days)
before being subject to delisting.
The Company does not know at this time if it will maintain its listing on
Nasdaq SmallCap Market; however, in the event the Company experiences losses
from operations or material adverse trading conditions, the Common Stock and
Redeemable Warrants could be subject to delisting from Nasdaq. It is
anticipated that if the Common Stock and Redeemable Warrants are delisted from
the Nasdaq SmallCap Market, trading, if any, therein would be conducted in the
over-the-counter market on the NASD OTC Electronic Bulletin Board established
for securities that do not meet the listing requirements or the Company's
securities would be quoted in what are commonly referred to as the "pink
sheets". In such event, an investor may find it more difficult to dispose of,
or to obtain accurate price quotations and volume information concerning, the
Common Stock and Redeemable Warrants.
FORWARD-LOOKING STATEMENTS - A number of the matters and subject areas
discussed in the foregoing "Risk Factors" section and elsewhere in this Annual
Report that are not historical or current facts deal with potential future
circumstances and developments. The discussion of such matters and subject
areas is qualified by the inherent risks and uncertainties surrounding future
expectations generally, and also may materially differ from the Company's actual
future experience involving any one or more of such matters and subject areas.
The Company has attempted to identify, in context, certain of the factors that
it currently believes may cause actual future experience and results to differ
from the Company's current expectations regarding the relevant matter or subject
area. The operation and results of the Company's business also may be subject
to the effects of other risks and uncertainties in addition to the relevant
qualifying factors identified elsewhere in the foregoing "Risk Factors" section,
including, but not limited to, general economic conditions in the geographic
markets served, changes in technological developments related to the personal
computer software industry, delays in product ship schedules, changes in
consumer preferences regarding entertainment and edutainment software, potential
limitations regarding the acquisition of quality and quantity licenses, and
other risks and uncertainties described from time to time in Company reports
filed with the Commission.
EXECUTIVE OFFICERS
The executive officers of the Company, their ages and their positions with
the Company as of August 31, 1997, are as follows:
<TABLE>
<CAPTION>
Name Age Position
- ------------------------- --- ---------------------------------------
<S> <C> <C>
Vincent J. Bitetti 42 Chairman of the Board, Chief Executive
Officer and Director
Ulrich E. Gottschling 39 President, Chief Operating Officer
Chief Financial Officer, Treasurer,
Secretary and Director
</TABLE>
Vincent J. Bitetti founded Sound Source Interactive, Inc., a California
corporation (the "Subsidiary"), in 1988 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
14
<PAGE>
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), limited edition
entertainment utilities and creativity center products. See Part I, Item 1,
"Description of Business - Risk Factors - Employment of Vincent J. Bitetti."
Ulrich E. Gottschling was appointed as Chief Financial Officer, Treasurer
and director of the Company on October 9, 1995, as Secretary of the Company on
November 17, 1995, and as President and Chief Operating Officer of the Company
on February 1, 1997. Prior to joining the Company, Mr. Gottschling was employed
from June 1991 through September 1995 as a certified public accountant with
Corbin & Wertz, who previously was the Company's independent auditors. From
1987 through May 1991, he was employed as a certified public accountant by
Deloitte & Touche LLP. 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 8,613 square feet of office and
warehousing space in Calabasas, Los Angeles County, California under a lease,
which expires on May 31, 2002. The Company currently expects that these
facilities will be sufficient for its needs at least through the term of the
lease. The Company may lease additional space as its needs require, which it
believes will be available on acceptable terms.
ITEM 3. LEGAL PROCEEDINGS.
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.
On December 13, 1996, the Company filed suit in Superior Court for the
County of Los Angeles, California, against Acclaim seeking compensatory damages
of at least $2,124,259 and consequential damages of at least $20,000,000 arising
out of Acclaim's alleged breach of its exclusive worldwide distribution
agreement with the Company and other related matters. This action is scheduled
for trial commencing February, 1998.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None
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. The following table sets forth
the range of the bid prices for the Common Stock and Redeemable Warrants during
the periods indicated, and represents interdealer prices, without retail mark-
ups, mark-downs or commissions to the broker-dealer, and may not represent
actual transactions.
15
<PAGE>
<TABLE>
<CAPTION>
Nasdaq
Symbol High Low
<S> <C> <C>
Common Stock SSII
1996
Third Calendar Quarter $6.25 $4.00
Fourth Calendar Quarter $5.75 $4.00
1997
First Calendar Quarter $4.31 $1.38
Second Calendar Quarter $1.62 $0.44
Third Calendar Quarter (through 9/15/97) $1.31 $0.75
Redeemable Warrants SSIIW
1996
Third Calendar Quarter $2.38 $1.00
Fourth Calendar Quarter $1.88 $1.00
1997
First Calendar Quarter $1.00 $0.31
Second Calendar Quarter $0.56 $0.13
Third Calendar Quarter (through 9/15/97) $0.25 $0.13
</TABLE>
As of August 31, 1997, there were approximately 149 holders of record of
the Common Stock and 36 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 following is a discussion of the consolidated financial condition and
result of operations of the Company for the fiscal years ended June 30, 1997,
1996 and 1995, and certain factors that are expected to affect the Company's
prospective financial condition. See Part I, Item 1, "Description of Business -
Risk Factors - Forward-Looking Statements."
The Company derives substantially all of its revenues from sales 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. 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. The Company had no sales to or through Acclaim during its fiscal years
ended June 30, 1997 and June 30, 1995. To date,
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<PAGE>
the Company has received a net payment of $912,134 from Acclaim pursuant to the
distribution agreement. The Company, however, believes that further amounts are
due from Acclaim. On December 13, 1996, the Company filed suit in Superior Court
for the County of Los Angeles, California, against Acclaim seeking compensatory
damages of at least $2,124,259 and consequential damages of at least $20,000,000
arising out of Acclaim's alleged breach of its exclusive worldwide distribution
agreement with the Company and other related matters. See Part I, Item 3, "Legal
Proceedings."
Effective June 1, 1996 the Company entered into a Distribution Services
Agreement with SSIDS that expires on May 31, 1998. Pursuant to this new
distribution agreement, SSIDS provides 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 is exclusive except with regard to 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. The
Company had no net sales to or through SSIDS during the years ended June 30,
1996 and 1995. During the year ended June 30, 1997, the Company had net sales
to or through SSIDS in the amount of $2,982,285, which accounted for
approximately 64.9% of the Company's total net sales.
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 boxes and manuals, media costs
and fulfillment.
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
1997 and 1996.
RESULTS OF OPERATIONS
FISCAL YEAR ENDED JUNE 30, 1996 COMPARED TO FISCAL YEAR ENDED JUNE 30, 1997
Net Sales. Net sales from continuing operations increased by 103.0 percent
from $2,264,633 for the fiscal year ended June 30, 1996 (fiscal 1996) to
$4,596,806 for the fiscal year ended June 30, 1997 (fiscal 1997). Total sales of
the Company's software products increased by 109.3 percent from $2,161,351 in
fiscal 1996 to $4,524,447 in fiscal 1997. Other revenues, principally comprised
of royalties and development fees decreased by 29.9 percent from $103,282 during
fiscal 1996 to $72,359 during fiscal 1997, as a result of the Company not
entering into any new original equipment manufacturing (OEM) agreements during
fiscal 1997. The 109.3 percent increase in product sales is principally due to
the success of two of the Company's products: the Star Wars Limited Edition
Entertainment Utility (the license for which expired on June 30, 1997) and The
Land Before Time Animated MovieBook(TM). The Company has also increased the
number of storefronts carrying the Company's products. New retailers carrying
the Company's products for the first time during fiscal 1997 included Toys R Us,
Dapy Stores, Spencer Gifts, Sam's Club and Office Depot. The Company anticipates
continuing in fiscal 1998 increasing the number of retailers carrying the
Company's products and will also attempt to increase the
17
<PAGE>
number and variety of products that each store offers for sale. Additionally,
the Company anticipates that during fiscal 1998, it will begin receiving
revenues from sales of certain of its products that have been localized into
foreign languages and will be sold on an international basis.
During fiscal 1997, of the Company's net revenues of $4,596,806, a total of
$2,982,285 was generated by SSIDS, $773,905 was generated by One Stop, Ltd., the
Company's distributor in the United Kingdom, and $279,164 was generated by
Electro Source. These three customers generated none of the Company's sales of
$2,264,633 during fiscal 1996. During fiscal 1996, net sales of $1,889,750 were
generated by Acclaim.
Cost of Sales. Cost of sales increased by 68.4 percent from $1,382,999 for
fiscal 1996 to $2,329,211 for fiscal 1997, representing 61.1 percent and 50.7
percent of net sales, respectively, and 64.0 percent and 51.5 percent of
products sales, respectively. This increase in cost of sales is attributable to
the above noted 103.0 percent increase in net sales, partially offset by
decreased royalty costs and decreased replication, assembly and freight costs.
Additionally, the Company has been able to increase the average sales price of
its products which has lead to a lower cost of sales percentage.
Marketing and Sales. Marketing and sales expenses increased by 37.4
percent from $1,054,602 for fiscal 1996 to $1,449,189 for fiscal 1997, and
decreased as a percentage of net sales from 46.6 percent to 31.5 percent,
respectively. The increase in expenses was 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 9.4 percent from $2,193,855 for fiscal 1996 to $1,988,213 for fiscal 1997,
and decreased as a percentage of net sales from 96.9 percent to 43.3 percent,
respectively. This decrease is primarily attributable to a reduction in bad
debt expense. During fiscal 1996, the Company recorded a bad debt expense in
the amount of $663,421 related to amounts due to the Company from Acclaim. This
reduction in general and administrative expenses in fiscal 1997 is partially
offset by costs incurred by the Company related to the Company's initial public
offering, costs associated with being a publicly held company such as insurance,
investor and stockholder relations, costs associated with the separation of the
former president of the Company, and costs associated with the Company's lawsuit
against Acclaim.
Compensation In Connection With Common Stock and Common Stock Options
Issued For Services Rendered. A total of $333,029 of the general and
administrative expenses for fiscal 1997 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 1996.
Development. Development expenses increased by 69.8 percent from $717,994
for fiscal 1996 to $1,219,456 for fiscal 1997, and decreased as a percentage of
net sales from 31.7 percent to 26.5 percent, respectively. The increase in
expenses during fiscal 1997 as compared to fiscal 1996, was primarily
attributable to costs related to new product development activities, some of
which will result in products that are not scheduled to be completed and shipped
until fiscal 1998. 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 losses in fiscal 1997 and 1996,
respectively.
Other. Other income (expense) increased from $(1,388,559) for fiscal 1996
to $55,372 for fiscal 1997, and increased as a percentage of net sales from
(61.3) percent to 1.2 percent, respectively. This decrease is due to expenses
incurred during fiscal 1996 related to debt financing incurred by the
18
<PAGE>
Company, which was repaid during July, 1997. These expenses were primarily
comprised of amortization of deferred loan costs in the amount of $1,035,200 and
interest expense in the amount of $374,175.
FISCAL YEAR ENDED JUNE 30, 1995 COMPARED TO FISCAL YEAR ENDED JUNE 30, 1996
Net Revenues. Net revenues 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 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, 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 46.6 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 increased
by 109.0 percent from $1,049,858 for fiscal 1995 to $2,193,855 for fiscal 1996,
and increased as a percentage of net sales from 48.7 percent to 96.9 percent,
respectively. The increase is primarily attributable to costs incurred by the
Company during fiscal 1996 related to the Company's initial public offering and
two private placements, increases in executive salaries related to the addition
of a Chief Financial Officer, and bad debt expense in the amount of $663,421
related to amounts due from Acclaim.
Compensation In Connection With Common Stock and Common Stock Options
Issued for Services Rendered. 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
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<PAGE>
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
1996.
Development. Development expenses increased by 89.7 percent from $378,471
for fiscal 1995 to $717,994 for fiscal 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 income tax provision for fiscal 1995 and fiscal 1996 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.
Other. Other income (expense) increased from $6,691 for fiscal 1995 to
$(1,388,599) for fiscal 1996, and increased as a percentage of net sales from .3
percent to (61.3) 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.
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 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 creased by
26.7 percent from $828,866 for fiscal 1994 to $1,049,858 for fiscal 1995, and
decreased as a percentage of net sales from 49.2 percent to 48.7 percent,
respectively. The increase was primarily due increased staffing and associated
overhead expenses necessary to manage and support the Company's growth.
Compensation In Connection With Common Stock and Common Stock Options
Issued for Services Rendered. A total of $2,992,862 of the fiscal 1994 general
and administrative expenses and
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<PAGE>
$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
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 securities issuances and financing
arrangements. As of the fiscal year ended June 30, 1997, the Company had
working capital of $851,290 and cash equivalents of $590,459.
The Company has experienced a significant increase in growth during the
last fiscal year as compared to the prior fiscal year. The Company continues to
search for new opportunities to obtain licenses, develop and sell products, and
to purchase products that are at or near completion of development.
Additionally, the Company is seeking new and innovative ways to deliver its
products to consumers, some of which may require large up-front cash resources.
If the Company enters into agreements to such business opportunities in the
future, the Company may require additional financing to fund its growth. See
Part I, Item 1, "Description of Business - Risk Factors - Possible Need for
Additional Financing" and "Description of Business - Risk Factors - Forward-
Looking Statements."
Pursuant to its initial public offering and the underwriters' exercise of a
portion of their "over-allotment" option during July and August, 1996, the
Company issued 2,560,000 shares of common stock
21
<PAGE>
at $4.00 per share and 1,371,775 redeemable warrants (the "Redeemable Warrants")
at $.25 per warrant. Net proceeds totaled $8,285,784, net of offering costs of
$2,297,408. 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 $90,985 during fiscal 1996 and
approximately $345,395 during fiscal 1997 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.
Effective September 1997, the Company entered into a factoring agreement
with Silicon Valley Financial Service, a division of Silicon Valley Bank. The
factoring agreement provides up to $1,500,000 of the Company's qualified gross
domestic accounts receivable, as defined in the agreement, at a rate of 1.75%
per month of the average gross daily factoring account balance. The credit is
secured by all the assets of the Company and matures one year from the date of
the agreement.
As shown in the Company's consolidated financial statements, the Company
has incurred net losses of $2,668,520, $4,474,976 and $1,734,160 for the years
ended June 30, 1997, 1996 and 1995, respectively. The Company has not
historically generated sufficient cash flows to fund operations. The Company
has had to rely on debt and equity financings to fund operations. The future
success of the Company is largely dependent upon the Company's ability to
generate revenues sufficient to fund operations.
Management believes that the combination of expected growth and the
aforemented line of credit agreement will provide sufficient cash flows for the
Company to meet its obligations in a timely manner for the next twelve months.
The Company continues to explore new opportunities to obtain licenses, develop
and sell products, and to purchase products that are at or near completion of
development. Additionally, the Company continues to seek new and innovative
methods to deliver its products to consumers, some of which may require large
up-front cash resources. If the Company enters into agreements in such business
opportunities in the future, the Company may require additional financings to
fund its growth.
ITEM 7. FINANCIAL STATEMENTS.
The information required by Item 7 is filed herewith under the Consolidated
Financial Statements of Sound Source Interactive, Inc. and Subsidiary together
with the report of Deloitte & Touche, LLP dated October 2, 1997 in the financial
information section, included as Appendix A of this report.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
For more than the two most recent fiscal years of the Company, Corbin &
Wertz, An Accountancy Corporation, was engaged as the Company's principal
accountant to audit its consolidated financial statements. The Company, based
upon the recommendation of the Board of Directors and Audit Committee, has
terminated its relationship with Corbin & Wertz and engaged Deloitte & Touche,
LLP as its independent auditor effective August 22, 1997.
The independent auditors' reports issued by Corbin & Wertz on the Company's
consolidated financial statements for the years ended June 30, 1996 and 1995 did
not contain an adverse opinion or disclaimer of opinion, and such reports were
not modified for any departure from generally accepted accounting principles or
for any limitation of scope. The report of Corbin & Wertz for the year ended
June 30, 1995, contained a paragraph regarding an uncertainty about the
Company's ability to continue
22
<PAGE>
as a going concern. The report of Corbin & Wertz for the year ended June 30,
1996, contained an explanatory paragraph emphasizing the Company's financial
dependence on a new distributor relationship and an uncertainty as to the
Company's ability to generate revenues sufficient to fund future operations.
During the prior two fiscal years and the interim period subsequent thereto
preceding the change in independent auditors, the Company had no disagreements
with Corbin & Wertz, on any matter of accounting principles or practices,
financial statement disclosure or auditing scope or procedure.
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, 1997, 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 LIST 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 Registrant's Registration Statement
No. 33-80827 ("Registration Statement No. 33-80827") and
incorporated herein by reference.]
3.2 Amended and Restated Bylaws of the Registrant. [Filed as Exhibit
3.2 to Registration Statement No. 33-80827 and incorporated herein
by reference.]
4.1 Specimen Common Stock Certificate. [Filed as Exhibit 4.1 to
Registration Statement No. 33-80827 and incorporated herein by
reference.]
4.2 Form of Warrant Agreement between the Registrant and Corporate
Stock Transfer, Inc., as warrant agent, and form of Redeemable
Warrant. [Filed as Exhibit 4.2 to Registration Statement No. 33-
80827 and incorporated herein by reference.]
4.3 Form of Warrant Agreement between the Registrant and The Boston
Group, LP and Joseph Stevens and Company, LP and form of
Underwriters' Warrant. [Filed as Exhibit 4.3 to Registration
Statement No. 33-80827 and incorporated herein by reference.]
4.4 Warrant dated April 30, 1996 issued to ASSI, Inc. [Filed as Exhibit
4.4 to Registration Statement No. 33-80827 and incorporated herein
by reference.]
4.5 Form of Underwriting Agreement among the Registrant, Vincent J.
Bitetti, Eric H. Winston and The Boston Group, LP and Joseph
Stevens & Co., LP, as underwriters. [Filed as Exhibit 1 to
Registration Statement No. 33-80827 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 Registration Statement No. 33-80827 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 Registration Statement No. 33-
80827 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 Registration Statement No. 33-80827
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 Registration Statement No. 33-
80827 and incorporated herein by reference.]
23
<PAGE>
9.5 Irrevocable Proxy and Voting Agreement of Martin Meyer to Vincent
J. Bitetti, dated May 4, 1994. [Filed as Exhibit 9.5 to
Registration Statement No. 33-80827 and incorporated herein by
reference.]
9.6 Irrevocable Proxy and Voting Agreement of Mark Lane to Vincent J.
Bitetti, dated May 10, 1994. [Filed as Exhibit 9.6 to Registration
Statement No. 33-80827 and incorporated herein by reference.]
10.1 Second Amended and Restated Employment Agreement of Vincent J.
Bitetti dated as of April 30, 1996. [Filed as Exhibit 10.1 to
Registration Statement No. 33-80827 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 Registration
Statement No. 33-80827 and incorporated herein by reference.]
10.3 Amended and Restated Employment Agreement of Ulrich E. Gottschling
dated as of February 1, 1997. [Filed as Exhibit 10.3 to the
Company's Registration Statement on Form SB-2 (No. 333-24271
("Registration Statement No. 333-24271") and incorporated herein by
reference.]
10.4 Sound Source Interactive, Inc. 1992 Stock Option Plan. [Filed as
Exhibit 10.4 to Registration Statement No. 33-80827 and
incorporated herein by reference.]
10.5 Sound Source Interactive, Inc. and 1995 Stock Option Plan. [Filed
as Exhibit 10.5 to the Registrant's Annual Report on Form 10-KSB
for the year ended June 30, 1996, as amended (the "1996 Form 10-
KSB"), and incorporated herein by reference.]
10.6 Warrant Agreement, dated as of September 26, 1995, among the
Registrant, Sound Source Interactive, Inc., a California
corporation (the "Subsidiary") and Financial West Group, Inc.,
corporation ("FWG"), as warrant agent. [Filed as Exhibit 10.6 to
Registration Statement No. 33-80827 and incorporated herein by
reference.]
10.7 Warrant Agreement, dated as of June 30, 1995, between the
Registrant and FWG, as warrant agent. [Filed as Exhibit 10.7 to
Registration Statement No. 33-80827 and incorporated herein by
reference.]
10.8 Sales and Distribution Agreement, dated as of June 15, 1995,
between the Registrant and Acclaim Distribution, Inc. [Filed as
Exhibit 10.13 to Registration Statement No. 33-80827 and
incorporated herein by reference.]
10.9 Termination Agreement, dated as of March 31, 1996, between the
Registrant and Acclaim Entertainment, Inc. [Filed as Exhibit 10.9
to Registration Statement No. 333-24271 and incorporated herein by
reference.]
10.10 Indemnification Agreement, dated as of January 1, 1996, between the
Registrant and Vincent J. Bitetti. [Filed as Exhibit 10.35 to
Registration Statement No. 33-80827 and incorporated herein by
reference.]
10.11 Indemnification Agreement, dated as of January 1, 1996, between the
Registrant and Eric H. Winston. [Filed as Exhibit 10.36 to
Registration Statement No. 33-80827 and incorporated herein by
reference.]
10.12 Indemnification Agreement, dated as of January 1, 1996, between the
Registrant and Ulrich Gottschling. [Filed as Exhibit 10.37 to
Registration Statement No. 33-80827 and incorporated herein by
reference.]
10.13 Consulting Agreement, dated as of April 30, 1996, between the
Company and ASSI, Inc. [Filed as Exhibit 10.45 to Registration
Statement No. 33-80827 and incorporated herein by reference.]
10.14 Share Purchase Agreement, dated April 3, 1995, between Eric Winston
and Vincent Bitetti. [Filed as Exhibit 10.46 to Registration
Statement No. 33-80827 and incorporated herein by reference.]
10.15 Distribution Services Agreement, dated June 1, 1996, between the
Registrant and Simon & Schuster Interactive Distribution Services.
[Filed as Exhibit 10.47 to Registration Statement No. 33-80827 and
incorporated herein by reference.]
24
<PAGE>
10.16 Note Purchase Agreement, dated as of May 30, 1996, between the
Registrant and ASSI, Inc. [Filed as Exhibit 10.48 to Registration
Statement No. 33-80827 and incorporated herein by reference.]
10.17 Convertible Promissory Note, dated May 30, 1996, issued by the
Company to ASSI, Inc. [Filed as Exhibit 10.49 to Registration
Statement No. 33-80827 and incorporated herein by reference.]
10.19 Indemnification Agreement, dated as of October 1, 1996, between the
Registrant and Mark A. James. [Filed as Exhibit 10.44 to the 1996
Form 10-KSB and incorporated herein by reference.]
10.20 Indemnification Agreement, dated as of October 1, 1996, between the
Registrant and Ernest T. Klinger. [Filed as Exhibit 10.45 to the
1996 Form 10-KSB and incorporated herein by reference.]
10.21 Indemnification Agreement, dated as of October 1, 1996, between the
Registrant and Ronald W. Hart. [Filed as Exhibit 10.46 to the 1996
Form 10-KSB and incorporated herein by reference.]
10.22 Separation and Release Agreement, dated as of October 24, 1996,
between the Registrant and Eric. H. Winston. [Filed as Exhibit
10.47 to the 1996 Form 10-KSB and incorporated herein by
reference.]
10.23 Indemnification Agreement, dated as of February 3, 1997, between
the Registrant and Robert. S. Burke. [Filed as Exhibit 10.23 to
Registration Statement No. 333-24271 and incorporated herein by
reference.]
10.24 Office Lease, dated as of March 4, 1997, between Arden Realty
Limited Partnership and the Registrant. [Filed as Exhibit 10.24 to
Registration Statement No. 333-24271 and incorporated herein by
reference.]
10.25 Factoring Agreement, dated as of September 19, 1997, between the
Registrant and Silicon Valley Financial Service, a division of
Silicon Valley Bank. Filed herewith.
10.26 Collateral Assignment, Patent Mortgage and Security Agreement,
dated as of September 19, 1997, between the Registrant and Silicon
Valley Financial Service, a division of Silicon Valley Bank. Filed
herewith.
21.1 Subsidiary of the Registrant. [Filed as Exhibit 21.1 to
Registration Statement No. 33-80827 and incorporated herein by
reference.]
23.1 Consent of Corbin & Wertz. Filed herewith.
23.2 Consent of Deloitte & Touche. Filed herewith.
27.1 Financial Data Schedule. Filed herewith.
(b) Reports on Form 8-K.
The Company filed a Form 8-K on August 27, 1997 (as amended by Form
8-K-A as filed on September 9, 1997), relating to the change in its
auditors.
25
<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: October 10, 1997 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 Chairman of the Board and October 10, 1997
- -------------------------------------- Chief Executive Officer (principal
Vincent J. Bitetti executive officer)
/s/ Ulrich E. Gottschling President, Chief Operating Officer, Chief October 10, 1997
- -------------------------------------- Financial Officer, Treasurer and Secretary
Ulrich E. Gottschling (principal financial and accounting
officer)
/s/ Ronald W. Hart Director October 10, 1997
- --------------------------------------
Ronald W. Hart
/s/ Mark A. James Director October 10, 1997
- --------------------------------------
Mark A. James
/s/ Ernest T. Klinger Director October 10, 1997
- --------------------------------------
Ernest T. Klinger
</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, 1997 will be
forwarded to stockholders.
26
<PAGE>
--------------------------------------------------
SOUND SOURCE INTERACTIVE,
INC. AND SUBSIDIARY
Consolidated Financial Statements as of June 30,
1997 and 1996 and for Each of the Three Years in
the Period Ended June 30, 1997 and Independent
Auditors' Report
<PAGE>
SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY
TABLE OF CONTENTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PAGE
<S> <C>
INDEPENDENT AUDITORS' REPORT 1
CONSOLIDATED FINANCIAL STATEMENTS AS OF JUNE 30, 1997 AND 1996 AND
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1997:
Balance Sheets 2
Statements of Operations 3
Statements of Stockholders' Equity (Deficiency) 4
Statements of Cash Flows 5-6
Notes to Consolidated Financial Statements 7-19
</TABLE>
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Sound Source Interactive, Inc.:
We have audited the accompanying consolidated balance sheet of Sound Source
Interactive, Inc. and subsidiary (the "Company") as of June 30, 1997, and the
related statements of operations, stockholders' equity (deficiency), and cash
flows for the year then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit 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 audit provides a reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of the Company as of June 30, 1997, and the
results of its operations and its cash flows for the year then ended in
conformity with generally accepted accounting principles.
By /s/ DELOITTE & TOUCHE LLP
------------------------------------
DELOITTE & TOUCHE LLP
Los Angeles, California
October 2, 1997
<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 SHEETS
JUNE 30, 1997 AND 1996
<TABLE>
- -----------------------------------------------------------------------------------------------------------------------
<CAPTION>
ASSETS 1997 1996
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 590,459 $ 181,985
Accounts receivable, net of allowance for doubtful accounts of
$703,421 as of June 30, 1997 and 1996 1,361,118 912,904
Inventories, net (Note 2) 228,677 262,657
Prepaid royalties 1,555,263 628,676
Deferred offering costs 620,904
Prepaid expenses and other 77,873 15,864
------------ ------------
Total current assets 3,813,390 2,622,990
PROPERTY AND EQUIPMENT, Net (Note 3) 414,455 177,067
OTHER ASSETS 14,553 12,900
------------ ------------
TOTAL $ 4,242,398 $ 2,812,957
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY)
CURRENT LIABILITIES:
Accounts payable and accrued expenses $ 1,328,261 $ 1,087,547
Notes payable (Note 5) 4,987,500
Accrued interest 367,695
Note payable to related party (Notes 5 and 8) 500,000
Accrued royalties 1,610,441 542,804
Short-term advance (Note 4) 400,000
Deferred revenue 12,000 84,360
Current portion of capital lease obligations (Note 4) 11,398 27,058
------------ ------------
Total current liabilities 2,962,100 7,996,964
CAPITAL LEASE OBLIGATIONS (Note 4) 2,414 13,811
------------ ------------
Total liabilities 2,964,514 8,010,775
------------ ------------
COMMITMENTS AND CONTINGENCIES (Note 4)
STOCKHOLDERS' EQUITY (DEFICIENCY) (Notes 5 and 6):
Common stock, $.001 par value; 20,000,000 shares authorized;
4,409,099 and 1,807,824 shares issued and outstanding as of
June 30, 1997 and 1996, respectively 4,409 1,808
Warrants 1,104,925 263,350
Additional paid-in capital 13,424,622 5,124,576
Accumulated deficit (13,256,072) (10,587,552)
------------ ------------
Total stockholders' equity (deficiency) 1,277,884 (5,197,818)
------------ ------------
TOTAL $ 4,242,398 $ 2,812,957
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
- 2 -
<PAGE>
SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED JUNE 30, 1997, 1996 AND 1995
<TABLE>
- --------------------------------------------------------------------------------------------------------------------
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
REVENUES:
Product sales $ 4,524,447 $ 2,161,351 $ 1,255,230
Development fees and other 72,359 103,282 899,696
------------- ------------- -------------
Net revenues 4,596,806 2,264,633 2,154,926
COST OF SALES (Note 4) 2,329,211 1,382,999 1,072,691
------------- ------------- -------------
GROSS PROFIT 2,267,595 881,634 1,082,235
------------- ------------- -------------
OPERATING EXPENSES:
Research and development (Note 4) 1,219,456 717,994 378,471
Sales and marketing 1,449,189 1,054,602 516,866
General and administrative (Note 8) 1,988,213 2,193,855 1,049,878
Compensation in connection with common stock and common
stock options issued for services rendered (Note 6) 333,029 733,165
------------- ------------- -------------
Total operating expenses 4,989,887 3,966,451 2,678,380
------------- ------------- -------------
OPERATING LOSS (2,722,292) (3,084,817) (1,596,145)
------------- ------------- -------------
OTHER INCOME (EXPENSE):
Interest income 75,858 35,430 16,994
Interest expense (16,428) (374,175) (7,045)
Amortization of deferred loan costs (1,035,200)
Other expense, net (4,058) (14,614) (3,258)
------------- ------------- -------------
Total other income (expense) 55,372 (1,388,559) 6,691
------------- ------------- -------------
LOSS BEFORE INCOME TAXES (2,666,920) (4,473,376) (1,589,454)
PROVISION FOR INCOME TAXES (Note 7) 1,600 1,600 1,600
------------- ------------- -------------
LOSS FROM CONTINUING OPERATIONS (2,668,520) (4,474,976) (1,591,054)
------------- ------------- -------------
DISCONTINUED OPERATIONS (Note 9):
Loss from operations of discontinued music division (111,106)
Operating loss and loss on disposal of discontinued
music division during phase-out period (32,000)
-------------
Loss from discontinued operations (143,106)
-------------
NET LOSS $ (2,668,520) $ (4,474,976) $ (1,734,160)
============= ============= =============
NET LOSS PER COMMON SHARE:
Loss from continuing operations $ (0.61) $ (2.44) $ (0.85)
Loss from discontinued operations (0.08)
------------- ------------- -------------
Net loss per common share $ (0.61) $ (2.44) $ (0.93)
============= ============= =============
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING 4,368,462 1,837,759 1,862,908
============= ============= =============
</TABLE>
See accompanying notes to consolidated financial statements.
- 3 -
<PAGE>
SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIENCY)
YEARS ENDED JUNE 30, 1997, 1996 AND 1995
<TABLE>
- ---------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
Common Stock Additional
------------------- Paid-in Accumulated
Shares Amount Warrants Capital Deficit Total
<S> <C> <C> <C> <C> <C> <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 59,238 59 706,048 706,107
Shares issued for services performed in
connection with private offering 42,227 42 504,644 504,686
Offering costs (504,686) (504,686)
Issuance of stock options for services 733,165 733,165
Issuance of common stock in connection
with exercise of options 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 $ 263,350 263,350
Cancellation of shares in connection with
settlement (15,120) (15) 15
Cancellation of shares for which the Company
had not received paid commissions (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)
Issuance of common stock in connection with
public offering, net of offering costs of
$2,297,408 (Note 5) 2,560,000 2,560 7,964,581 7,967,141
Issuance of common stock in connection
with exercise of employee stock options
(Note 6) 41,275 41 2,436 2,477
Issuance of warrants in connection with
public offering (Note 5) 337,411 337,411
Issuance of warrants in connection with
the conversion of a note payable and
accrued interest to related party 504,164 504,164
Issuance of stock options for services 333,029 333,029
Net loss (2,668,520) (2,668,520)
--------- ------ ---------- ----------- ------------ ----------
BALANCES, JUNE 30, 1997 4,409,099 $4,409 $1,104,925 $13,424,622 $(13,256,072) $1,277,884
========= ====== ========== =========== ============ ==========
</TABLE>
See accompanying notes to consolidated financial statements.
- 4 -
<PAGE>
SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED JUNE 30, 1997, 1996 AND 1995
<TABLE>
- --------------------------------------------------------------------------------------------------------
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Loss from continuing operations $(2,668,520) $(4,474,976) $(1,591,054)
Adjustments to reconcile loss from continuing
operations to net cash used in operating
activities:
Depreciation and amortization 108,007 45,230 27,541
Bad debts 663,421 40,000
Allowance for inventories 201,499
Common stock and stock options issued for
services rendered 333,029 733,165
Changes in operating assets and liabilities:
Accounts receivable (448,214) (1,515,497) (38,946)
Inventories 33,980 (313,836) (99,576)
Prepaid royalties (926,587) (147,264) 1,537
Prepaid expenses and other (62,009) (15,864)
Accounts payable and accrued expenses 240,714 308,462 (33,292)
Accrued interest (363,531) 367,695
Commissions payable (159,593) 114,786
Accrued royalties 1,067,637 291 (20,697)
Deferred revenue (72,360) 20,360 (8,795)
------------ ------------ ------------
Net cash used in continuing operations (2,757,854) (5,020,072) (875,331)
------------ ------------ ------------
Net loss from discontinued operations (143,106)
Reserve for estimated loss on disposal 32,000
Depreciation 8,878
Changes in operating assets and liabilities:
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:
Purchase of property and equipment (345,395) (90,985) (38,876)
Other assets (1,653) (9,840)
------------ ------------ ------------
Net cash used in investing activities of
continuing operations
(347,048) (100,825) (38,876)
------------ ------------ ------------
</TABLE>
See accompanying notes to consolidated financial statements.
(Continued)
- 5 -
<PAGE>
SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED JUNE 30, 1997, 1996 AND 1995
<TABLE>
- --------------------------------------------------------------------------------------------
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
CASH FLOWS FROM INVESTING ACTIVITIES
OF DISCONTINUED OPERATIONS -
Purchase of property and equipment $ (6,665)
----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of common stock $ 8,590,522 684,107
Proceeds from issuance of warrants 337,411 $ 263,350
Proceeds from issuance of notes payable 5,306,700
Repayments of notes payable (4,987,500) (319,200) (19,587)
Notes payable to officers (13,500) 13,500
Note payable to related party 500,000
Deferred offering costs (620,904)
Payments on capital lease obligations (27,057) (27,294) (13,678)
Short-term advance (400,000) 400,000
----------- ---------- ----------
Net cash provided by financing activities 3,513,376 5,089,152 1,064,342
----------- ---------- ----------
NET CHANGE IN CASH AND CASH EQUIVALENTS 408,474 (31,745) 59,133
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 181,985 213,730 154,597
----------- ---------- ----------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 590,459 $ 181,985 $ 213,730
=========== ========== ==========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION -
Cash paid during the year for:
Interest $ 16,428 $ 6,480 $ 9,742
=========== ========== ==========
Income taxes $ 1,600 $ 1,600 $ 1,600
=========== ========== ==========
</TABLE>
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
During 1997, the Company issued warrants in exchange for a $500,000 note
payable to a related party plus accrued interest of $4,164.
During the fiscal years ended June 30 ,1996 and 1995, the Company purchased
property and equipment valued of $38,471 and $8,979 through the issuance of
capital leases (see Notes 3 and 4).
During the fiscal year ended June 30, 1995, the Company repaid a note to an
affiliate of a stockholder totaling $22,000 through issuance of common stock
shares in connection with a private placement.
See accompanying notes to consolidated financial statements.
(Concluded)
- 6 -
<PAGE>
SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 1997, 1996 AND 1995
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION - Sound Source Interactive, Inc. (a Delaware
Corporation) through its wholly owned subsidiary Sound Source Interactive
Inc. (a California Corporation) (collectively, the "Company") creates,
develops, produces, publishes, distributes and otherwise exploits, worldwide,
interactive educational and entertainment software properties for personal
computers. Significant intercompany transactions and balances have been
eliminated.
HISTORICAL LOSSES - As shown in the accompanying consolidated financial
statements, the Company has incurred net losses of $2,668,520, $4,474,976 and
$1,734,160 for the years ended June 30, 1997, 1996 and 1995, respectively.
The Company has not historically generated sufficient cash flows to fund
operations. The Company has had to rely on debt and equity financings to
fund operations. The future success of the Company is largely dependent upon
the Company's ability to generate revenues sufficient to fund operations.
Subsequent to June 30, 1997, the Company secured additional financing (see
Note 10) to fund the working capital deficiency and growth expected in the
next twelve months.
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 carrying amounts of cash and cash
equivalents, accounts receivable and accounts payable approximate fair value
because of the short-term maturity of these instruments. Notes payable are
carried at amounts approximating fair values based on current rates offered
to the Company for debt with similar collateral and guarantees, if any, and
maturities. The fair value of notes payable to related parties could not be
determined due to the related party nature of the obligations.
CONCENTRATION OF CREDIT RISK - The Company at times maintains cash balances
at certain financial institutions in excess of federally insured deposits.
The Company performs periodic credit evaluations of its customers and
maintains allowances for potential credit losses. The Company estimates
credit losses 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.
Simon & Schuster Interactive Distribution Services ("SSIDS") accounted for
65% of consolidated revenues for the year ended June 30, 1997 (see Note 4).
The Company's former principal distributor accounted for 83% of consolidated
revenues in 1996 and sales to one customer accounted for 18% of 1995
consolidated revenues. The Company's accounts receivable at June 30, 1997
are primarily due from SSIDS and the Company's European distributor, One Stop
Direct Ltd.
No one company accounted for more than 10% of consolidated purchases for the
years ended June 30, 1997 and 1995. The Company purchased certain products
from two companies, which accounted for
- 7 -
<PAGE>
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.
RISK 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.
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 licensor.
Distribution
The Company entered into a distribution agreement with SSIDS which 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
original term of the agreement is for two years and expires May 31, 1998.
The Company is substantially dependent upon SSIDS for the marketing and
selling of its products throughout North America during the term of this
agreement. SSIDS, however, is not obligated to sell any specified minimum
quantity of the Company's products. There can be no assurance as to the
value of product sales that may be achieved by the distributor.
CASH AND CASH EQUIVALENTS - The Company considers all highly liquid
investments with original maturities of 90 days or less to be cash
equivalents.
INVENTORIES - Inventories, which consist primarily of software media and
related packaging materials, are stated at the lower of cost or market with
cost determined on a first-in, first-out (FIFO) basis.
- 8 -
<PAGE>
PROPERTY AND EQUIPMENT - Property and equipment are stated at cost less
accumulated depreciation and amortization. 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. Leasehold
improvements are amortized over the shorter of the lease term or the
estimated life of the improvement. Repairs and maintenance are charged to
expense as incurred; replacements and betterments are capitalized.
LONG-LIVED ASSETS - As of each balance sheet date, the Company evaluates the
recovery of its long-lived assets and recognizes impairment if it is probable
that the recorded amounts are not recoverable based upon future undiscounted
cash flows or if there is an event or change in circumstances which indicate
that the carrying amount of an asset may not be recoverable.
ROYALTIES - The Company enters into license agreements with movie studios,
actors and sound developers for recognized movie and television properties
which require the Company to pay upfront minimum guarantees against future
royalties. 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 expensed at the contractual royalty rate
based on actual net product sales. Royalty liabilities in excess of the
minimum guaranteed amount are recorded when such amounts are earned by the
licensor.
The Company periodically assesses the recoverability of prepaid royalties by
determining whether the minimum guarantee will be recovered through
anticipated future sales on a product by product basis. Any amounts not
expected to be recovered are charged to operations in the period assessed by
management. For the years ended June 30, 1997, 1996 and 1995, $40,000,
$99,798 and $66,559, respectively, of such royalties were charged to cost of
sales in the accompanying consolidated statements of operations.
INCOME TAXES - Deferred income taxes are provided for temporary differences
between the financial statement and income tax bases of the Company's assets
and liabilities, based on enacted tax rates. A valuation allowance is
provided when it is more likely than not that some portion or all of the
deferred income tax assets will not be realized.
REVENUE RECOGNITION - Direct-to-the-customer sales are recognized when
merchandise is shipped to customers and is recorded net of discounts,
allowances and estimated merchandise returns. While the Company has no
obligation 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 charged
to cost of sales as incurred in the accompanying consolidated statements of
operations.
Revenue from third party distributors are recognized as reported by such
distributors, net of distribution fees, and estimated returns. Reserves for
returns are based on management's evaluation of historical experience and
current industry trends.
SOFTWARE DEVELOPMENT COSTS - In accordance with Statement of Financial
Accounting Standards ("SFAS") No. 86, "Accounting for the Cost of Capitalized
Software to be Sold, Leased or Otherwise Marketed", the Company examines its
software development costs after technological feasibility has been
established to determine if capitalization is required. Through June 30,
1997, all software development costs have been expensed.
- 9 -
<PAGE>
STOCK-BASED COMPENSATION - In fiscal 1997, the Company adopted the disclosure
only provisions of SFAS No. 123. The Company continues to account for its
stock compensation arrangements using the intrinsic value method in
accordance with Accounting Principles Board ("APB") Opinion No. 25,
"Accounting for Stock Issued to Employees."
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.
The accompanying consolidated financial statements have been adjusted to
reflect the reverse stock split for all periods presented.
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, 1997, 1996 and 1995 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, except as discussed below.
For 1996 and 1995, pursuant to Securities and Exchange Commission Staff
Bulletin No. 83, common shares issued for consideration below the Company's
initial public offering ("IPO") ($4.00 per share) price and stock options
granted (see Note 6) with exercise prices below the IPO price during the
twelve-month period preceding the date of the IPO have been included in the
calculation of common share equivalents, using the treasury stock method, as
if they were outstanding for each period presented, including loss years
where the impact is anti-dilutive.
The only securities issued within twelve months of the IPO 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 6).
The computations of the weighted average common shares and equivalents
outstanding follows:
<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
Weighted average common shares outstanding
during the period 4,368,462 1,822,759 1,847,908
Incremental shares assumed to be outstanding
related to stock options granted - 15,000 15,000
--------- --------- ---------
Weighted average common shares and equivalents
outstanding 4,368,462 1,837,759 1,862,908
========= ========= =========
</TABLE>
RECLASSIFICATIONS - Certain reclassifications have been made to the 1996 and
1995 consolidated financial statements to conform with the current year's
presentation.
RECENT ISSUED ACCOUNTING PRONOUNCEMENTS - In February 1997, the Financial
Accounting Standards Board issued SFAS No. 128, "Earnings Per Share." The
statement is effective for interim periods and fiscal years ending after
December 15, 1997. The Company does not expect that the statement will have
a material effect on the Company's consolidated financial statements.
- 10 -
<PAGE>
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Reporting Comprehensive Income" and No. 131, "Disclosure about Segments of
an Enterprise and Related Information." These statements are effective for
financial statements issued for periods beginning after December 15, 1997.
The Company has not yet determined the impact of adopting these statements.
2. INVENTORIES
Inventories consisted of the following as of June 30:
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Finished goods $151,282 $159,151
Raw materials (components) 77,395 103,506
-------- --------
$228,677 $262,657
======== ========
</TABLE>
3. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following as of June 30:
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Leasehold improvements $ 7,781
Computer equipment 548,462 $ 246,107
Office furniture and equipment 96,173 60,914
--------- ---------
652,416 307,021
Accumulated depreciation and amortization (237,961) (129,954)
--------- ---------
$ 414,455 $ 177,067
========= =========
</TABLE>
As of June 30, 1997 and 1996, the Company had property and equipment with a
total cost of $86,723, of assets recorded under capital leases (see Note 4).
4. COMMITMENTS AND CONTINGENCIES
EMPLOYMENT CONTRACTS - The Company has entered into employment contracts with
four of its employees, including two officers, which expire on various dates
through February 1999 and provide for certain expense allowances.
Future minimum base salaries, by year and in the aggregate, consist of the
following as of June 30, 1997:
<TABLE>
<CAPTION>
YEARS ENDING
June 30,
<S> <C>
1998 $573,800
1999 61,667
--------
$635,467
========
</TABLE>
- 11 -
<PAGE>
Certain of the employment contracts provide for commissions based on net
revenues. Commissions under employment contracts for the years ended June 30,
1997, 1996 and 1995, related to continuing operations amounted to $41,633,
$66,067 and $132,078, respectively, and are included in sales and marketing
expense in the accompanying consolidated statements of operations.
OPERATING LEASES - The Company leases its facilities and certain equipment under
noncancelable operating leases which expire at various dates through May 2002.
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 sheets.
Future minimum lease payments as of June 30, 1997, due through May 31, 2002
under such leases total are as follows:
<TABLE>
<CAPTION>
OPERATING LEASE RENT DEFERRED
LEASES PAYMENTS EXPENSE RENT
<S> <C> <C> <C>
1997 $ 12,058 $ 35,008 $ (22,950)
1998 144,698 140,031 4,667
1999 144,698 140,031 4,667
2000 144,698 140,031 4,667
2001 144,698 140,031 4,667
2002 132,642 128,360 4,282
--------- --------- ---------
$ 723,492 $ 723,492 $ -
========= ========= =========
</TABLE>
Rent expense under operating lease agreements totaled $106,474, $89,192 and
$94,006 for the years ended June 30, 1997, 1996 and 1995, respectively, and are
included in general and administrative expenses in the accompanying consolidated
statements of operations.
CAPITAL LEASES - The Company leases certain equipment and computers under
capital lease obligations with interest rates ranging from 17.38% to 27.93% per
annum.
Future minimum lease payments, by year and in the aggregate, under capital
leases for equipment and computers consist of the following as of June 30, 1997:
<TABLE>
<CAPTION>
YEARS ENDING
JUNE 30,
<S> <C>
1998 $ 12,787
1999 3,151
--------
15,938
Less amount representing interest (2,126)
--------
Present value of net minimum lease payments 13,812
Less current portion (11,398)
--------
$ 2,414
========
-12-
</TABLE>
<PAGE>
SIMON & SCHUSTER DISTRIBUTION AGREEMENT - Effective June 1, 1996, the Company
entered into a two -year distribution services agreement with SSIDS. SSIDS
is the consumer software distribution unit of Simon & Schuster, Inc., the
publishing operations of Viacom, Inc. Pursuant to this new distribution
agreement, SSIDS provides 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 is exclusive except with regard to 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.
Pursuant to the agreement, SSIDS makes monthly payments 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 are due not later than 75 days after the calendar
month in question. Under the agreement with SSIDS, SSIDS is responsible for
collection of accounts receivable and the Company remains liable for product
returns.
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 sales and marketing expenses and
$33,759 is included in cost of sales in the accompanying consolidated
statements of operations. Effective February 1997, the consultant became an
employee of the Company. Royalties paid to this consultant in 1997 are
$37,769.
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. For the years ended June 30, 1997 and 1996, the
Company paid a total of $403,036 and $146,416, respectively, under such
agreements. No amounts were paid under such agreements during the year ended
June 30, 1995. Of such amounts, $403,036 and $113,125 are included in
research and development expenses for 1997 and 1996, respectively, and $0 and
$33,291 are included in cost of sales for 1997 and 1996, respectively, in the
accompanying consolidated statements of operations.
LITIGATION - Effective April 1, 1996, the Company and a former distributor
("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.
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 on August 26, 1996 and bearing interest at 10% per annum.
Such note 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 was no longer
obligated to repay the short-term advance totaling $400,000.
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.
On December 13, 1996, the Company filed suit in Superior Court for the County
of Los Angeles, California, against Acclaim seeking compensatory damages of
at least $2,124,259 and consequential
- 13 -
<PAGE>
damages of at least $20,000,000 arising out of Acclaim's alleged breach of
its exclusive worldwide distribution agreement with the Company and other
related matters. Based on the Company's own accounting, it has recorded an
additional $703,421 in accounts receivable from Acclaim, which has been fully
reserved for, due to disputes and discrepancies in the information as
reported by Acclaim.
5. COMMON STOCK
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 at $.25 per warrant. Net proceeds totaled $7,372,980, net of
offering costs of $2,208,625, related to the common stock, and $295,160
related to the redeemable warrants. 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 totaled $594,161, net of offering
costs of $88,783, related to the common stock, and $42,251 related to the
redeemable warrants.
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 on July 1, 1997, the redeemable warrants are
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 or redemption.
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 their 1995 private placement aggregating $4,987,500 plus accrued
interest of $373,753. The notes accrued interest at 10% per annum and were
secured by substantially all of the assets of the Company. The notes were
due upon the earlier of the Company's successful completion of an IPO or
September 1, 1996.
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 8) of $500,000, plus accrued interest of $4,164.
6. 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. Options are granted at the
discretion of a member committee (the "Committee") consisting of individuals
from these potential grantees.
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.
Stock options may be granted under 1992 Plan as non-qualified stock options
or incentive stock options. Incentive stock options may not be granted at a
price less than 100% of the fair market value of the
- 14 -
<PAGE>
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 less than
85% of the 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 under the 1992 Plan.
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 stock on the date of grant. Stock appreciation
rights may be exercised during a period of time fixed by the Committee.
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 of 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.
For the year ended June 30, 1997 and 1995, an aggregate of $333,029 and
$733,165, respectively, was charged to operating expenses for the options
vested during those years. No related expense was recognized in fiscal 1996.
On September 22, 1995, the Board of Directors resolved that no additional
shares shall be issued under the 1992 Plan.
THE 1995 STOCK OPTION PLAN - Pursuant to the Company's restated 1995 stock
option plan (the "1995 Plan"), the Company may 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, or in the form of non-qualified stock options. The 1995 Plan
terminates October 31, 2005 and is administered by a committee appointed by
the Board of Directors of the Company.
Incentive stock options under the 1995 Plan are 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).
- 15 -
<PAGE>
The term of each Option may not exceed 10 years from the date of grant (5 years
for any 10% stockholder). Vesting of the options is determined 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 employment, the holder
has 30 days to exercise any options held.
The following table summarizes option transactions during the three years ended
June 30, 1997 under both of the aforementioned plans:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
NUMBER PRICE
OF SHARES PER SHARE
<S> <C> <C>
Balances at July 1, 1994 491,968 $0.06
Exercised (4,184) $0.06
Canceled (12,550) $0.06
--------- -----
Balances at June 30, 1995 475,234 $0.06
Granted 300,000 $4.13
Canceled (100,000) $5.00
--------- -----
Balances at June 30, 1996 675,234 $1.26
Granted 405,857 $4.04
Exercised (41,275) $0.06
Canceled (20,952) $2.35
--------- -----
Balances as of June 30, 1997 1,018,864 $2.32
========= =====
Vested as of June 30, 1997 583,340
=========
</TABLE>
The following summarizes pricing and term information for options outstanding as
of June 30, 1997:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------------------- --------------------------
WEIGHTED
NUMBER AVERAGE WEIGHTED WEIGHTED
RANGE OF OUTSTANDING REMAINING AVERAGE EXERCISABLE AVERAGE
EXERCISE AT JUNE 30, CONTRACTUAL EXERCISE AT JUNE 30, EXERCISE
PRICES 1997 LIFE PRICE 1997 PRICE
<S> <C> <C> <C> <C> <C>
$ 0.06 425,174 7 years $0.06 383,340 $0.06
3.40 100,000 8 3.40 100,000 3.40
4.00 462,690 8.6 4.00 100,000 4.00
4.56-4.63 31,000 8 4.56 - -
---------- ---------
$0.06-4.63 1,018,864 7.9 $2.32 583,340 $1.31
========== =========
</TABLE>
The Company has adopted the disclosure-only provisions of SFAS 123, "Accounting
for Stock-Based Compensation." The estimated fair value of options granted
during 1997 and 1996 pursuant to SFAS 123 was approximately $1,023,193 and
$466,398, respectively. Had the Company adopted SFAS 123, pro forma net loss
would have been $3,183,357 and $4,689,267, and pro forma net loss per share
would have been $(0.72) and $(2.55) for 1997 and 1996, respectively. The fair
value of each
-16-
<PAGE>
option grant was estimated using the Black-Scholes option-pricing model with
the following weighted average assumptions: dividend yield of zero,
volatility of 40%, a risk free interest rate of 6.28% and expected option
lives of 10 years.
7. INCOME TAXES
The provision for income taxes from continuing operations for the years ended
June 30, 1997, 1996 and 1995 is comprised of minimum state taxes only.
A reconciliation of the provision for income taxes from continuing operations
with the expected income tax benefit computed by applying the federal
statutory income tax rate to loss from continuing operations before provision
for income taxes for the years ended June 30, 1997, 1996 and 1995 is as
follows:
<TABLE>
<CAPTION>
1997 1996 1995
------------------- --------------------- -------------------
$ % $ % $ %
<S> <C> <C> <C> <C> <C> <C>
Income tax benefit computed at
federal statutory tax rate $ (933,422) (35.0) $ (1,520,948) (34.0) $ (513,486) (34.0)
State and local taxes 1,600 1,600 1,600
Expenses not deductible for income
tax purposes 8,817 3,774 252,173 15.9
Change in the balance allocated to
income tax benefit 924,605 35.0 1,517,174 34.0 261,313 18.1
---------- ----- ------------- ----- ---------- -----
$ 1,600 - $ 1,600 - $ 1,600 -
========== ===== ============= ===== ========== =====
</TABLE>
The components of the net deferred income tax asset recorded in the
accompanying consolidated balance sheets as of June 30, 1997 and 1996 are as
follows:
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Reserves, principally due to allowance for sales returns
and obsolete inventory $ 281,360 $ 363,213
Accrued liabilities, principally due to accrual for financial
reporting purposes 1,373,227 1,811,583
Net operating loss carryforwards
3,936,250 2,129,913
Less valuation allowance (5,590,837) (4,304,709)
----------- -----------
$ - $ -
=========== ===========
</TABLE>
The valuation allowance increased $1,286,128 during the year ended June 30,
1997.
At June 30, 1997, the Company had federal and state net operating loss
carryforwards of approximately $9,708,000 and $6,830,000, respectively,
available to offset future taxable federal and state income. The federal and
state carryforwards amounts expire in varying amounts through 2012 and 2002,
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. The change
-17-
<PAGE>
of ownership that occurred during fiscal 1997 as a result of the IPO caused
the limitation of the Company's net operating loss carryforwards. However,
the limitations are not expected to have a material impact on the Company's
ability to use such net operating loss carryforwards.
8. RELATED PARTY TRANSACTIONS
NOTE PAYABLE TO RELATED PARTY - On May 30, 1996, ASSI, Inc., a stockholder,
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 5).
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 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
5), except that they became 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 stockholders
of the Company.
LEGAL SERVICE - A related party performed legal services on behalf of the
Company. The Company incurred $44,576 for the year ended June 30, 1997 which
is included in general and administrative expenses.
9. 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, 1997, $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.
- 18 -
<PAGE>
As of June 30, 1997 and 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>
10. SUBSEQUENT EVENTS
In September 1997, the Company entered into a factoring agreement with
Silicon Valley Financial Services, a division of Silicon Valley Bank. The
factoring agreement provides up to $1,500,000 of the Company's qualified
gross domestic accounts receivable, as defined in the agreement, at a rate of
1.75% per month of the average gross daily factoring account balance. The
credit is secured by all the assets of the Company and matures one year from
the date of the agreement.
- 19 -
<PAGE>
SILICON VALLEY FINANCIAL SERVICES
A Division of Silicon Valley Bank
3003 Tasman Drive
Santa Clara, Ca. 95054
(408) 654-1000 - Fax (408) 980-6410
FACTORING AGREEMENT
This Factoring Agreement (the "Agreement") is made on this NINETEENTH day
of SEPTEMBER, 1997, by and between Silicon Valley Financial Services (a division
of Silicon Valley Bank) ("Buyer") having a place of business at the address
specified above and SOUND SOURCE INTERACTIVE, INC., a DELAWARE corporation,
("Seller") having its principal place of business and chief executive office at
Street Address: 26115 Mureau Ste. B
City: Calabasas
County: Los Angeles
State: California
Zip code: 91302
Fax: 818/878-0007
1. DEFINITIONS. When used herein, the following terms shall have the following
meanings.
1.1. "Account Balance" shall mean, on any given day, the gross amount of all
Purchased Receivables unpaid on that day.
1.2. "Account Debtor" shall have the meaning set forth in the California
Uniform Commercial Code and shall include any person liable on any Purchased
Receivable, including without limitation, any guarantor of the Purchased
Receivable and any issuer of a letter of credit or banker's acceptance.
1.3. "Adjustments" shall mean all discounts, allowances, returns, disputes,
counterclaims, offsets, defenses, rights of recoupment, rights of return,
warranty claims, or short payments, asserted by or on behalf of any Account
Debtor with respect to any Purchased Receivable.
1.4. "Administrative Fee" shall have the meaning as set forth in Section 3.3
hereof.
1.5. "Advance" shall have the meaning set forth in Section 2.2 hereof.
1.6. "Collateral" shall have the meaning set forth in Section 8 hereof.
1.7. "Collections" shall mean all good funds received by Buyer from or on
behalf of an Account Debtor with respect to Purchased Receivables.
1.8 "Compliance Certificate" shall mean a certificate, in a form provided
by Buyer to Seller, which contains the certification of the chief financial
officer of Seller that, among other things, the
<PAGE>
representations and warranties set forth in this Agreement are true and correct
as of the date such certificate is delivered.
1.9. "Event of Default" shall have the meaning set forth in Section 9
hereof.
1.10. "Finance Charges" shall have the meaning set forth in Section 3.2
hereof.
1.11. "Invoice Transmittal" shall mean a writing signed by an authorized
representative of Seller which accurately identifies the receivables which
Buyer, at its election, may purchase, and includes for each such receivable the
correct amount owed by the Account Debtor, the name and address of the Account
Debtor, the invoice number, the invoice date and the account code.
1.12. "Obligations" shall mean all advances, financial accommodations,
liabilities, obligations, covenants and duties owing, arising, due or payable by
Seller to Buyer of any kind or nature, present or future, arising under or in
connection with this Agreement or under any other document, instrument or
agreement, whether or not evidenced by any note, guarantee or other instrument,
whether arising on account or by overdraft, whether direct or indirect
(including those acquired by assignment) absolute or contingent, primary or
secondary, due or to become due, now owing or hereafter arising, and however
acquired; including, without limitation, all Advances, Finance Charges,
Administrative Fees, interest, Repurchase Amounts, fees, expenses, professional
fees and attorneys' fees and any other sums chargeable to Seller hereunder or
otherwise.
1.13. "Purchased Receivables" shall mean all those accounts, receivables,
chattel paper, instruments, contract rights, documents, general intangibles,
letters of credit, drafts, bankers acceptances, and rights to payment, and all
proceeds thereof (all of the foregoing being referred to as "receivables"),
arising out of the invoices and other agreements identified on or delivered with
any Invoice Transmittal delivered by Seller to Buyer which Buyer elects to
purchase and for which Buyer makes an Advance.
1.14. "Refund" shall have the meaning set forth in Section 3.5 hereof.
1.15. "Reserve" shall have the meaning set forth in Section 2.4 hereof.
1.16. "Repurchase Amount" shall have the meaning set forth in Section 4.2
hereof.
1.17. "Reconciliation Date" shall mean the last calendar day of each
Reconciliation Period.
1.18. "Reconciliation Period" shall mean each calendar month of every year.
2. PURCHASE AND SALE OF RECEIVABLES.
2.1. OFFER TO SELL RECEIVABLES. During the term hereof, and provided that
there does not then exist any Event of Default or any event that with notice,
lapse of time or otherwise would constitute an Event of Default, Seller may
request that Buyer purchase receivables and Buyer may, in its sole discretion,
elect to purchase receivables. Seller shall deliver to Buyer an Invoice
Transmittal with respect to any receivable for which a request for purchase is
made. An authorized representative of Seller shall sign each Invoice
Transmittal delivered to Buyer. Buyer shall be entitled to rely on all the
information provided by Seller to Buyer on or with the Invoice Transmittal and
to rely on the signature on any Invoice Transmittal as an authorized signature
of Seller.
2.2. ACCEPTANCE OF RECEIVABLES. Buyer shall have no obligation to purchase
any receivable listed on an Invoice Transmittal. Buyer may exercise its sole
discretion in approving the credit of each Account Debtor before buying any
receivable. Upon acceptance by Buyer of all or any of the receivables described
on any Invoice Transmittal, Buyer shall pay to Seller 85 (%) percent of the face
------
amount of each receivable Buyer desires to purchase. Such payment shall be the
"Advance" with respect to such receivable. Buyer may, from time to time, in its
sole discretion, change the percentage of the Advance. Upon Buyer's acceptance
of the receivable and payment to Seller of the Advance, the receivable shall
become a "Purchased Receivable." It shall be a condition to each Advance that
(i) all of the representations and warranties set forth in Section 6 of this
Agreement be true and correct on and as of the date of the related Invoice
Transmittal and on and as of the date of such Advance as though made at and as
of each such date, and (ii) no Event of Default or any event or condition that
with notice, lapse of time or otherwise would constitute an Event of Default
shall have occurred and be continuing, or would result from such Advance.
Notwithstanding the foregoing, in no event shall the aggregate amount of all
Purchased Receivables outstanding at any time exceed ONE MILLION FIVE HUNDRED
THOUSAND AND NO/100 **** Dollars ($1,500,000.00).
<PAGE>
2.3. EFFECTIVENESS OF SALE TO BUYER. Effective upon Buyer's payment of an
Advance, and for and in consideration therefor and in consideration of the
covenants of this Agreement, Seller hereby absolutely sells, transfers and
assigns to Buyer, all of Seller's right, title and interest in and to each
Purchased Receivable and all monies due or which may become due on or with
respect to such Purchased Receivable. Buyer shall be the absolute owner of each
Purchased Receivable. Buyer shall have, with respect to any goods related to
the Purchased Receivable, all the rights and remedies of an unpaid seller under
the California Uniform Commercial Code and other applicable law, including the
rights of replevin, claim and delivery, reclamation and stoppage in transit.
2.4. ESTABLISHMENT OF A RESERVE. Upon the purchase by Buyer of each
Purchased Receivable, Buyer shall establish a reserve. The reserve shall be the
amount by which the face amount of the Purchased Receivable exceeds the Advance
on that Purchased Receivable (the "Reserve"); provided, the Reserve with respect
to all Purchased Receivables outstanding at any one time shall be an amount not
less than 15 (%) percent of the Account Balance at that time and may be set at a
------
higher percentage at Buyer's sole discretion. The reserve shall be a book
balance maintained on the records of Buyer and shall not be a segregated fund.
3. COLLECTIONS, CHARGES AND REMITTANCES.
3.1. COLLECTIONS. Upon receipt by Buyer of Collections, Buyer shall promptly
credit such Collections to Seller's Account Balance on a daily basis; provided,
that if Seller is in default under this Agreement, Buyer shall apply all
Collections to Seller's Obligations hereunder in such order and manner as Buyer
may determine. If an item of collection is not honored or Buyer does not receive
good funds for any reason, the amount shall be included in the Account Balance
as if the Collections had not been received and Finance Charges under Section
3.2 shall accrue thereon.
3.2. FINANCE CHARGES. On each Reconciliation Date Seller shall pay to Buyer
a finance charge in an amount equal to 1.75 (%) percent per month of the average
--------
daily Account Balance outstanding during the applicable Reconciliation Period
(the "Finance Charges"). Buyer shall deduct the accrued Finance Charges from the
Reserve as set forth in Section 3.5 below.
3.3. ADMINISTRATIVE FEE. On each Reconciliation Date Seller shall pay to
Buyer an Administrative Fee equal to .50 (%) percent of the face amount of each
-------
Purchased Receivable first purchased during that Reconciliation Period (the
"Administrative Fee"). Buyer shall deduct the Administrative Fee from the
Reserve as set forth in Section 3.5 below.
3.4. ACCOUNTING. Buyer shall prepare and send to Seller after the close of
business for each Reconciliation Period, an accounting of the transactions for
that Reconciliation Period, including the amount of all Purchased Receivables,
all Collections, Adjustments, Finance Charges, and the Administrative Fee. The
accounting shall be deemed correct and conclusive unless Seller makes written
objection to Buyer within thirty (30) days after the Buyer mails the accounting
to Seller.
3.5. REFUND TO SELLER. Provided that there does not then exist an Event of
Default or any event or condition that with notice, lapse of time or otherwise
would constitute an Event of Default, Buyer shall refund to Seller by check
after the Reconciliation Date, the amount, if any, which Buyer owes to Seller at
the end of the Reconciliation Period according to the accounting prepared by
Buyer for that Reconciliation Period (the "Refund"). The Refund shall be an
amount equal to:
(A) (1) The Reserve as of the beginning of that Reconciliation Period,
PLUS
(2) the Reserve created for each Purchased Receivable purchased during
that Reconciliation Period, MINUS
(B) The total for that Reconciliation Period of:
(1) the Administrative Fee;
(2) Finance Charges;
(3) Adjustments;
<PAGE>
(4) Repurchase Amounts, to the extent Buyer has agreed to accept
payment thereof by deduction from the Refund;
(5) the Reserve for the Account Balance as of the first day of the
following Reconciliation Period in the minimum percentage set
forth in Section 2.4 hereof; and
(6) all amounts due, including professional fees and expenses, as set
forth in Section 12 for which oral or written demand has been made
by Buyer to Seller during that Reconciliation Period to the extent
Buyer has agreed to accept payment thereof by deduction from the
Refund.
In the event the formula set forth in this Section 3.5 results in an amount due
to Buyer from Seller, Seller shall make such payment in the same manner as set
forth in Section 4.3 hereof for repurchases. If the formula set forth in this
Section 3.5 results in an amount due to Seller from Buyer, Buyer shall make such
payment by check, subject to Buyer's rights under Section 4.3 and Buyer's rights
of offset and recoupment.
4. RECOURSE AND REPURCHASE OBLIGATIONS.
4.1. RECOURSE. Buyer's acquisition of Purchased Receivables from Seller
shall be with full recourse against Seller. In the event the Obligations exceed
the amount of Purchased Receivables and Collateral, Seller shall be liable for
any deficiency.
4.2. SELLER'S AGREEMENT TO REPURCHASE. Seller agrees to pay to Buyer on
demand, the full face amount, or any unpaid portion, of any Purchased
Receivable:
(A) which remains unpaid ninety (90) calendar days after the invoice
date; or
(B) which is owed by any Account Debtor who has filed, or has had
filed against it, any bankruptcy case, assignment for the benefit
of creditors, receivership, or insolvency proceeding or who has
become insolvent (as defined in the United States Bankruptcy
Code) or who is generally not paying its debts as such debts
become due; or
(C) with respect to which there has been any breach of warranty or
representation set forth in Section 6 hereof or any breach of any
covenant contained in this Agreement; or
(D) with respect to which the Account Debtor asserts any discount,
allowance, return, dispute, counterclaim, offset, defense, right
of recoupment, right of return, warranty claim, or short payment;
together with all reasonable attorneys' and professional fees and
expenses and all court costs incurred by Buyer in collecting such
Purchased Receivable and/or enforcing its rights under, or
collecting amounts owed by Seller in connection with, this
Agreement (collectively, the "Repurchase Amount").
4.3. SELLER'S PAYMENT OF THE REPURCHASE AMOUNT OR OTHER AMOUNTS DUE BUYER.
When any Repurchase Amount or other amount owing to Buyer becomes due, Buyer
shall inform Seller of the manner of payment which may be any one or more of the
following in Buyer's sole discretion: (a) in cash immediately upon demand
therefor; (b) by delivery of substitute invoices and an Invoice Transmittal
acceptable to Buyer which shall thereupon become Purchased Receivables; (c) by
adjustment to the Reserve pursuant to Section 3.5 hereof; (d) by deduction from
or offset against the Refund that would otherwise be due and payable to Seller;
(e) by deduction from or offset against the amount that otherwise would be
forwarded to Seller in respect of any further Advances that may be made by
Buyer; or (f) by any combination of the foregoing as Buyer may from time to
time choose.
4.4. SELLER'S AGREEMENT TO REPURCHASE ALL PURCHASED RECEIVABLES. Upon and
after the occurrence of an Event of Default, Seller shall, upon Buyer's demand
(or, in the case of an Event of Default under Section 9(B), immediately without
notice or demand from Buyer) repurchase all the Purchased Receivables then
outstanding , or such portion thereof as Buyer may demand. Such demand may, at
Buyer's option, include and Seller shall pay to Buyer immediately upon demand,
cash in an amount equal to the Advance with respect to each Purchased Receivable
then outstanding together with all accrued Finance Charges, Adjustments,
Administrative Fees, attorney's and professional fees, court costs and expenses
as provided for herein, and any other Obligations. Upon receipt of payment in
full of the Obligations, Buyer shall immediately instruct Account Debtors to pay
Seller directly, and return to Seller any Refund due to Seller. For the purpose
of calculating any Refund due under this Section only, the Reconciliation Date
shall be deemed to be the date Buyer receives payment in good funds of all the
Obligations as provided in this Section 4.4.
<PAGE>
5. POWER OF ATTORNEY. Seller does hereby irrevocably appoint Buyer and its
successors and assigns as Seller's true and lawful attorney in fact, and hereby
authorizes Buyer, regardless of whether there has been an Event of Default, (a)
to sell, assign, transfer, pledge, compromise, or discharge the whole or any
part of the Purchased Receivables; (b) to demand, collect, receive, sue, and
give releases to any Account Debtor for the monies due or which may become due
upon or with respect to the Purchased Receivables and to compromise, prosecute,
or defend any action, claim, case or proceeding relating to the Purchased
Receivables, including the filing of a claim or the voting of such claims in any
bankruptcy case, all in Buyer's name or Seller's name, as Buyer may choose; (c)
to prepare, file and sign Seller's name on any notice, claim, assignment,
demand, draft, or notice of or satisfaction of lien or mechanics' lien or
similar document with respect to Purchased Receivables; (d) to notify all
Account Debtors with respect to the Purchased Receivables to pay Buyer directly;
(e) to receive, open, and dispose of all mail addressed to Seller for the
purpose of collecting the Purchased Receivables; (f) to endorse Seller's name
on any checks or other forms of payment on the Purchased Receivables; (g) to
execute on behalf of Seller any and all instruments, documents, financing
statements and the like to perfect Buyer's interests in the Purchased
Receivables and Collateral; and (h) to do all acts and things necessary or
expedient, in furtherance of any such purposes. If Buyer receives a check or
item which is payment for both a Purchased Receivable and another receivable,
the funds shall first be applied to the Purchased Receivable and, so long as
there does not exist an Event of Default or an event that with notice, lapse of
time or otherwise would constitute an Event of Default, the excess shall be
remitted to Seller. Upon the occurrence and continuation of an Event of
Default, all of the power of attorney rights granted by Seller to Buyer
hereunder shall be applicable with respect to all Purchased Receivables and all
Collateral.
6. REPRESENTATIONS, WARRANTIES AND COVENANTS.
6.1. RECEIVABLES' WARRANTIES, REPRESENTATIONS AND COVENANTS. To induce Buyer
to buy receivables and to render its services to Seller, and with full knowledge
that the truth and accuracy of the following are being relied upon by the Buyer
in determining whether to accept receivables as Purchased Receivables, Seller
represents, warrants, covenants and agrees, with respect to each Invoice
Transmittal delivered to Buyer and each receivable described therein, that:
(A) Seller is the absolute owner of each receivable set forth in the
Invoice Transmittal and has full legal right to sell, transfer and
assign such receivables;
(B) The correct amount of each receivable is as set forth in the
Invoice Transmittal and is not in dispute;
(C) The payment of each receivable is not contingent upon the
fulfillment of any obligation or contract, past or future and any and
all obligations required of the Seller have been fulfilled as of the
date of the Invoice Transmittal;
(D) Each receivable set forth on the Invoice Transmittal is based on an
actual sale and delivery of goods and/or services actually rendered, is
presently due and owing to Seller, is not past due or in default, has
not been previously sold, assigned, transferred, or pledged, and is
free of any and all liens, security interests and encumbrances other
than liens, security interests or encumbrances in favor of Buyer or any
other division or affiliate of Silicon Valley Bank;
(E) There are no defenses, offsets, or counterclaims against any of the
receivables, and no agreement has been made under which the Account
Debtor may claim any deduction or discount, except as otherwise stated
in the Invoice Transmittal;
(F) Each Purchased Receivable shall be the property of the Buyer and
shall be collected by Buyer, but if for any reason it should be paid to
Seller, Seller shall promptly notify Buyer of such payment, shall hold
any checks, drafts, or monies so received in trust for the benefit of
Buyer, and shall promptly transfer and deliver the same to the Buyer;
(G) Buyer shall have the right of endorsement, and also the right to
require endorsement by Seller, on all payments received in connection
with each Purchased Receivable and any proceeds of Collateral;
(H) Seller, and to Seller's best knowledge, each Account Debtor set
forth in the Invoice Transmittal, are and shall remain solvent as that
term is defined in the United States Bankruptcy Code and
<PAGE>
the California Uniform Commercial Code, and no such Account Debtor has
filed or had filed against it a voluntary or involuntary petition for
relief under the United States Bankruptcy Code;
(I) Each Account Debtor named on the Invoice Transmittal will not
object to the payment for, or the quality or the quantity of the
subject matter of, the receivable and is liable for the amount set
forth on the Invoice Transmittal;
(J) Each Account Debtor shall promptly be notified, after acceptance by
Buyer, that the Purchased Receivable has been transferred to and is
payable to Buyer, and Seller shall not take or permit any action to
countermand such notification; and
(K) All receivables forwarded to and accepted by Buyer after the date
hereof, and thereby becoming Purchased Receivables, shall comply with
each and every one of the foregoing representations, warranties,
covenants and agreements referred to above in this Section 6.1.
6.2. ADDITIONAL WARRANTIES, REPRESENTATIONS AND COVENANTS. In addition to
the foregoing warranties, representations and covenants, to induce Buyer to buy
receivables and to render its services to Seller, Seller hereby represents,
warrants, covenants and agrees that:
(A) Seller will not assign, transfer, sell, or grant , or permit any
lien or security interest in any Purchased Receivables or Collateral to
or in favor of any other party, without Buyer's prior written consent;
(B) The Seller's name, form of organization, chief executive office,
and the place where the records concerning all Purchased Receivables
Collateral are kept is set forth at the beginning of this Agreement,
Collateral is located only at the location set forth in the beginning
of this Agreement, or, if located at any additional location, as set
forth on a schedule attached to this Agreement, and Seller will give
Buyer at least thirty (30) days prior written notice if such name,
organization, chief executive office or other locations of Collateral
or records concerning Purchased Receivables or Collateral is changed or
added and shall execute any documents necessary to perfect Buyer's
interest in the Purchased Receivables and the Collateral.
(C) Seller shall (i) pay all of its normal gross payroll for employees,
and all federal and state taxes, as and when due, including without
limitation all payroll and withholding taxes and state sales taxes;
(ii) deliver at any time and from time to time at Buyer's request,
evidence satisfactory to Buyer that all such amounts have been paid to
the proper taxing authorities; and (iii) if requested by Buyer, pay its
payroll and related taxes through a bank or an independent payroll
service acceptable to Buyer.
(D) Seller has not, as of the time Seller delivers to Buyer an Invoice
Transmittal, or as of the time Seller accepts any Advance from Buyer,
filed a voluntary petition for relief under the United States
Bankruptcy Code or had filed against it an involuntary petition for
relief;
(E) If Seller owns, holds or has any interest in, any copyrights
(whether registered, or unregistered), patents or trademarks, and
licenses of any of the foregoing, such interest has been disclosed to
Buyer and is specifically listed and identified on a schedule to this
Agreement, and Seller shall immediately notify Buyer if Seller
hereafter obtains any interest in any additional copyrights, patents,
trademarks or licenses that are significant in value or are material to
the conduct of its business; and
(F) Seller shall provide Buyer with a Compliance Certificate (i) on a
quarterly basis to be received by Buyer no later than the fifth
calendar day following each calendar quarter, and; (ii) on a more
frequent or other basis if and as requested by Buyer.
7. ADJUSTMENTS. In the event of a breach of any of the representations,
warranties, or covenants set forth in Section 6.1, or in the event any
Adjustment or dispute is asserted by any Account Debtor, Seller shall promptly
advise Buyer and shall, subject to the Buyer's approval, resolve such disputes
and advise Buyer of any adjustments. Unless the disputed Purchased Receivable
is repurchased by Seller and the full Repurchase Amount is paid, Buyer shall
remain the absolute owner of any Purchased Receivable which is subject to
Adjustment or repurchase under Section 4.2 hereof, and any rejected, returned,
or recovered personal property, with the right to take possession thereof at any
time. If such possession is not taken by Buyer, Seller is to resell it for
Buyer's account at Seller's expense with the proceeds made payable to Buyer.
While Seller retains possession of said returned goods, Seller shall segregate
said goods and mark them "property of Silicon Valley Financial Services."
<PAGE>
8. SECURITY INTEREST. To secure the prompt payment and performance to Buyer
of all of the Obligations, Seller hereby grants to Buyer a continuing lien upon
and security interest in all of Seller's now existing or hereafter arising
rights and interest in the following , whether now owned or existing or
hereafter created, acquired, or arising, and wherever located (collectively, the
"Collateral"):
(A) All accounts, receivables, contract rights, chattel paper, instruments,
documents, letters of credit, bankers acceptances, drafts, checks, cash,
securities, and general intangibles (including, without limitation, all
claims, causes of action, deposit accounts, guaranties, rights in and claims
under insurance policies (including rights to premium refunds), rights to
tax refunds, copyrights, patents, trademarks, rights in and under license
agreements, and all other intellectual property);
(B) All inventory, including Seller's rights to any returned or rejected
goods, with respect to which Buyer shall have all the rights of any unpaid
seller, including the rights of replevin, claim and delivery, reclamation,
and stoppage in transit;
(C ) All monies, refunds and other amounts due Seller, including, without
limitation, amounts due Seller under this Agreement (including Seller's
right of offset and recoupment);
(D) All equipment, machinery, furniture, furnishings, fixtures, tools,
supplies and motor vehicles;
(E) All farm products, crops, timber, minerals and the like (including oil
and gas);
(F) All accessions to, substitutions for, and replacements of, all of the
foregoing;
(G) All books and records pertaining to all of the foregoing; and
(H) All proceeds of the foregoing, whether due to voluntary or involuntary
disposition, including insurance proceeds.
Seller is not authorized to sell, assign, transfer or otherwise convey any
Collateral without Buyer's prior written consent, except for the sale of
finished inventory in the Seller's usual course of business. Seller agrees to
sign UCC financing statements, in a form acceptable to Buyer, and any other
instruments and documents requested by Buyer to evidence , perfect, or protect
the interests of Buyer in the Collateral. Seller agrees to deliver to Buyer
the originals of all instruments, chattel paper and documents evidencing or
related to Purchased Receivables and Collateral.
9. DEFAULT. The occurrence of any one or more of the following shall
constitute an Event of Default hereunder.
(A) Seller fails to pay any amount owed to Buyer as and when due;
(B) There shall be commenced by or against Seller any voluntary or
involuntary case under the United States Bankruptcy Code, or any assignment
for the benefit of creditors, or appointment of a receiver or custodian for
any of its assets;
(C) Seller shall become insolvent in that its debts are greater than the
fair value of its assets, or Seller is generally not paying its debts as
they become due or is left with unreasonably small capital;
(D) Any involuntary lien, garnishment, attachment or the like is issued
against or attaches to the Purchased Receivables or any Collateral;
(E) Seller shall breach any covenant, agreement, warranty, or representation
set forth herein, and the same is not cured to Buyer's satisfaction within
ten (10) days after Buyer has given Seller oral or written notice thereof;
provided, that if such breach is incapable of being cured it shall
constitute an immediate default hereunder;
(F) Seller is not in compliance with, or otherwise is in default under, any
term of any document, instrument or agreement evidencing a debt, obligation
or liability of any kind or character of Seller, now or hereafter existing,
in favor of Buyer or any division or affiliate of Silicon Valley Bank,
regardless of whether such debt, obligation or liability is direct or
indirect, primary or secondary, joint, several or joint and several, or
fixed or contingent, together with any and all renewals and extensions of
such debts, obligations and liabilities, or any part thereof;
(G) An event of default shall occur under any guaranty executed by any
guarantor of the Obligations of Seller to Buyer under this Agreement, or any
material provision of any such guaranty shall for any reason cease to be
valid or enforceable or any such guaranty shall be repudiated or terminated,
including by operation of law;
(H) A default or event of default shall occur under any agreement between
Seller and any creditor of Seller that has entered into a subordination
agreement with Buyer; or
<PAGE>
(I) Any creditor that has entered into a subordination agreement with Buyer
shall breach any of the terms of or not comply with such subordination
agreement.
10. REMEDIES UPON DEFAULT. Upon the occurrence of an Event of Default, (1)
without implying any obligation to buy receivables, Buyer may cease buying
receivables or extending any financial accommodations to Seller; (2) all or a
portion of the Obligations shall be, at the option of and upon demand by Buyer,
or with respect to an Event of Default described in Section 9(B), automatically
and without notice or demand, due and payable in full; and (3) Buyer shall have
and may exercise all the rights and remedies under this Agreement and under
applicable law, including the rights and remedies of a secured party under the
California Uniform Commercial Code, all the power of attorney rights described
in Section 5 with respect to all Collateral, and the right to collect, dispose
of, sell, lease, use, and realize upon all Purchased Receivables and all
Collateral in any commercial reasonable manner. Seller and Buyer agree that any
notice of sale required to be given to Seller shall be deemed to be reasonable
if given five (5) days prior to the date on or after which the sale may be held.
In the event that the Obligations are accelerated hereunder, Seller shall
repurchase all of the Purchased Receivables as set forth in Section 4.4.
11. ACCRUAL OF INTEREST. If any amount owed by Seller hereunder is not paid
when due, including, without limitation, amounts due under Section 3.5,
Repurchase Amounts, amounts due under Section 12, and any other Obligations,
such amounts shall bear interest at a per annum rate equal to the per annum rate
of the Finance Charges until the earlier of (i) payment in good funds or (ii)
entry of a final judgment thereof, at which time the principal amount of any
money judgment remaining unsatisfied shall accrue interest at the highest rate
allowed by applicable law.
12. FEES, COSTS AND EXPENSES; INDEMNIFICATION. The Seller will pay to Buyer
immediately upon demand all fees, costs and expenses (including fees of
attorneys and professionals and their costs and expenses ) that Buyer incurs or
may from time to time impose in connection with any of the following: (a)
preparing, negotiating , administering, and enforcing this Agreement or any
other agreement executed in connection herewith, including any amendments,
waivers or consents in connection with any of the foregoing, (b) any litigation
or dispute (whether instituted by Buyer, Seller or any other person) in any way
relating to the Purchased Receivables, the Collateral, this Agreement or any
other agreement executed in connection herewith or therewith, (d) enforcing any
rights against Seller or any guarantor, or any Account Debtor, (e) protecting or
enforcing its interest in the Purchased Receivables or the Collateral, (f)
collecting the Purchased Receivables and the Obligations, and (g) the
representation of Buyer in connection with any bankruptcy case or insolvency
proceeding involving Seller, any Purchased Receivable, the Collateral, any
Account Debtor, or any guarantor. Seller shall indemnify and hold Buyer
harmless from and against any and all claims, actions, damages, costs, expenses,
and liabilities of any nature whatsoever arising in connection with any of the
foregoing.
13. SEVERABILITY, WAIVER, AND CHOICE OF LAW. In the event that any provision
of this Agreement is deemed invalid by reason of law, this Agreement will be
construed as not containing such provision and the remainder of the Agreement
shall remain in full force and effect. Buyer retains all of its rights, even if
it makes an Advance after a default. If Buyer waives a default, it may enforce
a later default. Any consent or waiver under, or amendment of, this Agreement
must be in writing. Nothing contained herein, or any action taken or not taken
by Buyer at any time, shall be construed at any time to be indicative of any
obligation or willingness on the part of Buyer to amend this Agreement or to
grant to Seller any waivers or consents. This Agreement has been transmitted by
Seller to Buyer at Buyer's office in the State of California and has been
executed and accepted by Buyer in the State of California. This Agreement shall
be governed by and interpreted in accordance with the internal laws of the State
of California.
14. ACCOUNT COLLECTION SERVICES. Certain Account Debtors may require or
prefer that all of Seller's receivables be paid to the same address and/or
party, or Seller and Buyer may agree that all receivables with respect to
certain Account Debtors be paid to one party. In such event Buyer and Seller
may agree that Buyer shall collect all receivables whether owned by Seller or
Buyer and (provided that there does not then exist an Event of Default or event
that with notice, lapse or time or otherwise would constitute an Event of
Default, and subject to Buyer's rights in the Collateral) Buyer agrees to remit
to Seller the amount of the
<PAGE>
receivables collections it receives with respect to receivables other than
Purchased Receivables. It is understood and agreed by Seller that this Section
does not impose any affirmative duty on Buyer to do any act other than to turn
over such amounts. All such receivables and collections are Collateral and in
the event of Seller's default hereunder, Buyer shall have no duty to remit
collections of Collateral and may apply such collections to the obligations
hereunder and Buyer shall have the rights of a secured party under the
California Uniform Commercial Code.
15. NOTICES. All notices shall be given to Buyer and Seller at the addresses
or faxes set forth on the first page of this Agreement and shall be deemed to
have been delivered and received: (a) if mailed, three (3) calendar days after
deposited in the United States mail, first class, postage pre-paid, (b) one (1)
calendar day after deposit with an overnight mail or messenger service; or (c)
on the same date of confirmed transmission if sent by hand delivery, telecopy,
telefax or telex.
16. JURY TRIAL. SELLER AND BUYER EACH HEREBY (a) WAIVE THEIR RESPECTIVE RIGHTS
TO A JURY TRIAL ON ANY CLAIM OR ACTION ARISING OUT OF OR IN CONNECTION WITH THIS
AGREEMENT, ANY RELATED AGREEMENTS, OR ANY OF THE TRANSACTIONS CONTEMPLATED
HEREBY OR THEREBY; (b) RECOGNIZE AND AGREE THAT THE FOREGOING WAIVER CONSTITUTES
A MATERIAL INDUCEMENT FOR IT TO ENTER INTO THIS AGREEMENT; AND (c) REPRESENT AND
WARRANT THAT IT HAS REVIEWED THIS WAIVER, HAS DETERMINED FOR ITSELF THE
NECESSITY TO REVIEW THE SAME WITH ITS LEGAL COUNSEL, AND KNOWINGLY AND
VOLUNTARILY WAIVES ALL RIGHTS TO A JURY TRIAL.
17. TERM AND TERMINATION. The term of this Agreement shall be for one (1) year
from the date hereof, and from year to year thereafter unless terminated in
writing by Buyer or Seller. Seller and Buyer shall each have the right to
terminate this Agreement at any time. Notwithstanding the foregoing, any
termination of this Agreement shall not affect Buyer's security interest in the
Collateral and Buyer's ownership of the Purchased Receivables, and this
Agreement shall continue to be effective, and Buyer's rights and remedies
hereunder shall survive such termination, until all transactions entered into
and Obligations incurred hereunder or in connection herewith have been completed
and satisfied in full.
18. TITLES AND SECTION HEADINGS. The titles and section headings used herein
are for convenience only and shall not be used in interpreting this Agreement.
<PAGE>
19. OTHER AGREEMENTS. The terms and provisions of this Agreement shall not
adversely affect the rights of Buyer or any other division or affiliate of
Silicon Valley Bank under any other document, instrument or agreement. The
terms of such other documents, instruments and agreements shall remain in full
force and effect notwithstanding the execution of this Agreement. In the event
of a conflict between any provision of this Agreement and any provision of any
other document, instrument or agreement between Seller on the one hand, and
Buyer or any other division or affiliate of Silicon Valley Bank on the other
hand, Buyer shall determine in its sole discretion which provision shall apply.
Seller acknowledges specifically that any security agreements, liens and/or
security interests currently securing payment of any obligations of Seller owing
to Buyer or any other division or affiliate of Silicon Valley Bank also secure
Seller's obligations under this Agreement, and are valid and subsisting and are
not adversely affected by execution of this Agreement. Seller further
acknowledges that (a) any collateral under other outstanding security
agreements or other documents between Seller and Buyer or any other division or
affiliate of Silicon Valley Bank secures the obligations of Seller under this
Agreement and (b) a default by Seller under this Agreement constitutes a
default under other outstanding agreements between Seller and Buyer or any other
division or affiliate of Silicon Valley Bank.
IN WITNESS WHEREOF, Seller and Buyer have executed this Agreement on the day
and year above written.
SELLER: SOUND SOURCE INTERACTIVE, INC.
By _______________________________________
Title _____________________________________
BUYER: SILICON VALLEY FINANCIAL SERVICES
A division of Silicon Valley Bank
By________________________________________
Title ______________________________________
<PAGE>
This FINANCING STATEMENT is presented for filing and will remain effective, with
certain exceptions, for five years from the date of filing, pursuant to Section
9403 of the California Uniform Commercial Code.
- --------------------------------------------------------------------------------
1. DEBTOR (Last Name First - If An Individual) 1A.Soc Sec No or Id No.
SOUND SOURCE INTERACTIVE, INC. 95-4264046
- --------------------------------------------------------------------------------
1B. MAILING ADDRESS 1C. CITY, STATE 1D. ZIP CODE
26115 Mureau Ste. B Calabasas, California 91302
- --------------------------------------------------------------------------------
2. ADDITIONAL DEBTOR (IF ANY) (Last Name First - If An Individual)
2A.Soc Sec No or Id No.
- --------------------------------------------------------------------------------
2B. MAILING ADDRESS 2C. CITY, STATE 2D. ZIP CODE
- --------------------------------------------------------------------------------
3. DEBTOR'S TRADE NAMES OR STYLES (IF ANY) 3A. FED TAX NO.
SOUND SOURCE UMLIMITED, INC. 95-4264046
================================================================================
4. SECURED PARTY 4A.Soc Sec No or Id No.
Name: SILICON VALLEY BANK/SILICON
VALLEY FINANCIAL SERVICES
Mailing Address: 3003 Tasman Drive, Mail Sort NC481
Santa Clara, California 95054
================================================================================
5. ASSIGNEE OF SECURED PARTY 5A.Soc Sec No or Id No.
Name: NONE
Mailing Address:
- --------------------------------------------------------------------------------
6. This FINANCING STATEMENT covers the following types or items of property
(include description of real property on which located and owner of record when
required by instruction 4).
Debtor hereby grants Secured Party a security interest in all of the following,
whether now owned or hereafter acquired, and wherever located, as collateral for
the payment and performance of all present and future indebtedness, liabilities,
guarantees and obligations of Debtor to Secured Party: All "accounts," "general
intangibles," "chattel paper," "documents," "letters of credit," "instruments,"
"deposit accounts," "inventory," "farm products," "fixtures" and "equipment," as
such terms are defined in Division 9 of the California Uniform Commercial Code
in effect on the date hereof, and all other types or items of property described
on Exhibit A hereto (but this Financing Statement shall be fully effective
notwithstanding any lack of any Exhibit A). Debtor is not authorized to sell,
transfer, or further encumber any of the foregoing collateral, except for the
sale of finished inventory in the ordinary course of business.
- --------------------------------------------------------------------------------
7. CHECK IF APPLICABLE: X-PRODUCTS OF COLLATERAL ARE ALSO COVERED.
================================================================================
SIGNATURE(S) OF DEBTOR: DATE: October 7, 1997
SOUND SOURCE INTERACTIVE, INC.
By__________________________________
Title_______________________________
================================================
SIGNATURE(S) OF SECURED PARTY:
SILICON VALLEY BANK/SILICON VALLEY FINANCIAL
SERVICES
By__________________________________
Title_______________________________
================================================
RETURN COPY TO:
SILICON VALLEY BANK
3003 Tasman Drive Mail Sort NC481
Santa Clara, California 95054
C | THIS SPACE FOR USE OF FILING OFFICER
O | (DATE, TIME, FILE NUMBER AND FILING
D | OFFICER)
E |
|
1 |
|
2 |
|
3 |
|
4 |
|
5 |
|
6 |
|
7 |
|
8 |
|
9 |
|
0 |
|
|
- --------------------------------------------------------------------------------
(1) FILING OFFICER COPY Form UCC-1
<PAGE>
This FINANCING STATEMENT is presented for filing and will remain effective, with
certain exceptions, for five years from the date of filing, pursuant to Section
9403 of the California Uniform Commercial Code.
- --------------------------------------------------------------------------------
1. DEBTOR (Last Name First - If An Individual) 1A.Soc Sec No or Id No.
SOUND SOURCE INTERACTIVE, INC. 95-4264046
- --------------------------------------------------------------------------------
1B. MAILING ADDRESS 1C. CITY, STATE 1D. ZIP CODE
26115 Mureau Ste. B Calabasas, California 91302
- --------------------------------------------------------------------------------
2. ADDITIONAL DEBTOR (IF ANY) (Last Name First - If An Individual)
2A.Soc Sec No or Id No.
- --------------------------------------------------------------------------------
2B. MAILING ADDRESS 2C. CITY, STATE 2D. ZIP CODE
- --------------------------------------------------------------------------------
3. DEBTOR'S TRADE NAMES OR STYLES (IF ANY) 3A. FED TAX NO.
SOUND SOURCE UMLIMITED, INC. 95-4264046
================================================================================
4. SECURED PARTY 4A.Soc Sec No or Id No.
Name: SILICON VALLEY BANK/SILICON
VALLEY FINANCIAL SERVICES
Mailing Address: 3003 Tasman Drive, Mail Sort NC481
Santa Clara, California 95054
================================================================================
5. ASSIGNEE OF SECURED PARTY 5A.Soc Sec No or Id No.
Name: NONE
Mailing Address:
- --------------------------------------------------------------------------------
6. This FINANCING STATEMENT covers the following types or items of property
(include description of real property on which located and owner of record when
required by instruction 4).
Debtor hereby grants Secured Party a security interest in all of the following,
whether now owned or hereafter acquired, and wherever located, as collateral for
the payment and performance of all present and future indebtedness, liabilities,
guarantees and obligations of Debtor to Secured Party: All "accounts," "general
intangibles," "chattel paper," "documents," "letters of credit," "instruments,"
"deposit accounts," "inventory," "farm products," "fixtures" and "equipment," as
such terms are defined in Division 9 of the California Uniform Commercial Code
in effect on the date hereof, and all other types or items of property described
on Exhibit A hereto (but this Financing Statement shall be fully effective
notwithstanding any lack of any Exhibit A). Debtor is not authorized to sell,
transfer, or further encumber any of the foregoing collateral, except for the
sale of finished inventory in the ordinary course of business.
- --------------------------------------------------------------------------------
7. CHECK IF APPLICABLE: X-PRODUCTS OF COLLATERAL ARE ALSO COVERED.
================================================================================
SIGNATURE(S) OF DEBTOR: DATE: October 7, 1997
SOUND SOURCE INTERACTIVE, INC.
By__________________________________
Title_______________________________
================================================
SIGNATURE(S) OF SECURED PARTY:
SILICON VALLEY BANK/SILICON VALLEY FINANCIAL
SERVICES
By__________________________________
Title_______________________________
================================================
RETURN COPY TO:
SILICON VALLEY BANK
3003 Tasman Drive Mail Sort NC481
Santa Clara, California 95054
C | THIS SPACE FOR USE OF FILING OFFICER
O | (DATE, TIME, FILE NUMBER AND FILING
D | OFFICER)
E |
|
1 |
|
2 |
|
3 |
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4 |
|
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7 |
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8 |
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0 |
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- --------------------------------------------------------------------------------
(2) FILING OFFICER COPY-ACKNOWLEDGMENT Form UCC-1
<PAGE>
This FINANCING STATEMENT is presented for filing and will remain effective, with
certain exceptions, for five years from the date of filing, pursuant to Section
9403 of the California Uniform Commercial Code.
- --------------------------------------------------------------------------------
1. DEBTOR (Last Name First - If An Individual) 1A.Soc Sec No or Id No.
SOUND SOURCE INTERACTIVE, INC. 95-4264046
- --------------------------------------------------------------------------------
1B. MAILING ADDRESS 1C. CITY, STATE 1D. ZIP CODE
26115 Mureau Ste. B Calabasas, California 91302
- --------------------------------------------------------------------------------
2. ADDITIONAL DEBTOR (IF ANY) (Last Name First - If An Individual)
2A.Soc Sec No or Id No.
- --------------------------------------------------------------------------------
2B. MAILING ADDRESS 2C. CITY, STATE 2D. ZIP CODE
- --------------------------------------------------------------------------------
3. DEBTOR'S TRADE NAMES OR STYLES (IF ANY) 3A. FED TAX NO.
SOUND SOURCE UMLIMITED, INC. 95-4264046
================================================================================
4. SECURED PARTY 4A.Soc Sec No or Id No.
Name: SILICON VALLEY BANK/SILICON
VALLEY FINANCIAL SERVICES
Mailing Address: 3003 Tasman Drive, Mail Sort NC481
Santa Clara, California 95054
================================================================================
5. ASSIGNEE OF SECURED PARTY 5A.Soc Sec No or Id No.
Name: NONE
Mailing Address:
- --------------------------------------------------------------------------------
6. This FINANCING STATEMENT covers the following types or items of property
(include description of real property on which located and owner of record when
required by instruction 4).
Debtor hereby grants Secured Party a security interest in all of the following,
whether now owned or hereafter acquired, and wherever located, as collateral for
the payment and performance of all present and future indebtedness, liabilities,
guarantees and obligations of Debtor to Secured Party: All "accounts," "general
intangibles," "chattel paper," "documents," "letters of credit," "instruments,"
"deposit accounts," "inventory," "farm products," "fixtures" and "equipment," as
such terms are defined in Division 9 of the California Uniform Commercial Code
in effect on the date hereof, and all other types or items of property described
on Exhibit A hereto (but this Financing Statement shall be fully effective
notwithstanding any lack of any Exhibit A). Debtor is not authorized to sell,
transfer, or further encumber any of the foregoing collateral, except for the
sale of finished inventory in the ordinary course of business.
- --------------------------------------------------------------------------------
7. CHECK IF APPLICABLE: X-PRODUCTS OF COLLATERAL ARE ALSO COVERED.
================================================================================
SIGNATURE(S) OF DEBTOR: DATE: October 7, 1997
SOUND SOURCE INTERACTIVE, INC.
By__________________________________
Title_______________________________
================================================
SIGNATURE(S) OF SECURED PARTY:
SILICON VALLEY BANK/SILICON VALLEY FINANCIAL
SERVICES
By__________________________________
Title_______________________________
================================================
RETURN COPY TO:
SILICON VALLEY BANK
3003 Tasman Drive Mail Sort NC481
Santa Clara, California 95054
C | THIS SPACE FOR USE OF FILING OFFICER
O | (DATE, TIME, FILE NUMBER AND FILING
D | OFFICER)
E |
|
1 |
|
2 |
|
3 |
|
4 |
|
5 |
|
6 |
|
7 |
|
8 |
|
9 |
|
0 |
|
|
- --------------------------------------------------------------------------------
(3) FILE COPY - SECURED PARTY Form UCC-1
<PAGE>
This FINANCING STATEMENT is presented for filing and will remain effective, with
certain exceptions, for five years from the date of filing, pursuant to Section
9403 of the California Uniform Commercial Code.
- --------------------------------------------------------------------------------
1. DEBTOR (Last Name First - If An Individual) 1A.Soc Sec No or Id No.
SOUND SOURCE INTERACTIVE, INC. 95-4264046
- --------------------------------------------------------------------------------
1B. MAILING ADDRESS 1C. CITY, STATE 1D. ZIP CODE
26115 Mureau Ste. B Calabasas, California 91302
- --------------------------------------------------------------------------------
2. ADDITIONAL DEBTOR (IF ANY) (Last Name First - If An Individual)
2A.Soc Sec No or Id No.
- --------------------------------------------------------------------------------
2B. MAILING ADDRESS 2C. CITY, STATE 2D. ZIP CODE
- --------------------------------------------------------------------------------
3. DEBTOR'S TRADE NAMES OR STYLES (IF ANY) 3A. FED TAX NO.
SOUND SOURCE UMLIMITED, INC. 95-4264046
================================================================================
4. SECURED PARTY 4A.Soc Sec No or Id No.
Name: SILICON VALLEY BANK/SILICON
VALLEY FINANCIAL SERVICES
Mailing Address: 3003 Tasman Drive, Mail Sort NC481
Santa Clara, California 95054
================================================================================
5. ASSIGNEE OF SECURED PARTY 5A.Soc Sec No or Id No.
Name: NONE
Mailing Address:
- --------------------------------------------------------------------------------
6. This FINANCING STATEMENT covers the following types or items of property
(include description of real property on which located and owner of record when
required by instruction 4).
Debtor hereby grants Secured Party a security interest in all of the following,
whether now owned or hereafter acquired, and wherever located, as collateral for
the payment and performance of all present and future indebtedness, liabilities,
guarantees and obligations of Debtor to Secured Party: All "accounts," "general
intangibles," "chattel paper," "documents," "letters of credit," "instruments,"
"deposit accounts," "inventory," "farm products," "fixtures" and "equipment," as
such terms are defined in Division 9 of the California Uniform Commercial Code
in effect on the date hereof, and all other types or items of property described
on Exhibit A hereto (but this Financing Statement shall be fully effective
notwithstanding any lack of any Exhibit A). Debtor is not authorized to sell,
transfer, or further encumber any of the foregoing collateral, except for the
sale of finished inventory in the ordinary course of business.
- --------------------------------------------------------------------------------
7. CHECK IF APPLICABLE: X-PRODUCTS OF COLLATERAL ARE ALSO COVERED.
================================================================================
SIGNATURE(S) OF DEBTOR: DATE: October 7, 1997
SOUND SOURCE INTERACTIVE, INC.
By__________________________________
Title_______________________________
================================================
SIGNATURE(S) OF SECURED PARTY:
SILICON VALLEY BANK/SILICON VALLEY FINANCIAL
SERVICES
By__________________________________
Title_______________________________
================================================
RETURN COPY TO:
SILICON VALLEY BANK
3003 Tasman Drive Mail Sort NC481
Santa Clara, California 95054
C | THIS SPACE FOR USE OF FILING OFFICER
O | (DATE, TIME, FILE NUMBER AND FILING
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(4) FILE COPY - DEBTOR Form UCC-1
<PAGE>
EXHIBIT "A"
TO FINANCING STATEMENT AND SECURITY AGREEMENT
This FINANCING STATEMENT and SECURITY AGREEMENT covers the following types or
items of property (in addition to, and without limiting the types of property
set forth on page 1 hereof):
A) All accounts, receivables, contract rights, chattel paper, instruments,
documents, letters of credit, bankers acceptances, drafts, checks, cash,
securities, deposit accounts, and general intangibles (including, without
limitation, all claims, causes of action, guaranties, rights in and claims
under insurance policies (including rights to premium refunds), rights to
tax refunds, copyrights, patents, trademarks, rights in and under license
agreements, and all other intellectual property);
B) All inventory, including Seller's rights to any returned or rejected goods,
with respect to which Buyer shall have all the rights of any unpaid seller,
including the rights of replevin, claim and delivery, reclamation, and
stoppage in transit;
C) All monies, refunds and other amounts due Seller, including, without
limitation, amounts due Seller under this Agreement (including Seller's
right of offset and recoupment);
D) All equipment, machinery, furniture, furnishings, fixtures, tools, supplies
and motor vehicles;
E) All farm products, crops, timber, minerals and the like (including oil and
gas);
F) All accessions to, substitutions for, and replacements of, all of the
foregoing;
G) All books and records pertaining to all of the foregoing; and
H) All proceeds of the foregoing, whether due to voluntary or involuntary
disposition, including insurance proceeds.
Initials _____________________
<PAGE>
SILICON VALLEY FINANCIAL SERVICES
A Division of Silicon Valley Bank
3003 Tasman Drive
Santa Clara, California 95054
(408) 654-1000 - Fax (408) 980-6410
CERTIFICATION OF OFFICERS
The undersigned, being all the officers of SOUND SOURCE INTERACTIVE, INC.,
a Delaware corporation (the "Corporation"), hereby certify to Silicon Valley
Financial Services, a division of Silicon Valley Bank ("SVFS") that:
1. The correct name of the Corporation is Sound Source Interactive, Inc.,
as set forth in the Articles of Incorporation.
2. The Corporation was incorporated on March 8, 1990, under the laws of
the State of Delaware, and is in good standing under such laws.
3. The Corporation's place of business and chief executive office being
the place at which the Corporation maintains its books and records pertaining to
accounts, accounts receivables, contract rights, chattel paper, general
intangibles, instruments, documents, inventory, and equipment, is located at:
26115 Mureau Ste. B
Calabasas, California 91302
4. The Corporation has other places of business at the following
addressees:
None
5. There is no provision in the Certificate of Incorporation, Articles of
Incorporation, or Bylaws of the Corporation, or in the laws of the State of its
incorporation, requiring any vote or consent of shareholders to authorize the
sale of receivables or the grant of a security interest in any assets of the
Corporation. Such power is vested exclusively in the Corporation's Board of
Directors.
6. The officers of the Corporation, and their respective titles and
signatures are as follows:
PRESIDENT:
----------------------------------------------
(Signature)
VICE PRESIDENT:
----------------------------------------------
(Signature)
SECRETARY:
----------------------------------------------
(Signature)
TREASURER:
----------------------------------------------
(Signature)
<PAGE>
OTHER OFFICER:
TITLE:
---------------------------------------------------------
(Signature)
7. Except as indicated in this paragraph 7, each of the officers listed
in paragraph 6 has signatory powers with respect to all the Corporation's
transactions with SVFS. Explanation of exceptions:
8. The undersigned shall give SVFS prompt written notice of any change or
amendment with respect to any of the foregoing. Until such written notice is
received by SVFS, SVFS shall be entitled to rely upon the foregoing in all
respects.
IN WITNESS WHEREOF, the undersigned have executed this Certification of
Officers on September 19, 1997.
------------------
PRESIDENT:
---------------------------------------------------------
VICE PRESIDENT:
---------------------------------------------------------
SECRETARY:
---------------------------------------------------------
TREASURER:
---------------------------------------------------------
<PAGE>
Silicon Valley Financial Services
A Division of Silicon Valley Bank
3003 Tasman Drive
Santa Clara, California 95054
(408) 654-1000 - Fax (408) 980-6410
SECRETARY'S CERTIFICATE OF RESOLUTION
The undersigned, as Secretary of Sound Source Interactive, Inc., a Delaware
corporation (the "Corporation"), hereby certifies to Silicon Valley Financial
Services that at a meeting duly convened at which a quorum was present the
following resolutions were adopted by the Board of Directors of the Corporation
and that such resolutions have not been modified, amended, or rescinded in any
respect and are in full force and effect as of today's date.
RESOLVED, that this corporation be and hereby is authorized to sell this
corporation's accounts receivable to Silicon Valley Financial Services, a
division of Silicon Valley Bank, and to grant Silicon Valley Financial Services
a security interest in this corporation's assets, including, without limitation,
accounts, accounts receivable, contract rights, chattel paper, general
intangibles, instruments, documents, letters of credit, drafts, inventory and
equipment, presently owned or hereafter acquired and proceeds and products of
the foregoing (the "Collateral," as defined in the Factoring Agreement).
RESOLVED, that this corporation be and hereby is authorized and directed to
execute and deliver certain agreements in connection with the sale of
receivables, and granting of security interests in the Collateral to Silicon
Valley Financial Services including, without limitations, a Factoring Agreement
and UCC-1 financing statement.
RESOLVED, that the following named officers of this corporation
("Authorized Officers") be, and any of them hereby are, authorized, empowered,
and directed to execute and deliver to Silicon Valley Financial Services on
behalf of this corporation all such further agreements and instruments as may be
deemed necessary or advisable in order to fully effectuate the purposes and
intent of the foregoing resolutions.
Print Names of Authorized Officers: Title:
- ------------------------------------------- -------------------------------
- ------------------------------------------- -------------------------------
- ------------------------------------------- -------------------------------
- ------------------------------------------- -------------------------------
- ------------------------------------------- -------------------------------
- ------------------------------------------- -------------------------------
RESOLVED, that the Secretary or Assistant Secretary of this corporation be,
and hereby is authorized, empowered and directed to certify to the passage of
the foregoing resolutions under the seal of this corporation.
IN WITNESS WHEREOF, the undersigned has duly executed this Certificate this
Nineteenth day
<PAGE>
COLLATERAL ASSIGNMENT, PATENT MORTGAGE
AND SECURITY AGREEMENT
This Collateral Assignment, Patent Mortgage and Security Agreement (this
"Assignment") is made as of the Nineteenth day of September, 1997 by and
between SOUND SOURCE INTERACTIVE, INC. ("Assignor"), and SILICON VALLEY
FINANCIAL SERVICES (a division of Silicon Valley Bank) ("Assignee").
RECITALS
A. Assignee has agreed to extend certain financial accommodations to
Assignor pursuant to a Factoring Agreement dated September 19, 1997 (the
"Factoring Agreement") and Assignor desired to obtain such financial
accommodations from Assignee. Assignee's obligations are or will be secured, in
part pursuant to the terms of the Factoring Agreement.
B. In order to induce Assignee to extend financial accommodations under
or amend the terms of the Factoring Agreement, Assignor has agreed to assign
certain intangible property to Assignee for purposes of securing the obligations
of Assignor to Assignee.
NOW, THEREFORE, THE PARTIES HERETO AGREE AS FOLLOWS:
1. Assignment, Patent Mortgage and Grant of Security Interest. As
-----------------------------------------------------------
collateral security for the prompt and complete payment and performance of all
of Assignor's present or future indebtedness, obligations and liabilities to
Assignee, Assignor hereby assigns, transfers, conveys and grants a security
interest and mortgage to Assignee, as security, but not as an ownership interest
in and to Assignor's entire right, title and interest in, to and under the
following (all of which shall collectively be called the "Collateral"):
(a) Any and all copyright rights, copyright applications, copyright
registrations and like protections in each work or authorship and derivative
work thereof, whether published or unpublished and whether or not the same also
constitutes a trade secret, now or hereafter existing, created, acquired or
held, including without limitation those set forth on Exhibit A attached hereto
---------
(collectively, the "Copyrights");
(b) Any and all trade secrets, and any and all intellectual property
rights in computer software and computer software products now or hereafter
existing, created, acquired or held;
(c) Any and all design rights which may be available to Assignor now
or hereafter existing, created, acquired or held;
(d) All patents, patent applications and like protections including,
without limitation, improvements, divisions, continuations, renewals, reissues,
extensions and continuations-in-part of the same, including without limitation
the patents and patent applications set forth on Exhibit B attached hereto
---------
(collectively, the "Patents");
(e) Any trademark and servicemark rights, whether registered or not,
applications to register and registrations of the same and like protections, and
the entire goodwill of the business of Assignor connected with and symbolized by
such trademarks, including without limitation those set forth on Exhibit C
---------
attached hereto (collectively, the "Trademarks")
(f) Any and all claims for damages by way of past, present and future
infringements of any of the rights included above, with the right, but not the
obligation, to sue for and collect such damages for said use or infringement of
the intellectual property rights identified above;
1
<PAGE>
(g) All licenses or other rights to use any of the Copyrights,
Patents or Trademarks, and all license fees and royalties arising from such use
to the extent permitted by such license or rights; and
(h) All amendments, extensions, renewals and extensions of any of the
Copyrights, Trademarks or Patents; and
(i) All proceeds and products of the foregoing, including without
limitation all payments under insurance or any indemnity or warranty payable in
respect of any of the foregoing.
THE INTEREST IN THE COLLATERAL BEING ASSIGNED HEREUNDER SHALL NOT BE CONSTRUED
AS A CURRENT ASSIGNMENT, BUT AS A CONTINGENT ASSIGNMENT TO SECURE ASSIGNOR'S
OBLIGATIONS TO ASSIGNEE UNDER THE FACTORING AGREEMENT.
2. Authorization and Request. Assignor authorizes and requests that the
--------------------------
Register of Copyrights and the Commissioner of Patents and Trademarks record
this conditional assignment.
3. Covenants and Warranties. Assignor represents, warrants, covenants and
-------------------------
agrees as follows:
(a) Assignor is now the sole owner of the Collateral, except for non-
exclusive licenses granted by Assignor to its customers in the ordinary course
of business.
(b) Performance of this Assignment does not conflict with or result
in a breach of any agreement to which Assignor is bound, except to the extent
that certain intellectual property agreements prohibit the assignment of the
rights thereunder to a third party without the licensor's or other party's
consent and this Assignment constitutes an assignment.
(c) During the term of this Assignment, Assignor will not transfer or
otherwise encumber any interest in the Collateral, except for non-exclusive
licenses granted by Assignor in the ordinary course of business or as set forth
in this Assignment;
(d) To its knowledge, each of the Patents is valid and enforceable,
and no part of the Collateral has been judged invalid or unenforceable, in whole
or in part, and no claim has been made that any part of the Collateral violates
the rights of any third party;
(e) Assignor shall promptly advise Assignee of any material adverse
change in the composition of the Collateral, including but not limited to any
subsequent ownership right of the Assignor in or to any Trademark, Patent or
Copyright not specified in this Assignment;
(f) Assignor shall (i) protect, defend and maintain the validity and
enforceability of the Trademarks, Patents and Copyrights, (ii) use its best
efforts to detect infringements of the Trademarks, Patents and Copyrights and
promptly advise Assignee in writing of material infringements detected and (iii)
not allow any Trademarks, Patents, or Copyrights to be abandoned, forfeited or
dedicated to the public without the written consent of Assignee, which shall not
be unreasonably withheld unless Assignor determines that reasonable business
practices suggest that abandonment is appropriate.
(g) Assignor shall promptly register the most recent version of any
of Assignor's Copyrights, if not so already registered, and shall, from time to
time, execute and file such other instruments, and take such further actions as
Assignee may reasonably request from time to time to perfect or continue the
perfection of Assignee's interest in the Collateral;
(h) This Assignment creates, and in the case of after acquired
Collateral, this Assignment will create at the time Assignor first has rights in
such after acquired Collateral, in favor of Assignee a valid and perfected first
priority security interest in the Collateral in the United States securing the
payment and performance of the obligations of Assignee under the Factoring
Agreement upon making the filings referred to in clause (i) below;
2
<PAGE>
(i) To its knowledge, except for, and upon, the filing with the
United States Patent and Trademark office with respect to the Patents and
Trademarks and the Register of Copyrights with respect to the Copyrights
necessary to perfect the security interests and assignment created hereunder and
except as has been already made or obtained, no authorization, approval or other
action by, and no notice to or filing with, any U.S. governmental authority of
U.S. regulatory body is required either (i) for the grant by Assignor of the
security interest granted hereby or for the execution, delivery or performance
of this Assignment by Assignor in the U.S. or (ii) for the perfection in the
United States or the exercise by Assignee of its rights and remedies thereunder;
(j) All information heretofore, herein or hereafter supplied to
Assignee by or on behalf of Assignor with respect to the Collateral is accurate
and complete in all material respects.
(k) Assignor shall not enter into any agreement that would materially
impair or conflict with Assignor's obligations hereunder without Assignee's
prior written consent, which consent shall not be unreasonably withheld.
Assignor shall not permit the inclusion in any material contract to which it
becomes a party of any provisions that could or might in any way prevent the
creation of a security interest in Assignor's rights and interest in any
property included within the definition of the Collateral acquired under such
contracts, except that certain contracts may contain anti-assignment provisions
that could in effect prohibit the creation of a security interest in such
contracts.
(l) Upon any executive officer of Assignor obtaining actual knowledge
thereof, Assignor will promptly notify Assignee in writing of any event that
materially adversely affects the value of any material Collateral, the ability
of Assignor to dispose of any material Collateral or the rights and remedies of
Assignee in relation thereto, including the levy of any legal process against
any of the Collateral.
4. Assignee's Rights. Assignee shall have the right, but not the
------------------
obligation, to take, at Assignor's sole expense, any actions that Assignor is
required under this Assignment to take but which Assignor fails to take, after
fifteen (15) days' notice to Assignor. Assignor shall reimburse and indemnify
Assignee for all reasonable costs and reasonable expenses incurred in the
reasonable exercise of its rights under this section 4.
5. Inspection Rights. Assignor hereby grants to Assignee and its
------------------
employees, representatives and agents the right to visit, during reasonable
hours upon prior reasonable written notice to Assignor, and any of Assignor's
plants and facilities that manufacture, install or store products (or that have
done so during the prior six-month period) that are sold utilizing any of the
Collateral, and to inspect the products and quality control records relating
thereto upon reasonable written notice to Assignor and as often as may be
reasonably requested, but not more than one (1) in every six (6) months;
provided, however, nothing herein shall entitle Assignee access to Assignor's
trade secrets and other proprietary information.
6. Further Assurances; Attorney in Fact.
-------------------------------------
(a) On a continuing basis, Assignor will, subject to any prior
licenses, encumbrances and restrictions and prospective licenses, make, execute,
acknowledge and deliver, and file and record in the proper filing and recording
places in the United States, all such instruments, including appropriate
financing and continuation statements and collateral agreements and filings with
the United States Patent and Trademarks Office and the Register of Copyrights,
and take all such action as may reasonably be deemed necessary or advisable, or
as requested by Assignee, to perfect Assignee's security interest in all
Copyrights, Patents and Trademarks and otherwise to carry out the intent and
purposes of this Collateral Assignment, or for assuring and confirming to
Assignee the grant or perfection of a security interest in all Collateral.
(b) Assignor hereby irrevocably appoints Assignee as Assignor's
attorney-in-fact, with full authority in the place and stead of Assignor and in
the name of Assignor, Assignee or otherwise, from time to time in Assignee's
discretion, upon Assignor's failure or inability to do so, to take any action
and to execute any instrument which Assignee may deem necessary or advisable to
accomplish the purposes of this Collateral Assignment, including:
3
<PAGE>
(i) To modify, in its sole discretion, this Collateral
Assignment without first obtaining Assignor's approval of or signature to such
modification by amending Exhibit A, Exhibit B and Exhibit C hereof, as
appropriate, to include reference to any right, title or interest in any
Copyrights, Patents or Trademarks acquired by Assignor after the execution
hereof or to delete any reference to any right, title or interest in any
Copyrights, Patents or Trademarks in which Assignor no longer has or claims any
right, title or interest; and
(ii) To file, in its sole discretion, one or more financing or
continuation statements and amendments thereto, relative to any of the
Collateral without the signature of Assignor where permitted by law.
7. Events of Default. The occurrence of any of the following shall
------------------
constitute an Event of Default under the Assignment:
(a) An event of default occurs under the Factoring Agreement; or
(b) Assignor breaches any warranty or agreement made by Assignor in
this Assignment.
8. Remedies. Upon the occurrence and continuance of an Event of Default,
---------
Assignee shall have the right to exercise all the remedies of a secured party
under the California Uniform Commercial Code, including without limitation the
right to require Assignor to assemble the Collateral and any tangible property
in which Assignee has a security interest and to make it available to Assignee
at a place designated by Assignee. Assignee shall have a nonexclusive, royalty
free license to use the Copyrights, Patents and Trademarks to the extent
reasonably necessary to permit Assignee to exercise its rights and remedies upon
the occurrence of an Event of Default. Assignor will pay any expenses
(including reasonable attorney's fees) incurred by Assignee in connection with
the exercise of any of Assignee's rights hereunder, including without limitation
any expense incurred in disposing of the Collateral. All of Assignee's rights
and remedies with respect to the Collateral shall be cumulative.
9. Indemnity. Assignor agrees to defend, indemnify and hold harmless
----------
Assignee and its officers, employees, and agents against: (a) all obligations,
demands, claims, and liabilities claimed or asserted by any other party in
connection with the transactions contemplated by this Assignment, and (b) all
losses or expenses in any way suffered, incurred, or paid by Assignee as a
result of or in any way arising out of, following or consequential to
transactions between Assignee and Assignor, whether under this Assignment or
otherwise (including without limitation, reasonable attorneys fees and
reasonable expenses), except for losses arising from or out of Assignee's gross
negligence or willful misconduct.
10. Reassignment. At such time as Assignor shall completely satisfy all of
-------------
the obligations secured hereunder, Assignee shall execute and deliver to
Assignor all deed, assignments, and other instruments as may be necessary or
proper to reinvest in Assignor full title to the property assigned hereunder,
subject to any disposition thereof which may have been made by Assignee pursuant
hereto.
11. Course of Dealing. No course of dealing, nor any failure to exercise,
------------------
nor any delay in exercising any right, power or privilege hereunder shall
operate as a waiver thereof.
12. Attorneys' Fees. If any action relating to this Assignment is brought
----------------
by either party hereto against the other party, the prevailing party shall be
entitled to recover reasonable attorneys fees, costs and disbursements.
13. Amendments. This Assignment may be amended only by a written
-----------
instrument signed by both parties hereto.
14. Counterparts. This Assignment may be executed in two or more
-------------
counterparts, each of which shall be deemed an original but all of which
together shall constitute the same instrument.
4
<PAGE>
15. California Law and Jurisdiction. This Assignment shall be governed by
--------------------------------
the laws of the State of California, without regard for choice of law
provisions. Assignor and Assignee consent to the nonexclusive jurisdiction of
any state or federal court located in Santa Clara County, California.
16. Confidentiality. In handling any confidential information, Assignee
----------------
shall exercise the same degree of care that it exercises with respect to its own
proprietary information of the same types to maintain the confidentiality of any
non-public information thereby received or received pursuant to this Assignment
except that the disclosure of this information may be made (i) to the affiliates
of the Assignee, (ii) to prospective transferee or purchasers of an interest in
the obligations secured hereby, provided that they have entered into comparable
confidentiality agreement in favor of Assignor and have deliver a copy to
Assignor, (iii) as required by law, regulation, rule or order, subpoena judicial
order or similar order and (iv) as may be required in connection with the
examination, audit or similar investigation of Assignee.
IN WITNESS WHEREOF, the parties hereto have executed this Assignment on the
day and year first above written.
ADDRESS OF ASSIGNOR: ASSIGNOR:
26115 Mureau Rd., Suite B SOUND SOURCE INTERACTIVE, INC.
Calabasas, CA 91302-3126
By:
------------------------------------
Name:
----------------------------------
Title:
---------------------------------
ALL-PURPOSE ACKNOWLEDGMENT
5
<PAGE>
<TABLE>
<S> <C>
State of _______________________ CAPACITY CLAIMED BY SIGNER
County of ______________________
[] INDIVIDUAL(S)
On _______________ before me, _______________________________, [] CORPORATE__________
personally appeared _________________________________, [ ] OFFICER(S)_________
personally known to me -OR- [ ] proved to me on the basis of TITLE(S)
satisfactory evidence to the person(s) whose name(s) is/are [] PARTNER(S)
subscribed to the within instrument and acknowledged to me that [] ATTORNEY-IN-FACT
he/she/they executed the same in his/her/their authorized [] TRUSTEE(S)
capacity(ies), and that by his/her/their signature(s) on the [] SUBSCRIBING WITNESS
instrument the person(s), or the entity upon behalf of which the [] GUARDIAN/CONSERVATOR
person(s) acted, executed the instrument. [] OTHER:______________
Witness my hand and official seal. SIGNER IS REPRESENTING:
NAME OF PERSON(S) OR ENTITY(IES)
___________________________________________
__________________________________________
SIGNATURE OF NOTARY
</TABLE>
6
<PAGE>
Exhibit "A" attached to that certain Collateral Assignment, Patent Mortgage and
Security Agreement dated September 19, 1997.
EXHIBIT "A"
COPYRIGHTS
SCHEDULE A - ISSUED COPYRIGHTS
- ------------------------------
COPYRIGHT REGISTRATION DATE OF
DESCRIPTION NUMBER ISSUANCE
- ----------- ------------ --------
SCHEDULE B - PENDING COPYRIGHT APPLICATIONS
- -------------------------------------------
FIRST DATE
COPYRIGHT APPLICATION DATE OF DATE OF OF PUBLIC
DESCRIPTION NUMBER FILING CREATION DISTRIBUTION
- ----------- ----------- ------- -------- ------------
SCHEDULE C - UNREGISTERED COPYRIGHTS (Where No Copyright Application is Pending)
- --------------------------------------------------------------------------------
DATE AND
RECORDATION
NUMBER
OF ASSIGNMENT TO
ORIGINAL ASSIGNOR (IF
AUTHOR OR ORIG. AUTHOR OR
OWNER OF OWNER OF
FIRST DATE COPYRIGHT COPYRIGHT
COPYRIGHT DATE OF OF (IF DIFFERENT IS DIFFERENT FROM
DESCRIPTION CREATION DISTRIBUTION FROM ASSIGNOR ASSIGNOR
- ----------- -------- ------------ ------------- -----------------
7
<PAGE>
Exhibit "B" attached to that certain Collateral Assignment, Patent Mortgage and
Security Agreement dated September 17, 1997.
EXHIBIT "B"
PATENTS
PATENT
DESCRIPTION DOCKET NO. COUNTRY SERIAL NO. FILING DATE STATUS
- ----------- ---------- ------- ---------- ----------- ------
8
<PAGE>
Exhibit "C" attached to that certain Collateral Assignment, Patent Mortgage and
Security Agreement dated September 19, 1997.
EXHIBIT "C"
TRADEMARKS
TRADEMARK
DESCRIPTION COUNTRY SERIAL NO. REG. NO STATUS
- ----------- ------- ---------- ------- ------
9
<PAGE>
Exhibit "D" attached to that certain Collateral Assignment, Patent Mortgage and
Security Agreement dated September 19, 1997.
EXHIBIT "D"
LICENSES
DESCRIPTION DATE
----------- ----
10
<PAGE>
EXHIBIT 23.1
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statements No.
333-11481 and No. 333-11843 of Sound Source Interactive, Inc. on Form S-8 of our
report dated September 16, 1996, appearing in this Annual Report on Form 10-KSB
of Sound Source Interactive, Inc. for the year ended June 30, 1997 and 1995.
By: /s/ CORBIN & WERTZ
--------------------
CORBIN & WERTZ
Irvine, California
October 9, 1997
<PAGE>
EXHIBIT 23.2
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statements No.
333-11481 and No. 333-11843 of Sound Source Interactive, Inc. on Form S-8 of our
report dated October 2, 1997, appearing in this Annual Report on Form 10-KSB of
Sound Source Interactive, Inc. for the year ended June 30, 1997.
By: /s/ DELOITTE & TOUCHE LLP
-------------------------
DELOITTE & TOUCHE LLP
Los Angeles, California
October 7, 1997
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS CONSOLIDATED FINANCIAL INFORMATION EXTRACTED FROM SOUND
SOURCE INTERACTIVE, INC AND SUBSIDIARY FOR THE PERIOD JULY 1, 1996 THROUGH
JUNE 30, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH CONSOLIDATED
FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> JUN-30-1997
<PERIOD-START> JUL-1-1996
<PERIOD-END> JUN-30-1997
<CASH> 590,459
<SECURITIES> 0
<RECEIVABLES> 2,064,539
<ALLOWANCES> (703,421)
<INVENTORY> 228,677
<CURRENT-ASSETS> 3,813,390
<PP&E> 652,416
<DEPRECIATION> (237,961)
<TOTAL-ASSETS> 4,242,398
<CURRENT-LIABILITIES> 2,962,100
<BONDS> 0
0
0
<COMMON> 4,409
<OTHER-SE> 1,273,475
<TOTAL-LIABILITY-AND-EQUITY> 4,242,398
<SALES> 4,524,447
<TOTAL-REVENUES> 4,596,806
<CGS> 2,329,211
<TOTAL-COSTS> 4,989,887
<OTHER-EXPENSES> 4,050
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 16,428
<INCOME-PRETAX> (2,666,520)
<INCOME-TAX> 1,600
<INCOME-CONTINUING> (2,668,520)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,668,520)
<EPS-PRIMARY> (0.61)
<EPS-DILUTED> (0.61)
</TABLE>
