<PAGE>
As filed with the Securities and Exchange Commission on May 9, 1997
Registration No. 333-24271
================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------------
PRE-EFFECTIVE AMENDMENT NO. 1 TO
FORM SB-2
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
--------------------------
SOUND SOURCE INTERACTIVE, INC.
(Name of Small Business Issuer in its Charter)
Delaware 7372 95-4264046
(State or Other (Primary Standard (I.R.S. Employer
Jurisdiction of Industrial Classification Identification No.)
Incorporation or Code Number)
Organization)
26115 Mureau Road, Suite B
Calabasas, California 91302-3126
(818) 878-0505
(Address and Telephone Number of
Principal Executive Offices)
Vincent J. Bitetti
Chief Executive Officer
26115 Mureau Road, Suite B
Calabasas, California 91302-3126
(818) 878-0505
(Name, Address and Telephone Number
of Agent for Service)
-----------
Copy to:
Sean P. McGuinness, Esq.
McDermott, Will & Emery
1850 K Street, N.W.
Suite 500
Washington, D.C. 20006
(202) 887-8000
Fax: (202) 778-8087
Approximate date of commencement of proposed sale to the public: As soon as
practicable after the effective date of this Registration Statement.
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box: [X]
-----------
Pursuant to Rule 429 of the Securities Act of 1933, the Prospectus
contained herein is a combined Prospectus relating to securities registered
hereby and under Registration Statement No. 33-80827.
The Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant shall
file a further amendment which specifically states that this Registration
Statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933 or until this Registration Statement shall become
effective on such date as the Commission, acting pursuant to said Section 8(a),
may determine.
(Continued on next page)
================================================================================
<PAGE>
(Continued from previous page)
CALCULATION OF REGISTRATION FEE
<TABLE>
<CAPTION>
===========================================================================================================================
Proposed Proposed
Maximum Maximum Amount of
Title of Each Class of Amount to Offering Price Aggregate Registration
Securities to be Registered be Registered Per Security(1) Offering Price(1) Fee
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Common Stock, $.001 par value ("Common
Stock")(3).............................. 200,000 (sh) $1.50 $ 300,000.00 $ 90.91
- ---------------------------------------------------------------------------------------------------------------------------
Common Stock Purchase Warrants(3)...........
4,016,657 (wt) $0.34 $1,365,663.38 $413.84
- ---------------------------------------------------------------------------------------------------------------------------
Total Registration Fee...................... $504.75(4)
===========================================================================================================================
</TABLE>
(1) Estimated solely for the purpose of calculating the registration fee.
Computed in accordance with Rule 457(c) on the basis of the last trade
prices for the Common Stock and Redeemable Warrants as reported by the
Nasdaq SmallCap Market on March 27, 1997.
(2) Pursuant to Rule 416, there are also being registered hereby such
additional indeterminate number of shares of such Common Stock as may
become issuable by reason of stock splits, stock dividends and similar
adjustments as set forth in the provisions of the Redeemable Warrants.
(3) An additional 11,318,097 shares of Common Stock to be issued by the Company
pursuant to outstanding warrants (including the warrants being registered
hereby), and an additional 490,338 outstanding shares of Common Stock and
1,041,650 warrants to be sold by security holders, have been registered
under an earlier Registration Statement on Form SB-2 (File No. 33-80827)
which was declared effective by the Securities and Exchange Commission on
July 1, 1996, and which is being amended by the filing of this Registration
Statement pursuant to Rule 429. Accordingly, both Registration Statements
use the Prospectus that is a part of this Registration Statement.
(4) A registration fee of $504.75 was paid with the initial filing of this
Registration Statement. Consequently, no fee is being paid with this
filing.
<PAGE>
SOUND SOURCE INTERACTIVE, INC.
Cross-Reference Sheet
showing location in each Prospectus of
Information Required by Items of Form SB-2
<TABLE>
<CAPTION>
Form SB-2 Item Number and Caption Location in Prospectuses
- --------------------------------- ------------------------
<S> <C> <C>
1. Front of Registration Statement and Outside Front
Cover of Prospectus............................................ Outside Front Cover Page
2. Inside Front and Outside Back Cover Pages of
Prospectus..................................................... Inside Front Cover Page; Outside Back
Cover Page
3. Summary Information and Risk Factors........................... Prospectus Summary; Risk Factors
4. Use of Proceeds................................................ Use of Proceeds
5. Determination of Offering Price................................ Outside Front Cover Page; Risk Factors
6. Dilution....................................................... Dilution
7. Selling Security Holders....................................... Selling Security Holders
8. Plan of Distribution........................................... Outside Front Cover Page; Plan of
Distribution
9. Legal Proceedings.............................................. Business - Legal Matters
10. Directors, Executive Officers, Promoters and Control
Persons........................................................ Management - Executive Officers and
Directors; Principal Stockholders
11. Security Ownership of Certain Beneficial Owners and
Management..................................................... Principal Stockholders
12. Description of Securities...................................... Description of Securities
13. Interest of Named Experts and Counsel.......................... Experts
14. Disclosure of Commission Position on Indemnification
for Securities Act Liabilities................................. Management - Limitation of Liability and
Indemnification of Directors
15. Organization Within Last Five Years............................ Business
16. Description of Business........................................ Business
17. Management's Discussion and Analysis or Plan of
Operation...................................................... Management's Discussion and Analysis of
Financial Condition and Results of
Operations
18. Description of Property........................................ Business
19. Certain Relationships and Related Transactions................. Management; Certain Transactions
20. Market for Common Equity and Related Stockholder
Matters........................................................ Risk Factors; Description of Securities;
Market Price of Securities
21. Executive Compensation......................................... Management - Executive Compensation
22. Financial Statements........................................... Financial Statements
23. Changes in and Disagreements With Accountants On
Accounting and Financial Disclosure............................ Not Applicable
</TABLE>
<PAGE>
PROSPECTUS
11,318,097 Shares of Common Stock Issuable Upon Exercise of Warrants
690,338 Shares of Common Stock for Selling Security Holders
5,058,307 Redeemable Warrants for Selling Security Holders
This Prospectus relates to the sale by Sound Source Interactive, Inc., a
Delaware corporation (the "Company"), and certain selling security holders
(the "Selling Security Holders") of the following: (i) 11,078,097 shares of
the Company's common stock, par value $.001 (the "Common Stock"), underlying
11,078,097 outstanding Common Stock purchase warrants (the "Redeemable
Warrants"); (ii) 240,000 shares of Common Stock underlying outstanding
Underwriters' Warrants (as hereinafter defined); (iii) 5,058,307 outstanding
Redeemable Warrants being offered by the Selling Security Holders, including
4,816,657 Redeemable Warrants being offered by ASSI, Inc. (the "ASSI
Warrants"), an affiliated Selling Security Holder; and (iv) 690,338
outstanding shares of Common Stock being offered by the Selling Security
Holders, including 200,000 shares being offered by Vincent J. Bitetti, the
Company's Chairman of the Board and Chief Executive Officer, and 392,838
shares being offered by Eric H. Winston, an affiliated Selling Security
Holder. See "Selling Security Holders" and "Plan of Distribution." The Common
Stock and Redeemable Warrants offered by the Selling Security Holders are
sometimes collectively referred to herein as the "Selling Security Holders'
Securities." The Company will not receive any proceeds from the sale of the
Selling Security Holders' Securities.
Each Redeemable Warrant entitles the holder to purchase one share of
Common Stock for $4.40 during the period from July 1, 1997, to January 1,
2002. The Redeemable Warrants (other than the ASSI Warrants, while held by
ASSI, Inc.) are subject to redemption by the Company, at any time commencing
July 2, 1997, at a price of $.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 notice of redemption. See
"Description of Securities -Redeemable Warrants."
Upon the completion of the Company's initial public offering (the "IPO")
in July 1996, the Company sold to The Boston Group, L.P. and Joseph Stevens &
Company, L.P., the underwriters of such offering (the "Underwriters")
warrants (the "Underwriters' Warrants") to purchase 240,000 shares of Common
Stock for $5.80 per share during the period from July 2, 1997 to July 1,
2001. The Underwriters' Warrants are subject to certain separate registration
rights. See "Certain Transactions - Agreements with the Underwriters."
The Company's publicly traded Common Stock and Redeemable Warrants are
currently listed separately on the automated quotation system of the Nasdaq
SmallCap Market ("Nasdaq") under the symbols "SSII" and "SSIIW,"
respectively. On May 6, 1997, the last trade prices for the Common Stock
and the Redeemable Warrants reported on Nasdaq were $1.06 per share, and
$0.31 per Redeemable Warrant, respectively.
Investors in the securities offered hereby who reside in the State of
California shall be required to have a minimum annual gross income of $30,000
and a net worth of $30,000 or, in the alternative, a minimum net worth of
$75,000, determined exclusive of home, home furnishings and automobiles.
THESE SECURITIES ARE HIGHLY SPECULATIVE AND INVOLVE A HIGH DEGREE OF RISK
AND IMMEDIATE SUBSTANTIAL DILUTION. SEE "RISK FACTORS" AND "DILUTION" COMMENCING
ON PAGES 8 AND 22, RESPECTIVELY.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED
UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
The date of this Prospectus is May 9, 1997
<PAGE>
The Company previously issued the ASSI Warrants to ASSI, Inc. in a series
of private transactions. Upon completion of the IPO, the ASSI Warrants were,
in accordance with their terms, automatically converted into Redeemable
Warrants. However, as so long as such warrants are held by ASSI, Inc. or
any affiliate thereof, their terms will differ from those of the Redeemable
Warrants in the following respects: (i) they became exercisable October 1, 1996;
(ii) they are not mandatorily redeemable by the Company; and (iii) they are
subject to certain separate registration rights. See "Certain Transactions -
Agreements With ASSI, Inc."
Pursuant to agreements with the Underwriters, without the prior
consent of such Underwriters, prior to January 2, 1998, Vincent J. Bitetti may
not sell any of the 200,000 shares of Common Stock which he is offering hereby,
and Eric H. Winston may not sell more than 10,000 of the 392,838 shares of
Common Stock which he is offering hereby. See "Certain Transaction - Agreements
With the Underwriters."
The various exercise prices of each of the Redeemable Warrants and
Underwriters' Warrants are all subject to adjustment pursuant to the
anti-dilution provisions thereof. The Company will receive proceeds from
the exercise of the Redeemable Warrants and the Underwriters' Warrants, if
any are exercised, but will not receive any proceeds from the resale thereof.
The Company will not receive any of the proceeds from sales of the Selling
Securityholders' Securities by the Selling Securityholders. See "Use of
Proceeds." All costs, expenses and fees in connection with the registration
of the Selling Security Holders' Securities will be borne by the Company. The
Company has agreed to indemnify the Selling Security Holders against certain
liabilities, including liabilities under the Securities Act of 1933, as
amended (the "Securities Act").
The sale of the Selling Security Holders' Securities may be effected from
time to time in transactions (which may include block transactions by or for the
account of the Selling Security Holders) in the over-the-counter market or in
negotiated transactions, through the writing of options on the Selling Security
Holders' Securities, through a combination of such methods of sale or otherwise.
Sales may be made at fixed prices which may be changed, at market prices
prevailing at the time of sale, or at negotiated prices. If any Selling Security
Holder sells his, her or its Selling Security Holders' Securities pursuant to
this Prospectus at a fixed price or at a negotiated price which is, in either
case, other than the prevailing market price or in a block transaction to a
purchaser who resells, or if any Selling Security Holder pays compensation to a
broker-dealer that is other than the usual and customary discounts, concessions
or commissions, or if there are any arrangements either individually or in the
aggregate that would constitute a distribution of the Selling Security Holders'
Securities, a post-effective amendment to the Registration Statement of which
this Prospectus is a part would need to be filed and declared effective by the
Securities and Exchange Commission before such Selling Security Holder could
make such sale, pay such compensation or make such a distribution. The Company
is under no obligation to file a post-effective amendment to the Registration
Statement of which this Prospectus is a part under such circumstances.
The exercise of the Redeemable Warrants may be prohibited in certain
states. See "Risk Factors - Current Prospectus and State Registration to
Exercise Warrants." Although the Redeemable Warrants were initially sold in
jurisdictions in which the Redeemable Warrants and underlying shares of
Common Stock were qualified for sale, purchasers who reside in or may move to
jurisdictions in which the Redeemable Warrants or underlying shares are not
registered for sale or otherwise qualified may have purchased such Redeemable
Warrants in the aftermarket during the period when the Redeemable Warrants
are exercisable. In this event the Company would be unable to issue shares to
such persons desiring to exercise their Redeemable Warrants unless and until
the shares could be qualified for sale in the jurisdictions in which such
purchasers reside, or unless an exemption to such qualification exists. The
exercise prices and other terms of the Redeemable Warrants were originally
determined by negotiation between the Company and the Underwriters,
and such terms were not necessarily related to the Company's asset
value, net worth or any other established criteria of value. See "Risk
Factors," "Selling Security Holders" and "Plan of Distribution."
<PAGE>
ADDITIONAL INFORMATION
The Company is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and, in accordance
therewith, files reports, proxy statements and other information with the
Securities and Exchange Commission (the "SEC"). Such reports and other
information filed by the Company can be inspected and copied at the public
reference facilities of the SEC at its principal office at Judiciary Plaza, 450
Fifth Street, N.W., Room 1024, Washington, D.C. 20549, and at the SEC's regional
offices at Northwestern Atrium Center, 500 West Madison Street, Suite 1400,
Chicago, Illinois 60661, and at 7 World Trade Center, 13th Floor, New York, New
York 10048. Copies of each such document may be obtained at prescribed rates
from the Public Reference Section of the SEC at its principal office at
Judiciary Plaza, 450 Fifth Street, N.W., Room 1024, Washington, D.C. 20549. In
addition, all reports filed via the SEC's Electronic Data Gathering and
Retrieval System ("EDGAR") can be obtained from the SEC's Internet web site
located at www.sec.gov.
The Company has filed with the SEC two Registration Statements on Form
SB-2 (Nos. 33-80827 and 333-24271) (collectively with any amendments
thereto, the "Registration Statement") under the Securities Act with respect
to the securities being offered by this Prospectus. This Prospectus does not
contain all of the information set forth in the Registration Statement and
the schedules and exhibits thereto. For further information with respect to
the Company, and the Common Stock and Redeemable Warrants, reference is
hereby made to the Registration Statement and to the exhibits filed as a part
thereof. The statements contained in this Prospectus as to the contents of
any contract or other document identified as an exhibit in this Prospectus
are not necessarily complete and, in each instance, reference is made to a
copy of such contract or document filed as an exhibit to the Registration
Statement, each statement being qualified in any and all respects by such
reference. The Registration Statement, including exhibits, may be inspected
without charge at the principal reference facilities maintained by the SEC at
450 Fifth Street, N.W., Washington, D.C. 20549, and copies of all or any part
thereof may be obtained upon payment of fees prescribed by the SEC from the
Public Reference Section of the SEC at its principal office in Washington,
D.C. set forth above.
The Company's Common Stock and Redeemable Warrants are quoted on the Nasdaq
SmallCap Market under the symbols SSII and SSIIW, respectively. All of the
reports required to be filed by the Company with National Association of
Securities Dealers, Inc., if any, and other information concerning the Company
can be inspected at the offices of the National Association of Securities
Dealers, Inc., 1735 K Street, N.W., Washington, D.C. 20006.
The Company will provide without charge to each person to whom a Prospectus
is delivered, upon written or oral request of such person, a copy of any and all
documents referred to above that have been incorporated into this Prospectus by
reference. Written or oral requests for such copies should be directed to:
Secretary, Sound Source Interactive, Inc., 26115 Mureau Road, Suite B,
Calabasas, California 91302-3126, telephone (818) 878-0505.
1
<PAGE>
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by, and must be read in
conjunction with, the more detailed information and financial statements
appearing elsewhere in this Prospectus.
The Company
Sound Source Interactive, Inc., a Delaware corporation (the "Company," as
previously defined), is engaged primarily in developing, publishing and
marketing educational, interactive computer software for children. The Company's
major software products are Interactive MovieBooks(TM), which combine animation
text, photos, sound clips and actual film footage of well recognized family
films and cartoon series. Interactive MovieBooks(TM) are developed and published
by the Company on compact disk-read only memory ("CD-ROM") for multimedia
personal computers ("Multimedia PCs") as entertaining, interactive reading tools
for young children. The Company also produces a variety of entertainment
computer software utilities which incorporate screen savers, sound clips known
as AudioClips(R) and other content based on licensed entertainment properties.
The new entertainment utilities are marketed as limited edition serialized
collector editions. The Company has developed another line of children's
products which it refers to as Creativity Centers(TM). This product line
combines learning activities such as painting, drawing, matching, puzzles and
mazes within a framework of three distinct skill levels. In July 1996, the
Company created a "games" division, and in August 1996 it signed an agreement
with Twentieth Century Fox Licensing and Merchandising to produce a game sequel
to the 1989 theatrical release The Abyss(TM).
The Company's products are based on licensed content of major motion
pictures and television shows under agreement with major entertainment studios
including Viacom Consumer Products (as agent for Paramount Pictures Corp.),
Warner Bros. Consumer Products, CBS Entertainment, MCA/Universal Merchandising,
Inc., Carolco Pictures, Inc., DC Comics, MGM/UA Merchandising, Inc. and others.
The Company's license agreements for existing products include Babe(TM),
Lassie(TM), The Little Rascals(TM), Black Beauty(TM), The Adventures of Batman
and Robin(TM), Terminator 2: Judgment Day(TM), Free Willy 2(TM), The Secret
Garden(TM), Star Trek(TM), The Twilight Zone(TM), I Love Lucy(TM) and other
popular titles. The Company also holds licenses for new products based on Star
Trek: Deep Space 9(TM), Star Trek: Voyager(TM), All Dogs Go to Heaven II(TM),
The Land Before Time(TM), DragonHeart(TM), I Love Lucy(TM) and Free Willy 3(TM).
The Company is continuing the negotiation of additional licenses for its
children's titles, 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 powerful capabilities and declining price of Multimedia PCs have
enabled them to draw acceptance as all-purpose, functional educational and
entertainment products for home and school use. Data from industry sources
indicates that the installed base of Multimedia PCs exceeds 9,000,000 units.
The technological capabilities of Multimedia PCs have allowed the Company to
produce interactive software that is "user friendly" while maintaining what
management believes are high standards in design, animation, sound quality
and quality duplication of motion picture footage.
2
<PAGE>
The Company believes that as of February 28, 1997, its products were in
distribution to approximately 6,000 retail outlets. Retailers currently selling
the Company's products include Target, Tower Records, Sears, Wal-Mart,
Price/Costco, CompUSA, Best Buy, BJ's, Computer City, Egghead, Electronics
Boutique, Babbages, Etc., Kmart, Barnes & Noble, Sam's Club, Musicland and
others.
On June 1, 1996, the Company entered into a Distribution Services Agreement
with Simon & Schuster Interactive Distribution Services ("SSIDS"). SSIDS is the
consumer software distribution unit of Simon & Schuster, Inc., the publishing
operation of Viacom Inc. Pursuant to this 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 within the
assigned territory except as regards the rights to distribute the Company's
products in direct-to-the-customer programs including direct mail, telemarketing
and in-box coupon fulfillment, which are nonexclusive. The Company also has
entered into separate agreements providing for the distribution of its products
internationally. See "Business-Product Distribution."
The Company's objective is to be a leading publisher of high quality,
value priced, family-oriented software. To achieve this objective, the
Company intends to (i) focus primarily on developing products with
educational and entertainment value which are based on popular movies,
television series and comic book characters and are easy to use and install,
(ii) develop a broad line of products, upgrade successful products and
develop product line extensions and complementary products, (iii) leverage
studio relationships to develop cross-marketing promotional programs, (iv)
promote tradename recognition, (v) develop alternative distribution channels,
including bundling with home video and other products, (vi) leverage its
licensed content to develop products intended for the game market, and (vii)
pursue strategic alliances and acquisitions of products and/or companies. See
"Business - Business Strategy."
The Company is located at 26115 Mureau Road, Suite B, Calabasas, California
91302-3126. Its telephone number is (818) 878-0505. Its facsimile number is
(818) 878-0007, and its Internet web site is located at www.cris.com/~ssi.
Liquidity and Capital Resources
Since its formation, the Company has financed its operations and capital
expenditures primarily with cash provided by operating activities, securities
issuances and financing arrangements. As of the fiscal year ended June 30, 1996,
the Company had negative working capital of $(5,373,974) and cash and cash
equivalents of $181,985.
The Company utilized a portion of the $8,285,784 in net proceeds of its
IPO to repay certain notes payable aggregating $4,987,500 plus accrued
interest of $373,573. Contemporaneous with the initial closing of the IPO,
the Company issued 2,016,657 Redeemable Warrants in connection with the
conversion of a note payable to ASSI, Inc. which was in the principal amount
of $500,000, plus accrued interest of $4,164. See "Certain Transactions -
Agreements With ASSI, Inc." As a result of these transactions, the Company
was able to eliminate its long term debt and substantially reduce its trade
payables, to renew favorable terms with its vendors, to make required royalty
payments under its various license agreements and to increase its investments.
3
<PAGE>
As of December 31, 1996, the Company had working capital of $2,555,381
in comparison with ($5,373,974) at June 30, 1996, an increase of $7,929,355.
Cash and cash equivalents increased $1,505,448 as a result, in part, of the
Company's IPO. Accounts receivable increased $443,283 due to increased sales
of products to the Company's North American distributor, its international
distributors and other direct sales, partially offset by the collection of
$512,134 (net of a short-term advance of $400,000) from the Company's former
distributor. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations - Liquidity and Capital Resources."
The Company has experienced a significant increase in growth during the
six-month period ended December 31, 1996, as compared to the same period of
time in 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 pursue such business opportunities in the
future, the Company may require additional financing to fund its growth. See
"Risk Factors - Possible Need for Additional Financing."
4
<PAGE>
The Offering
Securities Offered ............. 11,078,097 shares of Common Stock issuable by
the Company upon exercise of the Redeemable
Warrants (including the 4,816,657 ASSI
Warrants).
240,000 shares of Common Stock issuable by
the Company upon exercise of the
Underwriters' Warrants.
690,338 shares of Common Stock being offered
by the Selling Security Holders (including
200,000 shares being offered by Vincent J.
Bitetti, the Company's Chairman of the Board
and Chief Executive Officer, 392,838 shares
being offered by Eric H. Winston, an
affiliate, and 40,000 shares being offered
by ASSI, Inc., an affiliate).
5,058,307 Redeemable Warrants being offered
by the Selling Security Holders (including
4,816,657 Redeemable Warrants being offered
by ASSI, Inc., an affiliate).
Terms of the Redeemable
Warrants ................... Each Redeemable Warrant entitles the holder
to purchase one share of Common Stock at a
price of $4.40, subject to adjustment, during
the period from July 1, 1997, until January
1, 2002.
The Redeemable Warrants (other than the ASSI
Warrants, while held by ASSI, Inc.) are
subject to redemption by the Company, at any
time commencing July 1, 1997, at a price of
$.25 per Redeemable Warrant, if the average
closing bid price of the Common Stock equals
or exceeds $5.60 per share for any 20 trading
days within a period of 30 consecutive
trading days ending on the fifth trading day
prior to the date of the notice of
redemption. In the event that the Redeemable
Warrants are called for redemption, they will
be exercisable for 30 days preceding the
applicable redemption date. See "Description
of Securities - Redeemable Warrants."
References herein to the Redeemable Warrants
include the ASSI Warrants, except as
expressly set forth herein. The terms of the
ASSI Warrants are identical to those of the
other Redeemable Warrants, except that for
so long as they are held by ASSI, Inc. or any
affiliate thereof their terms will differ
from those of the other Redeemable Warrants
in the following respects: (i) they became
exercisable on October 1, 1996; (ii) they are
not mandatorily redeemable by the Company;
and (iii) they are subject to separate
registration rights. See "Certain
Transactions - Agreements With ASSI, Inc."
5
<PAGE>
Shares of Common Stock
Outstanding as of
February 28, 1997 .......... 4,409,099 shares.
Common Stock Issuable Upon
Exercise of Redeemable
Warrants ................... 11,078,097 shares.
Common Stock Issuable
Upon Exercise of
Underwriters' Warrants ..... 240,000 shares.
Use of Proceeds ................ The net proceeds from the exercise of the
Redeemable Warrants and Underwriters'
Warrants, if any are exercised, will be used
for working capital and general corporate
purposes. The Company will not receive any of
the proceeds from the resale of any
Redeemable Warrants or Common Stock by the
Selling Security Holders as described herein.
See "Use of Proceeds."
Nasdaq Symbols:
Common Stock ............... SSII
Redeemable Warrants ........ SSIIW
Risk Factors ................... An investment in the Common Stock and
Redeemable Warrants involves a high degree of
risk and immediate substantial dilution. See
"Risk Factors" and "Dilution."
6
<PAGE>
Summary Financial Information
The following table of summary financial information is derived from
and should be read in conjunction with the Company's financial statements and
the footnotes thereto included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
Six Months Ended
Year Ended June 30, December 31,
------------------------------- -------------------------------
Statement of Operations Data 1995 1996 1995 1996
- ------------------------------------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Retail software sales .................... $ 1,255,230 $ 2,161,351 $ 1,077,547 $ 2,362,542
OEM sales ................................ 479,675 70,895 21,466 0
Development agreement revenues ........... 343,250 0 0 12,000
Royalties ................................ 76,771 32,387 21,678 55,704
------------ ------------ ------------ ------------
Net sales from continuing operations . 2,154,926 2,264,633 1,120,691 2,430,246
Gross profit ............................. 1,082,235 881,634 438,181 1,477,244
Noncash compensation expense recorded in
connection with Common Stock and
Common Stock options issued for
services ............................. 733,165 0 0 178,607
Other expenses ........................... 1,940,124 5,356,610 2,448,553 2,240,273
Loss from continuing operations .......... (1,591,054) (4,474,976) (2,010,372) (941,636)
Loss from discontinued operations ........ (143,106) 0 0 0
Net loss ................................. (1,734,160) (4,474,976) (2,010,372) (941,636)
Loss per common share from continuing
operations ........................... $ (0.85) $ (2.44) $ (1.08) $ (0.22)
Loss per common share from
discontinued operations .................. (0.08) 0 0 0
------------ ------------ ------------ ------------
Net loss per common share ................ $ (0.93) (2.44) (1.08) $ (0.22)
Weighted average number of common shares
outstanding .......................... 1,862,908 1,837,759 1,868,145 4,318,096
</TABLE>
Balance Sheet Data December 31, 1996
- ------------------ -----------------
Actual As Adjusted(1)
------ --------------
Working capital ............................ $ 2,555,381 $ 48,811,826
Total assets ............................... 4,559,193 50,815,638
Current liabilities ........................ 1,604,890 1,604,890
Long term debt ............................. 124,602 124,602
Stockholders' equity ....................... 2,829,701 49,086,146
- --------------------
(1) As adjusted to reflect the issuance of 11,078,097 shares of Common Stock
upon exercise of the 11,078,097 Redeemable Warrants at an exercise price of
$4.40 per share, net of the expenses of this offering (estimated at $50,000
for costs and $2,437,181 for the five percent warrant exercise fee payable
to the Underwriters). Does not reflect the exercise of any other
outstanding warrants or options.
7
<PAGE>
RISK FACTORS
An investment in the securities offered hereby involves a high degree of
risk and immediate substantial dilution. In addition to the other information
contained in the Prospectus, prospective investors should carefully consider
the following risk factors before making an investment. This Prospectus
contains and incorporates by reference forward-looking statements within the
"safe harbor" provisions of the Private Securities Litigation Reform Act of
1995. Reference is made in particular to the discussion set forth under
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" herein. Such statements are based on current expectations that
involve a number of uncertanties including those set forth in the risk
factors below. Actual results could differ materially from those projected in
the forward-looking statements.
Product Distribution. On June 1, 1996 the Company entered into a
Distribution Services Agreement with SSIDS. 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 within the assigned territory except as regards the rights to
distribute the Company's products in direct-to-the-customer programs including
direct mail, telemarketing and in-box coupon fulfillment, which are
nonexclusive. The Company also has entered into separate agreements providing
for the distribution of its products internationally. See "Business - Product
Distribution."
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, will not be obligated to sell any specified
minimum quantity of the Company's products. There can be no assurance as to
the volume of product sales that may be achieved by SSIDS. Because the
Company's rights to market its 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.
Product Returns; Collection of Accounts Receivable; Credit Risk. Under
the SSIDS distribution agreement, SSIDS is responsible for collection of
accounts and the Company is responsible for product returns. The Company
intends to maintain an appropriate reserve for product returns which, based
upon its prior experience and current market conditions, will approximate 15
percent of gross revenues, against which credits for actual returns will be
applied. Although the Company believes that these reserves will be adequate,
there can be no assurance that its actual losses due to returns will not
exceed the reserved amount. See "Business - Product Distribution."
Past Operating Losses; No Assurance of Future Profitability. The Company
sustained net losses of $1,734,160 and $4,474,976 for the fiscal years ended
June 30, 1995, and 1996, respectively, and a net loss of $941,636 for the six
months ended December 31, 1996. There can be no assurance as to when, if
ever, the Company will achieve profitability. See generally "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
The Company will continue to sustain losses unless it can further increase
product sales.
Limited History of Business Operations. The Company has a limited
operating history. The Company conducted substantially no business prior to
its acquisition of Sound Source Interactive, Inc., a California corporation
(the "Subsidiary") in 1994. The Subsidiary itself commenced operations
originally as a nonincorporated entity in 1988. The Subsidiary's revenues
originally were derived from the sale of sound patches for music
synthesizers. Since 1993, revenues and income have been predominately derived
from entertainment utilities software for Apple Macintosh and IBM-compatible
computers incorporating content licensed from major motion picture studios.
See generally "The Company" and "Business."
New Business Risks for Licensed Software Products. The business of
creating and marketing licensed software derived from motion pictures is a new
and evolving industry, which will be subject to
8
<PAGE>
a number of risks, including trends in personal computer sales, changes in
available technology and changes in the competition for licenses to develop
software derived from motion pictures. Changes in these factors could have a
material adverse effect on the Company's revenues and potential profitability.
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, including computer hardware or software
manufacturers, diversified media companies, toy manufacturers and book
publishing companies, 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 or may compete in the future
have greater financial, technical, marketing, sales and customer support
resources, as well as greater name recognition and better access to consumers,
than the Company. The competition for retail shelf space is also likely to
increase due to the continued proliferation of consumer software products and
companies. In addition, 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.
The Company has entered into license agreements with Viacom Consumer
Products (as agent for Paramount Pictures Corp.), Warner Bros. Consumer
Products, CBS Entertainment, MCA/Universal Merchandising, Inc., Carolco
Pictures Inc., DC Comics, MGM/UA Merchandising, Inc. and others. Several of
these major motion picture studios now have captive software divisions. As
these types of software products become better known in the marketplace,
these divisions may begin to vie for their studios' products. Management
believes that Disney, Lucasfilm and Paramount/Viacom are currently the most
active studios in publishing their own product to create software packages.
Fox, Universal Pictures, Sony Pictures and Warner Bros. each have announced
the formation of their own interactive computer software divisions to publish
software products using their own licensed content, which could have a
material adverse effect on the Company's ability to renew existing licenses
or obtain new licenses for additional movie titles. The establishment of
these divisions may limit the Company's ability to obtain licenses from the
studios involved, which in turn could reduce the Company's potential product
offerings. To date, the Company has had ample product licensing
opportunities, and management believes that even if some sources are lost due
to the establishment of interactive software divisions by some motion picture
studios, there will continue to be multiple sources of licensing for the
Company's new products. There can be no assurance, however, that the Company
will have sufficient product licensing opportunities in the future. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Seasonality" and "Business - Competition."
Dependence on Key Personnel. 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 J.
Bitetti, Chairman of the Board and Chief Executive Officer, could have a
material adverse effect on the Company. Mr. Bitetti has agreed to work full-time
for the
9
<PAGE>
Company and has signed an employment agreement with a term ending on
September 15, 1998. Competition for highly skilled employees with technical,
management, marketing, sales, creative product development and other
specialized training is intense, and there can be no assurance that the
Company will be successful in attracting and retaining such personnel. In
addition, there can be no assurance that employees will not leave the Company
or compete against the Company. The Company's failure to attract additional
qualified employees or to retain the services of key personnel could have a
material adverse effect on the Company's business, operating results and
financial condition. The Company is the beneficiary of a $5,000,000 life
insurance policy on Vincent J. Bitetti, Chairman of the Board and Chief
Executive Officer, and a $500,000 life insurance policy on Ulrich E.
Gottschling, President, Chief Operating Officer, Chief Financial Officer,
Treasurer and Secretary, but does not currently maintain life insurance on
any of its other employees. See "Management - Directors and Executive
Officers" and "Employment Agreements."
Limitation on Directors' Liability; Indemnification. The Company's
Certificate of Incorporation provides that a director of the Company, to the
maximum extent now or hereafter permitted by Section 102(b)(7) of the Delaware
General Corporation Law (the "Delaware GCL"), will have no personal liability to
the Company or its stockholders for monetary damages for breach of fiduciary
duty as a director. The Company's Bylaws generally require the Company to
indemnify and advance expenses to its directors, officers, employees and other
agents to the fullest extent permitted by Delaware law. The Company also has
entered into indemnification agreements with each of its directors whereby the
Company will indemnify each such person against certain claims arising out of
certain past, present or future acts, omissions or breaches of duty committed by
an indemnitee while serving as a Company director. See "Management - Limitation
of Liability and Indemnification of Directors."
Changes in Technology and Industry Standards. The consumer software
industry is undergoing rapid changes, including evolving industry standards,
frequent new product introductions and changes in consumer requirements and
preferences. The introduction of new technologies, including operating systems
and media formats, could render the Company's existing products obsolete or
unmarketable. In 1993, for example, there was a significant shift in consumer
demand from DOS-based software to Microsoft(R)-Windows(R)-based software. More
recently, consumer demand has been shifting from disk-based software to software
on CD-ROM. In addition, the introduction of the Windows '95(R) operating system
may affect consumer preferences and the demand for new consumer software in ways
which cannot be foreseen. In the future, there could be radical changes in
software delivery systems, replacing CD-ROM with on-line or other methods of
distribution.
There can be no assurance that the current demand for the Company's
Windows(R) and CD-ROM products will continue or that the mix of the Company's
future product offerings will keep pace with technological changes or satisfy
evolving consumer preferences. The success of the Company will be dependent upon
its ability to develop, introduce and market products which respond to such
changes in a timely fashion. The Company intends to maintain its products in
accordance with industry standards. The development cycle for products utilizing
new operating systems or formats may be significantly longer than the Company's
current development cycle for products on existing operating systems and formats
and may require the Company to invest resources in products that may not become
profitable. Although the Company's software is Windows '95(R) compatible, there
can be no assurance that the Company will be successful in developing and
marketing products for certain advanced and emerging operating systems and
formats that may arise in the future. Failure to develop and introduce new
products and product enhancements in a timely fashion could result in
significant product returns and
10
<PAGE>
inventory obsolescence and could impair the Company's business, operating
results and financial condition. See "Business - Products" and "- Development."
Uncertainty of Market Acceptance; Short Product Life Cycles. Consumer
preferences for software products are difficult to predict, and few consumer
software products achieve sustained market acceptance. The Company believes that
the highest sales of each of its products will occur during the six- to
nine-month periods following their introduction, and that thereafter sales will
diminish and pricing will be reduced. Therefore, the Company's success is
dependent upon the market acceptance of its existing products and the continued
development and introduction of new products which achieve market acceptance.
There can be no assurance that the Company's existing products will continue to
realize market acceptance, or that new products introduced by the Company will
achieve any significant degree of market acceptance or sustain any such
acceptance for any significant period of time. Failure of the Company's new and
existing products to achieve and sustain market acceptance will have a material
adverse effect on the Company's business, operating results and financial
condition. See "Business - Products" and "- Development."
Fluctuations in Operating Results; Seasonality. 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, ability to
add new distribution channels, 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. In response to competitive
pressures for new product introductions, the Company may take certain pricing or
marketing actions that could materially and adversely affect the Company's
business, operating results and financial condition. The Company's expense
levels are based, in part, on its expectations as to future sales. Therefore,
operating results could be disproportionately affected by a reduction in sales
or a failure to meet the Company's sales expectations. The Company may be
required to pay in advance or to guarantee royalties, which may be substantial,
to obtain licenses of intellectual properties from third parties before such
properties have been introduced or achieved market acceptance. Defective
products may result in higher customer support costs and product returns.
Additionally, the consumer software business traditionally has been
seasonal. Typically, net sales are highest during the fourth calendar quarter
and decline 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. There can be no
assurance that the Company will achieve consistent profitability on a
quarterly or annual basis. Nevertheless, management believes that in the
future its results may be less subject to seasonal fluctuations because its
products will be marketed in conjunction with the release of home videos,
which occur throughout the year. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Quarterly Results of
Operations" and "- Seasonality."
Dependence on Retailers. The Company's retail customers include computer
stores, office supply stores, warehouse clubs, consumer electronics stores,
bookstores, video stores and alternative channels. The Company's customers are
not contractually required to make future purchases of the Company's products
and therefore could discontinue carrying the Company's products in favor of
competitors' products or for any other reason. Retailers compete in a volatile
industry that is subject to rapid change,
11
<PAGE>
consolidation, financial difficulty and increasing competition from new
distribution channels. Due to increased competition for limited shelf space,
retailers are increasingly in a better position to negotiate favorable purchase
terms, including price discounts and product return policies. Retailers often
require software publishers to pay fees in exchange for preferred shelf space.
Retailers may give higher priority to products other than the Company's, thus
reducing their efforts to sell the Company's products. There can be no assurance
that the Company will be able to increase or sustain its current amount of
retail shelf space or promotional resources, and as a result, the Company's
operating results could be materially adversely affected. In addition, other
types of retail outlets and methods of product distribution may become important
in the future, such as on-line services. It is critical to the success of the
Company that as these changes occur, the Company gains access to those channels
of distribution. See "Business Sales and Marketing."
Dependence on Outside Suppliers. The Company contracts with third party
suppliers to provide manufacturing of its products, which the Company
believes allows it to control effectively its costs of production. The
Company relies upon the ability of such suppliers to provide products which
are free of defects. To the extent that any supplier-produced defective
product was not discovered until the product was shipped, it could result in
the Company's liability for returned merchandise and a loss of its reputation
for high quality products. Although the Company would attempt to recoup from
the supplier of defective product any expenses incurred, there can be no
assurance that the Company would be fully compensated for any losses that
resulted. See "Business - Development" and "-Operations."
Risk of Inability to Manage Rapid Growth. The Company is currently
experiencing a period of rapid growth that has placed, and could continue to
place, a significant strain on the Company's financial, management and other
resources. The Company's ability to manage its growth effectively will
require it to continue to improve its operational, financial and management
information systems, and to attract, train, motivate, manage and retain key
employees. The Company may make additional investments in capital equipment
to expand into new product lines. No assurances can be given that these new
systems will be implemented successfully. The failure to do so, or to
otherwise effectively manage potential future growth, could have a material
adverse effect on the Company's business, operating results and financial
condition. See "Business - Operations" and "Management -Directors and
Executive Officers."
Risks Associated with Acquisitions. As part of its strategy to enhance
revenue growth and market presence, the Company continually evaluates
acquisitions of entertainment software companies and selected titles within
existing or new product categories. In considering an acquisition, the Company
may compete with other potential acquirors, many of which may have greater
financial and operational resources. Further, the evaluation, negotiation and
integration of such acquisitions may divert significant time and resources of
the Company, particularly of its management. There can be no assurance that
suitable acquisition candidates will be identified, that any acquisitions can be
consummated, or that any acquired businesses or products can be successfully
integrated into the Company's operations. In addition, there can be no assurance
that future acquisitions will not have a material adverse effect upon the
Company's business, operating results and financial condition, particularly in
the fiscal quarters immediately following the consummation of such transactions
due to unexpected expenses which may be associated with integrating such
acquisitions. See "Business - Business Strategy - Acquisitions."
Limited Protection of Intellectual Property and Proprietary Rights. The
Company regards its software as proprietary and relies primarily on a
combination of trademark, copyright and trade secret
12
<PAGE>
laws, employee and third party nondisclosure agreements and other methods to
protect its proprietary rights. All of the Company's new products are CD-ROM
based, and hence are difficult to copy. However, unauthorized copying occurs
within the software industry, and if a significant amount of unauthorized
copying of the Company's products were to occur, the Company's business,
operating results and financial condition could be materially adversely
affected.
As the number of software products in the industry increases and the
functionality of these products further overlaps, software developers and
publishers may increasingly become subject to infringement claims. There can
be no assurance that third parties will not assert infringement claims
against the Company in the future with respect to current or future products.
See "Business - Proprietary Rights and Licenses."
Although the Company has not been the subject of any actual, pending or
threatened intellectual property litigation, there has been substantial
litigation regarding copyright, trademark and other intellectual property rights
involving computer software companies. In the future, litigation may be
necessary to enforce the Company's proprietary rights, to protect copyrights,
trademarks and trade secrets and other intellectual property rights owned by the
Company or its licensors, to defend the Company against claimed infringements of
the rights of others and to determine the scope and validity of the proprietary
rights of the Company and others. Any such litigation, with or without merit,
could be costly and result in a diversion of management's attention, which could
have a material adverse effect on the Company's business, operating results and
financial condition. Adverse determinations in such litigation could result in
the loss of the Company's proprietary rights, subject the Company to significant
liabilities, require the Company to seek licenses from third parties or prevent
the Company from selling its products, any of which could have a material
adverse effect on the Company's business, operating results and financial
condition.
Licenses Terminable Upon Change in Ownership, Control or Management. The
Company's licenses and other intellectual property may not be transferred to
third parties without the consent of the licensors. Transfer of ownership of
stated percentages of the Common Stock could constitute a prohibited transfer
of the Company's licenses for the Star Trek(TM) titles. All of the Company's
licenses with Warner Bros. (including The Secret Garden(TM), Black
Beauty(TM), Free Willy 2(TM), Free Willy 3(TM) and Babylon 5(TM)) provide
that a change in "management" will be deemed an unauthorized assignment of
the license. It is not clear under what circumstances the Company might be
deemed to have a change in management which could result in the termination
of these licenses.
The completion of the Company's IPO may have resulted, and any future
change in ownership or control of the Company (including exercise of the
Redeemable Warrants) could result, in the termination of the licenses referred
to above. The potential terminability of such licenses could have the effect of
delaying, deferring or preventing a change in control of the Company, may
discourage bids for the Common Stock at a premium over the market price of the
Common Stock and may materially adversely affect the market price of the Common
Stock.
Limited Time Period of Licenses. 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. See "Business -
General" and "- Products." All of the license and development agreements to
which the Company currently is a party are for fixed terms which will expire
over the next 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.
13
<PAGE>
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 all material licenses will be renewed even
if such requirements are satisfied. See "Business - Proprietary Rights and
Licenses."
Possible Need for Additional Financing. The Company heretofore has been
substantially dependent on the net proceeds of its securities offerings,
including the IPO, to fund its working capital requirements. As of December
31, 1996, the Company had working capital of $2,555,381 and cash and cash
equivalents of $1,687,433. The Company has experienced a significant increase
in growth during the six-month period ended December 31, 1996, as compared to
the same period of time in 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 pursue such business
opportunities in the future, the Company may require additional financing to
fund its growth. See "Use of Proceeds" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Liquidity and
Capital Resources."
Broad Discretion in Use of Proceeds. The net proceeds from the exercise of
the Redeemable Warrants and Underwriters' Warrants, if any are exercised, will
be used for working capital and general corporate purposes. The Company will
have broad discretion in the use of funds allocated to working capital. The
Company will not receive any proceeds from the resale of any Redeemable Warrants
or Common Stock by the Selling Security Holders as described herein. See "Use of
Proceeds."
Risk of Limitation of Use of Net Operating Loss Carryforwards. As of June
30, 1996, the Company had net operating loss carryforwards of approximately
$5,742,000 for federal income tax purposes, which may be utilized from 1997 to
2012 (subject to certain limitations). The consummation of the IPO resulted in
an "ownership change" as defined in Section 382 of the Internal Revenue Code of
1986, as amended (the "Code"), and the Treasury Regulations promulgated
thereunder. Consequently, the Company's use of its net operating loss
carryforwards to offset taxable income in any post-change period is subject to
certain specified annual limitations. There can be no assurance as to the
specific amount of net operating loss carryforwards available in any post-change
year since the calculation is based upon a fact-dependent formula.
Control of the Company by Officers and Directors and ASSI, Inc. As of
February 28, 1997, the Company had 4,409,099 outstanding shares of Common
Stock. Vincent J. Bitetti, who is the Company's largest stockholder, owned of
record 1,234,684 shares (27.9 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 owns 4,856,657 shares of
Common Stock, representing approximately 52.5 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 Redeemable Warrants, but no other outstanding warrants and
options). Louis Habash of Las Vegas, Nevada, has advised the Company that he
owns all of the voting equity securities of ASSI, Inc., and thus is the
ultimate beneficial owner of all of the Common Stock and ASSI Warrants owned
by ASSI, Inc. See "Principal Stockholders" and "Certain Transactions -
Agreements with ASSI, Inc."
14
<PAGE>
If the holders of all of the Redeemable Warrants other than the ASSI
Warrants were to exercise such Warrants, but no other outstanding warrants or
options were exercised, the voting power of Vincent J. Bitetti would be reduced
to approximately 11.6 percent. If ASSI, Inc. were to exercise all of the ASSI
Warrants beneficially owned by it as described above, but no other outstanding
warrants or options were exercised, the voting power of Vincent J. Bitetti would
be reduced to approximately 13.4 percent, and would be further reduced to
approximately 8.0 percent assuming exercise in full of all of the other
Redeemable Warrants but no other outstanding warrants and options). ASSI, Inc.
has indicated to the Company that it acquired the ASSI Warrants and Common Stock
beneficially owned by it as an investment with a view to long-term appreciation.
See "Certain Transactions - Agreements with ASSI, Inc.
The Company has granted each of the Underwriters and ASSI, Inc. the
right to nominate from time to time one director (or to have a designee
attend all Board meetings as a nonvoting advisor). In addition, Vincent J.
Bitetti, the Company's Chairman of the Board and Chief Executive Officer, and
Eric H. Winston, its former President and Chief Operating Officer, have
entered into voting agreements with each of the Underwriters and ASSI, Inc.
Pursuant to these agreements, Messrs. Bitetti and Winston have agreed to vote
all of their Common Stock for the three director nominees of the Underwriters
and ASSI, Inc. In addition, ASSI, Inc. has agreed to vote all of its shares
of Common Stock for two directors nominated by Mr. Bitetti for as long as he
holds at least 20 percent of the outstanding Common Stock, and for one
director nominated by Mr. Bitetti for as long as he holds at least ten
percent but less than 20 percent of the issued and outstanding Common Stock.
The voting agreements with ASSI, Inc. will terminate when Messrs. Bitetti and
Winston together cease to own at least ten percent of the outstanding Common
Stock. Pursuant to these arrangements, Vincent J. Bitetti has designated
himself and Ulrich E. Gottschling as his director nominees, and ASSI, Inc.
has nominated Mark A. James as a director. The Underwriters have not
exercised their director nomination rights. See "Management - Directors and
Executive Officers" and "Certain Transactions - Agreements With ASSI, Inc."
and "- Agreements With the Underwriters."
The Company is a quasi-California corporation subject to certain provisions
of the California General Corporation Law (the "California GCL"). See
"Description of Securities - Application of California GCL." Among other
consequences of the Company's status as a quasi-California corporation, at the
request of any stockholder, the election of the Company's directors will be
determined by cumulative voting procedures. Consequently, if cumulative voting
is exercised (and without regard to the various voting agreements described
herein), the Company's stockholders other than Vincent J. Bitetti will have
sufficient votes to elect four of its six directors assuming no exercise of the
Redeemable Warrants, and to elect five of its six directors assuming exercise of
the Redeemable Warrants in full.
Immediate Substantial Dilution. If all 6,261,440 of the outstanding
Redeemable Warrants other than the ASSI Warrants are exercised, such exercise
will result in dilution to the exercising investors of $1.67 per share
(38.2 percent) between the Warrant exercise price ($4.40 per share) and the
pro forma net tangible book value per share of Common Stock upon completion
of such Warrant exercise. If all 11,078,097 of the outstanding Redeemable
Warrants (including the ASSI Warrants) are exercised, such exercise will
result in dilution to the exercising investors of $1.22 per share (27.7
percent) between the exercise price ($4.40 per share) thereof and the pro
forma net tangible book value per share of Common Stock upon completion of
the exercise of such Warrants. The exercise of the 240,000 Underwriters'
Warrants, which have an exercise price of $5.80 per share, will be
anti-dilutive to investors who exercise Redeemable Warrants and/or ASSI
Warrants. See "Dilution."
15
<PAGE>
Underwriters' Potential Influence on the Market. The Underwriters have
advised the Company that a significant amount of the shares of Common Stock
and the Redeemable Warrants sold in the IPO were sold to customers of the
Underwriters. Although the Underwriters are, as of the date of this
Prospectus, making a market in the Common Stock and Redeemable Warrants, they
have no legal obligation to do so. It should be noted that one of the
Underwriters, The Boston Group, L.P., suspended making a market in the Common
Stock and the Redeemable Warrants from March 13, 1997, to March 21, 1997,
while it arranged for new financing. There presently are eight market makers
for the Common Stock and the Redeemable Warrants, in addition to the
Underwriters. Nevertheless, the Underwriters have been and may remain a
dominating influence in the market for the Common Stock and the Redeemable
Warrants. The prices and the liquidity of the Common Stock and the Redeemable
Warrants may be significantly affected by the degree, if any, of the
Underwriters' participation in the market. No assurance can be given that any
market making activities of the Underwriters will be continued.
Current Prospectus and State Registration to Exercise Warrants. The
Redeemable Warrants are not exercisable unless, at the time of the exercise,
the Company has a current prospectus covering the shares of Common Stock
issuable upon exercise of the Redeemable Warrants and such shares have been
registered, qualified or deemed to be exempt under the securities or "blue
sky" laws of the jurisdiction of residence of the exercising holder of the
Redeemable Warrants. In addition, in the event that any holder of Redeemable
Warrants attempts to exercise such Redeemable Warrants at any time after nine
months from the date of this Prospectus, the Company may be required to file
a post-effective amendment and deliver a current prospectus before the
Redeemable Warrants may be exercised. Although the Company has undertaken to
use its best efforts to have all the shares of Common Stock issuable upon
exercise of the Redeemable Warrants registered or qualified on or before the
exercise date and to maintain a current prospectus relating thereto until the
expiration of the Redeemable Warrants, there is no assurance that it will be
able to do so. The value of the Redeemable Warrants may be greatly reduced if
a current prospectus covering the Common Stock issuable upon the exercise of
the Redeemable Warrants is not kept effective or if such Common Stock is not
qualified or exempt from qualification in the jurisdictions in which the
holders of the Redeemable Warrants then reside.
Although the Redeemable Warrants were not knowingly sold in the IPO to
purchasers in jurisdictions in which the Redeemable Warrants were not registered
or otherwise qualified for sale, investors may purchase the Redeemable Warrants
in the secondary market or may move to jurisdictions in which the shares of
Common Stock underlying the Redeemable Warrants are not registered or qualified
during the period that the Redeemable Warrants are exercisable. In such event,
the Company would be unable to issue shares to those persons desiring to
exercise their Redeemable Warrants unless and until the shares could be
qualified for sale in jurisdictions in which such purchasers reside, or an
exemption from such qualification exists in such jurisdictions, and holders of
the Redeemable Warrants would have no choice but to attempt to sell the
Redeemable Warrants in a jurisdiction where such sale is permissible or allow
them to expire unexercised. See "Description of Securities - Redeemable
Warrants."
Adverse Effect to Holders of Possible Redemption of Redeemable Warrants.
The Redeemable Warrants (other than the ASSI Warrants) are subject to
redemption by the Company, at any time commencing July 1, 1997, at a price of
$.25 per Redeemable Warrant, if the average closing bid price for the Common
Stock equals or exceeds $5.60 for any 20 trading days within a period of 30
consecutive trading days ending on the fifth trading day prior to the date of
the notice of redemption. If the Redeemable Warrants are redeemed prior to
their exercise, the holders thereof would lose their right to exercise
Redeemable Warrants except during such period of notice of redemption and the
benefit of the difference, if any, between the market price of the underlying
Common Stock as of such date and the exercise price of such Redeemable
Warrants, as well as any possible future price appreciation in the Common
Stock. Upon the receipt of a notice of redemption of the Redeemable Warrants,
the holders thereof
16
<PAGE>
would be required to: (i) exercise the Redeemable Warrants and pay the exercise
price at a time when it may be disadvantageous for them to do so; (ii) sell the
Redeemable Warrants at the market price, if any, when they might otherwise wish
to hold the Redeemable Warrants; or (iii) accept the redemption price, which is
likely to be substantially less than the market value of the Redeemable Warrants
at the time of redemption. See "Description of Securities - Redeemable
Warrants."
Securities Eligible for Future Sale. As of February 28, 1997, a total of
4,409,099 shares of Common Stock and 11,078,097 Redeemable Warrants (including
the 4,816,657 ASSI Warrants) were issued and outstanding. An additional
12,433,272 shares of Common Stock were issuable pursuant to the following
outstanding options and warrants: (a) 342,337 shares of Common Stock underlying
options granted pursuant to the Company's 1992 Stock Option Plan; (b) 500,000
shares of Common Stock underlying options which have been or may be granted
pursuant to the Company's 1995 Stock Option Plan; (c) 282,838 shares of Common
Stock underlying options granted to a Selling Security Holder; and (d) an
aggregate of 11,318,097 shares of Common Stock issuable upon the exercise of (i)
the Redeemable Warrants (11,078,097 shares) and (ii) the Underwriters' Warrants
(240,000 shares).
Of the 4,409,099 shares of Common Stock and 11,078,097 Redeemable Warrants
issued and outstanding as of February 28, 1997 (subject to the assumptions in
the preceding paragraph), 3,012,469 shares and 6,019,790 Redeemable Warrants are
freely tradeable without further registration under the Securities Act (except
for any such securities held by an "affiliate" of the Company), and the
remaining 1,396,630 outstanding shares and 5,058,307 Redeemable Warrants are
"restricted securities" as defined in Rule 144 under the Securities Act and may
not be sold without registration under the Securities Act unless pursuant to an
applicable exemption therefrom. Of such restricted securities, 407,500 shares of
Common Stock and all 5,058,307 Redeemable Warrants may be sold pursuant to this
Prospectus, and upon such sale will become freely tradeable (except for any such
shares or Redeemable Warrants held by an "affiliate" the Company). See "Selling
Security Holders." Further, the 11,318,097 shares of Common Stock issuable by
the Company upon exercise of the Redeemable Warrants and Underwriters' Warrants
and the 282,838 shares issuable by the Company upon exercise of an option held
by a Selling Security Holder may likewise be sold pursuant to this Prospectus
and upon such sale will become freely tradeable (except for any such shares held
by an "affiliate" of the Company).
As of February 28, 1997, options for the purchase of 342,337 shares of
Common Stock were issued pursuant to the Company's 1992 Stock Option Plan. The
Company has determined not to issue any further options under its 1992 Stock
Option Plan, but all outstanding options under such Plan will remain valid. Of
the 342,337 options granted under the 1992 Stock Option Plan, 258,668 are
presently exercisable, 41,834 will become exercisable later in fiscal 1997 and
the balance will become exercisable in fiscal 1998. The Company also has
reserved 500,000 shares of Common Stock for issuance to key employees, officers,
directors and consultants pursuant to the Company's 1995 Stock Option Plan. As
of February 28, 1997, the Company had granted options for the purchase of
404,607 shares of Common Stock pursuant to the 1995 Stock Option Plan, of which
5,054 are presently exercisable, 3,401 will become exercisable later in fiscal
1997, 148,652 will become exercisable in fiscal 1998, 147,000 will become
exercisable in fiscal 1999, 100,250 will become exercisable in fiscal 2000 and
250 will become exercisable in fiscal 2001. The Company has filed separate
registration statements pertaining to all of the Common Stock issuable upon
exercise of options granted or to be granted pursuant to the 1992 Stock Option
Plan and the 1995 Stock Option Plan. All Common Stock issuable upon exercise of
the options will be freely tradeable (except for any such shares held by an
"affiliate" of the Company). See "Management - 1995 Stock Option Plan" and "-
1992 Stock Option Plan."
17
<PAGE>
Certain of the Company's security holders are entitled to registration
rights as described under "Management - Employment Agreements" (as to Vincent
J. Bitetti and Eric H. Winston), "Certain Transactions - 1995 Bridge
Financing" (as to holders of Redeemable Warrants issued upon conversion of
the Bridge Warrants (as hereinafter defined) and the Common Stock underlying
such Redeemable Warrants), "Certain Transactions - 1995 Private Placement"
(as to holders of Redeemable Warrants issued upon conversion of the Private
Warrants (as hereinafter defined) and the Common Stock underlying such
Redeemable Warrants, and Common Stock issued in the Concurrent Private
Placement (as hereinafter defined)), "Certain Transactions - Agreements with
ASSI, Inc." (as to the ASSI Warrants and the Common Stock underlying such
ASSI Warrants), and "Certain Transactions -Agreements with the Underwriters"
(as to the Underwriters' Warrants and underlying Common Stock). Sales of any
or all such securities described in the preceding paragraphs may depress the
price of the Common Stock or the Redeemable Warrants. See "Securities
Eligible for Future Sale."
An additional 3,157,629 shares of Common Stock remain available for
issuance at the discretion of the Board of Directors. The potential issuance of
such authorized and unissued Common Stock may have the effect of delaying,
deferring or preventing a change in control of the Company, may discourage bids
for the Common Stock at a premium over the market price of the Common Stock and
may materially adversely affect the market price of, and the voting and other
rights of the holders of the Common Stock. Although the Company has no present
intention to issue any such shares of its authorized and unissued Common Stock,
there can be no assurance the Company will not do so in the future. See
"Description of Securities - Common Stock."
No Preemptive Rights; Possible Dilutive Event. The holders of Common Stock
do not have any subscription, redemption or conversion rights, nor do they have
any preemptive or other rights to acquire or subscribe for additional, unissued
or treasury shares. Accordingly, if the Company were to elect to sell additional
shares of Common Stock, or securities convertible into or exercisable to
purchase shares of Common Stock, persons acquiring Common Stock in this offering
would have no right to purchase additional shares, and as a result, their
percentage equity interest in the Company would be diluted. See "Description of
Securities - Common Stock."
No Dividends. As of the date of this Prospectus, the Company has not
paid any cash dividends on its Common Stock and does not intend to declare
any such dividends in the foreseeable future. The Company's ability to pay
dividends is subject to limitations imposed by the Delaware GCL and, as a
quasi-California corporation, to the more restrictive provisions of the
California GCL. The sole source of funds available to the Company for the
payment of dividends is dividends or loans advanced to it by the Subsidiary,
which is itself a California corporation and therefore subject to the
dividend payment provisions of the California GCL.
Under the Delaware GCL, dividends may be paid out of a corporation's
capital surplus, or if there is no surplus, out of the corporation's net
profits for the fiscal year in which the dividend is declared or the
preceding fiscal year. The California GCL generally prohibits a corporation
from paying dividends unless the retained earnings of the corporation
immediately prior to the distribution exceed the amount of the distribution.
Alternatively, a corporation may pay dividends if (i) the assets of the
corporation exceed 1 1/4 times its liabilities, and (ii) the current assets of
the corporation equal or exceed its current liabilities, but if the average
pre-tax earnings of the corporation before interest expense for the two years
preceding the distribution were less than the average interest expense of the
corporation for those years, the current assets of the corporation must exceed
1 1/4 times its current liabilities. Under the foregoing requirements, the
Company will not be able to pay dividends for the foreseeable future. See
"Dividend Policy" and "Description of Securities."
18
<PAGE>
Qualification Requirements for Nasdaq Securities; Risk of Low Priced
Securities. Certain qualification requirements are established for the
initial and continued listing of securities on Nasdaq. The Common Stock and
the Redeemable Warrants currently are listed on the Nasdaq SmallCap Market
under these rules. For continued listing, a company must, among other things,
maintain at least $2,000,000 in total assets, at least $1,000,000 in total
capital and surplus, and a minimum bid price of $1.00 per share of Common
Stock. In late January 1997 the Boards of the Nasdaq Stock Market and the
National Association of Securities Dealers proposed substantial changes to
Nasdaq's listing qualification standards which, if adopted by the Securities
and Exchange Commission, would impose more stringent criteria for continued
listing of securities on Nasdaq.
The Company expects to maintain its listing on Nasdaq; 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 under either the current or, if adopted, the
proposed listing standards. It is anticipated that if the Common Stock and
Redeemable Warrants are delisted from Nasdaq, 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 Nasdaq 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.
In addition, if the Common Stock and Redeemable Warrants are delisted from
Nasdaq, they might be subject to the low priced security or so-called "penny
stock" rules that impose additional sales practice requirements on
broker-dealers who sell such securities to persons other than established
customers and accredited investors (generally defined as investors with a net
worth in excess of $1,000,000 or annual income exceeding $200,000, or $300,000
together with a spouse). For any transaction involving a penny stock, unless
exempt, the rules require, among other things, the delivery, prior to the
transaction, of a disclosure schedule required by the SEC relating to the penny
stock market. The broker-dealer also must disclose the commissions payable to
both the broker-dealer and the registered representative, current quotations for
the securities and, if the broker-dealer is the sole market-maker, the
broker-dealer must disclose this fact and the broker-dealer's presumed control
over the market. Finally, monthly statements must be sent disclosing recent
price information for the penny stock held in the account and information on the
limited market in penny stocks.
Although the Company believes that the Common Stock and Redeemable Warrants
will not be defined as a penny stock due to their anticipated continued listing
on Nasdaq, in the event they subsequently become characterized as a penny stock,
the market liquidity therefor could be severely affected. In such an event, the
regulations relating to penny stocks could limit the ability of broker-dealers
to sell the Common Stock and Redeemable Warrants and, thus, the ability of
purchasers in this offering to sell their Common Stock and Redeemable Warrants
in the secondary market.
19
<PAGE>
USE OF PROCEEDS
The net proceeds from the exercise of the Redeemable Warrants and
Underwriters' Warrants, if any are exercised, will be used for working capital
and general corporate purposes. The proceeds to the Company from the exercise of
all the Redeemable Warrants net of the expenses of this offering (estimated at
$50,000 for costs and $2,437,181 for the five percent warrant exercise fee
payable to the Underwriters) would be approximately $46,256,446. The Company
will not receive any of the proceeds from the resale of any Redeemable Warrants
or Common Stock by the Selling Security Holders as described herein. See "Risk
Factors - Broad Discretion in Use of Proceeds."
DIVIDEND POLICY
The Company has not declared or paid any cash dividends on its Common Stock
since its inception. It is the current policy of the Company that it will retain
its earnings, if any, for expansion of its operations and other corporate
purposes, and that it will not pay any dividends in respect of the Common Stock
in the foreseeable future. The payment of dividends, if any, is within the
discretion of the Board of Directors and will depend upon the Company's
earnings, if any, its capital requirements and financial condition, and such
other factors as the Board of Directors may consider.
The Company's ability to pay dividends is subject to the applicable
provisions of the Delaware GCL, which is the corporation law of the Company's
jurisdiction of incorporation. As a quasi-California corporation, the Company
also is subject to the relatively more restrictive provisions of the California
GCL. The sole source of funds available to the Company for the payment of
dividends is dividends and loans advanced to it by the Subsidiary, which is
itself a California corporation and therefore subject to the dividend payment
provisions of the California GCL.
Under the Delaware GCL, dividends may be paid out of a corporation's
capital surplus, or if there is no surplus, out of the corporation's net profits
for the fiscal year in which the dividend is declared or the preceding fiscal
year. The California GCL generally prohibits a corporation from paying dividends
unless the retained earnings of the corporation immediately prior to the
distribution exceed the amount of the distribution. Alternatively, a corporation
may pay dividends if the assets of the corporation exceed 1 1/4 times its
liabilities, and (ii) the current assets of the corporation equal or exceed its
current liabilities, but if the average pre-tax earnings of the corporation
before interest expense for the two years preceding the distribution were less
than the average interest expense of the corporation for those years, the
current assets of the corporation must exceed 1 1/4 times its current
liabilities. Under the foregoing requirements, the Company will not be able to
pay dividends until it achieves positive retained earnings, which management
does not anticipate will occur for the foreseeable future. See "Risk Factors -
No Dividends" and "Description of Securities - Application of California GCL."
20
<PAGE>
MARKET PRICE OF SECURITIES
The Common Stock and Redeemable Warrants have been listed for trading on
the Nasdaq SmallCap Market since July 1, 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.
Nasdaq
Symbol High Low
------ ---- ---
Common Stock SSII
1996
Third Quarter $6.25 $4.00
Fourth Quarter $5.75 $4.00
1997
First Quarter $4.31 $1.25
Second Quarter (4/1/97-5/6/97) $1.63 $0.44
Redeemable Warrants SSIIW
1996
Third Quarter $2.38 $1.00
Fourth Quarter $1.88 $1.00
1997
First Quarter $1.00 $0.31
Second Quarter (4/1/97-5/6/97) $0.56 $0.19
See the cover page of this Prospectus for a recent last sale price of the
Common Stock and Redeemable Warrants on the Nasdaq SmallCap Market.
As of February 28, 1997, there were approximately 150 holders of record of
the Common Stock and 20 holders of the 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.
21
<PAGE>
DILUTION
The following discussion and tables reflect the potential dilution to
holders who exercise their Redeemable Warrants at $4.40 per share. The
difference between the exercise price per Warrant and the pro forma net tangible
book value per share of Common Stock after such exercise constitutes the
resulting dilution per share of Common Stock. "Net tangible book value per
share" represents the total tangible assets of the Company, less total
liabilities, divided by the number of shares of Common Stock outstanding. At
December 31, 1996, the Company had 4,377,824 shares of Common Stock outstanding
and at such date the net tangible book value of the Company was $2,829,701 or
approximately $.65 per share of Common Stock. See "Risk Factors - Immediate
Substantial Dilution."
After giving effect to the exercise of all Redeemable Warrants other than
the ASSI Warrants (and assuming the exercise of no other warrants or options) to
purchase 6,261,440 shares of Common Stock net of the related expenses of this
offering (estimated at $50,000 for costs and $1,377,517 for the five percent
warrant exercise fee payable to the Underwriters), the pro forma net tangible
book value of the Company at December 31, 1996, would have been $29,052,520 or
$2.73 per share, representing an immediate increase in net tangible book value
of $2.08 per share to existing stockholders and an immediate dilution of $1.67
per share (38.2 percent) to purchasers of shares of Common Stock upon the
exercise of such Warrants.
The following table illustrates the dilution to new investors on a per
share basis assuming exercise of all 6,261,440 Redeemable Warrants other than
the ASSI Warrants (and assuming the exercise of no other warrants or options):
Description Amount Amount
- ----------- ------ ------
Exercise price per share of Common
Stock under Redeemable Warrants $ 4.40
Pro forma net tangible book value per share
of Common Stock before exercise of
Redeemable Warrants $ 0.65
Increase in net tangible book value per
share of Common Stock attributable to the
sale of 6,262,440 shares of Common
Stock upon exercise of Redeemable Warrants 2.08
------
Pro forma net tangible book value per share
of Common Stock after exercise of
Redeemable Warrants 2.73
------
Dilution per share of Common Stock to new
investors upon exercise of Redeemable Warrants $ 1.67
======
After giving effect to the exercise of all Redeemable Warrants (including
the ASSI Warrants and assuming the exercise of no other warrants or options) to
purchase 11,078,097 shares of Common Stock net of the related expenses of this
offering (estimated at $50,000 for costs and $2,437,181 for the five percent
warrant exercise fee payable to the Underwriters), the pro forma net tangible
book value of the Company at December 31, 1996, would have been $49,086,146, or
$3.18 per share, representing an immediate increase in net tangible book value
of $2.53 per share to existing stockholders and an
22
<PAGE>
immediate dilution of $1.22 per share (27.7 percent) to purchasers of Common
Stock upon the exercise of such Warrants.
The following table illustrates the dilution to new investors on a per
share basis assuming exercise of all 11,078,097 Redeemable Warrants (including
the ASSI Warrants and assuming the exercise of other warrants or options):
Description Amount Amount
- ----------- ------ ------
Exercise price per share of Common
Stock under Redeemable Warrants $ 4.40
Pro forma net tangible book value per share
of Common Stock before exercise of
Redeemable Warrants $ 0.65
Increase in net tangible book value per
share of Common Stock attributable to the
sale of 11,078,097 shares of Common Stock
upon exercise of Redeemable Warrants 2.53
------
Pro forma net tangible book value per
share of Common Stock after exercise
of all Redeemable Warrants 3.18
------
Dilution per share of Common Stock
to new investors upon exercise of
Redeemable Warrants $ 1.22
======
The foregoing computations assume the exercise of no warrants or stock
options after December 31, 1996. See "Risk Factors - Securities Available for
Future Sale" and "Securities Eligible for Future Sale."
23
<PAGE>
CAPITALIZATION
The following table sets forth, as of December 31, 1996, the capitalization
of the Company on an actual basis and as adjusted to give effect to the exercise
of the Redeemable Warrants to purchase a total of 11,078,097 shares of Common
Stock at $4.40 per share, and the initial application of the estimated net
proceeds therefrom. The table should be read in conjunction with the financial
statements and the notes to the financial statements which are contained
elsewhere in this Prospectus.
<TABLE>
<CAPTION>
December 31, 1996
---------------------------------
Actual As Adjusted(1)
------------ --------------
<S> <C> <C>
Long-Term Debt ....................................... $ 124,602 $ 124,602
Stockholder's equity (deficit)
Common Stock, $.001 par value; 20,000,000 shares
authorized;4,377,824 shares issued and outstanding
(actual); 15,455,921 outstanding (as adjusted) ... 4,378 15,456
Warrants ......................................... 1,104,925 50
Additional paid capital .............................. 13,249,586 60,599,828
Accumulated deficit .................................. (11,529,188) (11,529,188)
------------ ------------
Total stockholders' equity ........................... 2,829,701 49,086,146
------------ ------------
Total Capitalization ............................. $ 2,954,303 $ 49,210,748
============ ============
</TABLE>
- ---------------------
(1) As adjusted to reflect the issuance of 11,078,097 shares of Common Stock
upon exercise of the 11,078,097 Redeemable Warrants at an exercise price of
$4.40 per share, net of the expenses of this offering (estimated at $50,000
for costs and $2,437,181 for the five percent warrant exercise fee payable
to the Underwriters). Does not reflect the exercise of any other
outstanding warrants or options.
24
<PAGE>
SELECTED FINANCIAL DATA
The following table of selected financial data is derived from and should
be read in conjunction with the Company's financial statements and the footnotes
thereto included elsewhere in this Prospectus. The financial data for the fiscal
years ended June 30, 1995 and 1996 has been derived from audited financial
statements prepared by Corbin & Wertz, certified public accountants, who are the
Company's independent auditors. The financial data for the six-month periods
ended December 31, 1995 and 1996 are derived from unaudited financial statements
of the Company. The unaudited financial statements include all adjustments
consisting of normal recurring accruals which the Company considers necessary
for a fair presentation of the financial position and the results of operations.
Operating results for the six-month period are not necessarily indicative of the
results that may be expected for the entire year ending June 30, 1997. See "Risk
Factors - Fluctuations in Operating Results; Seasonality" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Quarterly Results of Operations."
<TABLE>
<CAPTION>
Six Months Ended
Year Ended June 30, December 31,
----------------------------- -----------------------------
Statement of Operations Data 1995 1996 1995 1996
- ------------------------------------------ ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Retail software sales .................... $ 1,255,230 $ 2,161,351 $ 1,077,547 $ 2,362,542
OEM sales ................................ 479,675 70,895 21,466 0
Development agreement revenues ........... 343,250 0 0 12,000
Royalties ................................ 76,771 32,387 21,678 55,704
----------- ----------- ----------- -----------
Net sales from continuing operations ... 2,154,926 2,264,633 1,120,691 2,430,246
Gross profit ............................. 1,082,235 881,634 438,181 1,477,244
Compensation in connection with
Common Stock and Common
Stock options issued for services ...... 733,165 0 0 178,607
Other expenses ........................... 1,940,124 5,356,610 2,448,553 2,240,273
Loss from continuing operations .......... (1,591,054) (4,474,976) (2,010,372) (941,636)
Loss from discontinued operations ........ (143,106) $ 0 $ 0 $ 0
Net loss ................................. (1,734,160) (4,474,976) (2,010,372) (941,636)
Loss per common share from continuing
operations ............................. $ (0.85) $ (2.44) $ (1.08) $ (0.22)
Loss per common share from discontinued
operations ............................. $ (0.08) $ 0 $ 0 $ 0
Net loss per common share ................ $ (0.93) $ (2.44) $ (1.08) $ (0.22)
Weighted average number of common shares
outstanding ............................ 1,862,908 1,837,759 1,868,145 4,318,096
</TABLE>
Balance Sheet Data December 31, 1996
- ------------------ -----------------
As
Actual Adjusted(1)
------ -----------
Working capital ............................ $ 2,555,381 $ 48,811,826
Total assets ............................... 4,559,193 50,815,638
Current liabilities ........................ 1,604,890 1,604,890
Long term debt ............................. 124,602 124,602
Stockholders' equity ....................... 2,829,701 49,086,146
(1) As adjusted to reflect the issuance of 11,078,097 shares of Common Stock
upon exercise of the 11,078,097 Redeemable Warrants at an exercise price of
$4.40 per share, net of the expenses of this offering (estimated at $50,000
for costs and $2,437,181 for the five percent warrant exercise fee payable
to the Underwriters). Does not reflect the exercise of any other
outstanding warrants or options.
25
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion contains forward-looking statements.
Prospective investors are cautioned that such forward-looking statements are
not guarantees of future performance and involve risks and uncertainties, and
that actual events or results may differ materially from those discussed in
such statments as a result of various factors, including, without limitation,
those discussed in the "Risk Factors" section of this Prospectus and the
matters set forth in this Prospectus generally.
Overview
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/or entertainment
value, which are easy to use and install, using popular movies, television
series and comic book characters.
In June 1995, the Company entered into a Sales and Distribution
Agreement with Acclaim Distribution, Inc., a subsidiary of Acclaim
Entertainment, Inc. (collectively, "Acclaim"), a distributor of entertainment
software and related products. The Company had no sales to or through Acclaim
during the fiscal year ended June 30, 1995. During the fiscal year ended June
30, 1996, of the Company's net sales of $2,264,633, a total of $1,889,750
(83.4%) were generated by Acclaim. Under the terms of the Sales and
Distribution 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 terminated the distribution agreement as of
April 1, 1996. See "Business - Legal Proceedings."
Effective June 1, 1996 the Company entered into a Distribution Services
Agreement with Simon and Schuster Interactive Distribution Services, Inc.
("SSIDS"). Pursuant to the Distribution Services 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 within
the assigned territory 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. For the
six months ended December 31, 1996, of the Company's net revenues of
$2,430,246, a total of $1,185,664 (48.8%) were generated by SSIDS. The
Company also has entered into separate agreements providing for the
distribution of its products internationally. See "Risk Factors - Product
Distribution" and "Business - Product Distribution."
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. See "Risk Factors-Product Returns."
Costs of sales consist primarily of product cost, freight charges,
royalties to outside programmers and content providers, and an inventory
provision for damaged and obsolete products. Product costs consist of the costs
to purchase the underlying materials and print both boxes and manuals, media
costs (disks and CD-ROMs) and fulfillment (assembly and shipping).
From the Company's inception through October 24, 1995, the Company sold
synthesizer sound libraries. In July 1995, the Company's Board of Directors
approved a formal plan to license the proprietary assets related to such
revenues in exchange for royalties. The results of operations discussion and
analysis which follows includes only the continuing operations of the Company,
primarily
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comprised of software sales. The Company sustained losses from its
discontinued synthesizer operations of $143,106 in fiscal 1995, including an
estimated loss of $32,000 during the phase-out period. No additional losses from
the discontinued operations were recorded during fiscal 1996.
Results of Operations
Six Months Ended December 31, 1995 Compared to Six Months Ended December
31, 1996
Net Sales. Net sales increased by 116.9 percent from $1,120,691 for the
six months ended December 31, 1995, to $2,430,246 for the six months ended
December 31, 1996. The increase is primarily attributable to increased
distribution by SSIDS, the Company's North American distributor, sales by the
Company to its foreign distributors and other direct sales in North America.
Sales to international distributors for the six months ended December 31,
1996 were approximately $435,131, as compared to no international sales
during the same period in 1995. Sales to SSIDS for the six-month period ended
December 31, 1996, were $1,185,664. No sales during the
comparable period in 1995 were to SSIDS. During the six months ended December
31, 1995, the Company recorded sales to its former distributor, Acclaim, in
the amount of $819,619.
Cost of Sales. Cost of sales increased by 39.6 percent from $682,510 for
the six months ended December 31, 1995, to $953,002 for the six months ended
December 31, 1996. However, cost of sales as a percentage of net sales
decreased from 60.9 percent to 39.2 percent during these respective periods.
The increase in total cost of sales is due to the above noted 116.9 percent
increase in net sales. The decrease in cost of sales as a percentage of net
sales is primarily due to changes in product mix to higher priced items and
the sale of certain end-of-life inventory which had been previously
written-off as slow-moving. During the six months ended December 31, 1995,
the Company recorded reserves related to guaranteed royalties and slow-moving
inventories which also resulted in the higher percentage of cost of sales for
such period.
Marketing and Sales. Marketing and sales expenses increase by 20.9
percent from $572,778 for the six months ended December 31, 1995, to $692,752
for the six months ended December 31, 1996, and decreased as a percentage of
net sales from 51.1 percent to 28.5 percent, respectively. The change in
dollar amount is principally related to increased marketing and sales efforts
to support new product releases during the six month period ended December
31, 1996, and increased salaries due to additional sales personnel. The
decrease as a percentage of net sales is due to the above noted 116.9 percent
increase in net sales, particularly international sales for which a smaller
percentage of marketing effort is required by the Company as many of those
functions are primarily performed by the individual distributors.
Research and Development. Research and development costs increased 113.7
percent from $266,153 during the six months ended December 31, 1995, to
$568,874 for the six months ended December 31, 1996, and decreased as a
percentage of net sales from 23.7 percent to 23.4 percent, respectively. The
increase in costs is primarily associated with (i) the Company hiring
programmers to bring all product development in-house, (ii) increased
personnel and hardware/software costs associated with the development of the
Company's first interactive video game; and (iii) the enhancement of its
current product lines. The Company anticipates that research and development
costs will continue to increase as the Company hires additional personnel to
support an increase in the number of products under development and to
perform all development activities internally.
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General and Administrative. General and administrative expenses
decreased by 16.0 percent from $1,208,838 during the six months ended
December 31, 1995, to $1,014,853 for the six months ended December 31, 1996,
and decreased as a percentage of net sales from 107.9 percent to 41.8
percent, respectively. Included in general and administrative expenses for
the six months ended December 31, 1996, is a one-time charge of $307,028
related to the departure of the Company's former president/chief operating
officer. Additionally, during the six months ended December 31, 1996, the
Company recorded expenses associated with being a publicly held company,
principally printing, mailing and legal fees associated with the Company's
annual report and stockholder meeting. During the six month period ended
December 31, 1995, the Company recorded an allowance for doubtful accounts
receivable from its former distributor, Acclaim, in the amount of $422,310.
Compensation in Connection with Common Stock and Common Stock Options
Issued for Services Rendered. Expenses recorded by the Company in connection
with Common Stock and Common Stock options issued for services rendered
amounted to $178,607 for the six months ended December 31, 1996, and relate
to the vesting of Common Stock options issued during fiscal 1994. No such
expense was recorded for the six month period ended December 31, 1995, as no
vesting occurred during this period.
Fiscal Year Ended June 30, 1995 Compared to Fiscal Year Ended June 30, 1996
Net Sales. Net Sales from continuing operations increased by 5.1 percent
from $2,154,926 for the fiscal year ended June 30, 1995 (fiscal 1995) to
$2,264,633 for the fiscal year ended June 30, 1996 (fiscal 1996). In fiscal
1996, the Company determined to concentrate its focus on development of its
educational and entertainment utility interactive CD-ROM software and to
reduce its development work for third parties. Consequently, total retail
sales of the Company's software products increased by 72.2 percent from
$1,255,230 in fiscal 1995 to $2,161,351 in fiscal 1996. However, the Company
had no development revenues during fiscal 1996 as compared with $343,250 for
fiscal 1995. Revenues from OEM sales declined from $479,675 for fiscal 1995
to $70,895 for fiscal 1996, reflecting a one-time agreement with Acer that
produced significant revenues in calendar 1994 but not in calendar 1995. In
addition, the Company's royalty fees declined from $76,771 for fiscal 1995 to
$32,387 for fiscal 1996. The higher royalty revenues for fiscal 1995
resulted primarily from product introductions incorporating content
sublicensed by the Company that were not repeated in fiscal 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 (83.4%) were generated by Acclaim. None of the Company's net sales of
$2,154,926 during the fiscal 1995 were generated by Acclaim. As described above,
the Company terminated its exclusive distribution agreement with Acclaim as of
April 30, 1996, and entered into a new distribution agreement with SSIDS as of
June 1, 1996.
Cost of Sales. Cost of Sales increased by 28.9 percent from $1,072,691
for fiscal 1995 to $1,382,999 for fiscal 1996, representing 49.8 percent and
61.1 percent of net sales, respectively, and 85.5 percent and 64.0 percent of
product sales, respectively. This decrease in cost of sales as a percentage
of product sales 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.
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Marketing and Sales. Marketing and sales expenses increased by 104.0
percent from $516,886 for fiscal 1995 to $1,054,602 for fiscal 1996, and
increased as a percentage of net sales from 24.0 percent to 46.7 percent,
respectively. These increases were primarily due to increased marketing
activities to promote the Company's products and brand name among retail
purchasers, and increased personnel costs.
Research and Development. Research and development costs increased by
89.7 percent from $378,471 for fiscal 1995 to $717,994 for fiscal year 1996,
and increased as a percentage of net sales from 17.6 percent to 31.7 percent,
respectively. These increases were primarily attributable to costs related to
product upgrades and new product development activities. The Company believes
that research and development expenses will increase in dollar amount in the
future as the Company continues to expand its development activities.
General and Administrative. General and administrative expenses
increased by 23.0 percent from $1,783,023 for fiscal 1995 to $2,193,855 for
fiscal 1996, and increased as a percentage of net sales from 82.7 percent to
96.9 percent, respectively. This increase is primarily attributable to costs
incurred by the Company during fiscal year 1996 related to the Company's IPO
and two private placements, as well as increases in executive salaries
related to the addition of a Chief Financial Officer. A total of $733,165 of
the general and administrative expenses for fiscal 1995 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 of
such options on the date of grant and the exercise price thereof. No such
charge was incurred during fiscal year 1996. In addition, the Company
recorded an allowance for doubtful accounts of $40,000 during fiscal 1995
compared to an allowance for doubtful accounts related to a claim of $663,421
during fiscal 1996.
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 had a loss in each of fiscal 1995 and
1996.
Other. Other income (expense) increased from $6,691 for fiscal 1995 to
$(1,388,559) 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 the fiscal year ended June 30, 1994 (fiscal 1994) to
$2,154,296 for the fiscal year ended June 30, 1995 (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 revenues 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.
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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. The decrease in cost
of sales 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.
Research and Development. Research and development costs 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.
General and Administrative. General and administrative expenses
decreased by 53 percent from $3,821,728 for fiscal 1994 to $1,783,023 for
fiscal 1995, and decreased as a percentage of net sales from 227 percent to
83 percent, respectively. The decrease in general and administrative expenses
was primarily due to a decrease in noncash compensation in connection with
Common Stock issued for services provided, partially offset by increased
staffing and associated overhead expenses necessary to manage and support the
Company's growth. A total of $2,992,862 of the fiscal 1994 general and
administrative expenses and $733,165 of the fiscal 1995 general and
administrative expenses related 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.
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 for fiscal 1994 or fiscal 1995 as
the Company had a current year loss and a net operating loss carryforward for
both such years.
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. See "Risk Factors - Fluctuations in Operating
Results; Seasonality."
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Seasonality
The consumer software business traditionally has been seasonal.
Typically, net sales are the highest during the fourth calendar quarter and
decline 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 and during television ratings "sweep" periods. See "Risk
Factors - Fluctuations in Operating Results; Seasonality."
Liquidity and Capital Resources
Since its formation, the Company has financed its operations and capital
expenditures primarily with cash provided by operating activities, securities
issuances and financing arrangements. As of the fiscal year ended June 30,
1996, the Company had negative working capital of $(5,373,974) and cash and
cash equivalents of $181,985.
Pursuant to its IPO, the Company issued a total of 2,560,000 shares of
Common Stock at $4.00 per share and 1,371,775 Redeemable Warrants at $.25 per
Redeemable Warrant. Net proceeds totalled $8,285,784 net of offering costs of
$2,297,408. In connection with the IPO, Vincent J. Bitetti, who is the Company's
Chairman of the Board and Chief Executive Officer and its largest stockholder,
sold 20,000 shares of Common Stock for net proceeds of $69,600.
The Company utilized a portion of the net proceeds of the IPO to repay
certain notes payable aggregating $4,987,500, plus accrued interest of $373,573.
Contemporaneous with the initial closing of the IPO, the Company issued
2,016,657 Redeemable Warrants, effectively at the IPO price of $0.25 per
Redeemable Warrant, in connection with the conversion of a note
payable to ASSI, Inc. which was in the principal amount of $500,000, plus
accrued interest of $4,164. See "Certain Transactions - Agreements with ASSI,
Inc." As a result of these transactions, the Company was able to eliminate its
long term debt and substantially reduce its trade payables, to renew favorable
terms with its vendors, to make required royalty payments under its various
license agreements and to increase its investments.
The Company invested approximately $47,855 during the fiscal year ended
June 30, 1995, approximately $129,456 during the fiscal year ended June
30, 1996, and approximately $266,308 during the six months ended December 31,
1996, for capital equipment to expand into new product lines and to address
potential capacity constraints created by the Company's growing unit sales
volumes.
As of December 31, 1996, the Company had working capital of $2,555,381
in comparison with ($5,373,974) at June 30, 1996, an increase of $7,929,355.
Cash and cash equivalents increased $1,505,448 as a result, in part, of the
Company's IPO. Accounts receivable increased $443,283 due to increased sales
of products to the Company's North American distributor, its international
distributors and other direct sales, partially off-set by the collection of
$512,134 (net of a short-term advance of $400,000) from Acclaim.
During the six months ended December 31, 1996, current liabilities
decreased by $6,392,074, from $7,996,964 at June 30, 1996, to $1,604,890 at
December 31, 1996. This decrease is primarily attributable to the repayment of
notes payable, notes payable to related party and a short-term advance, as well
as accrued interest thereon, aggregating $6,255,195 at June 30, 1996.
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The Company has experienced a significant increase in growth during the
six-month period ended December 31, 1996, as compared to the same period of
time in 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 pursue such business opportunities in the
future, the Company may require additional financing to fund its growth. See
"Risk Factors - Possible Need for Additional Financing."
Management expects that in the future cash in excess of current
requirements will be invested in investment-grade, interest-bearing securities.
To date, the Company has not invested in derivative securities or any other
financial instruments that involve a high degree of complexity or risk, and
management does not intend to invest in these types of securities or financial
instruments in the future.
New Accounting Standards
In October 1995, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" ("SFAS No. 123"). SFAS No. 123 establishes a method
of accounting for stock compensation plans based on the fair value of grants
made under such plans on the date of grant using certain option-pricing
models. SFAS No. 123 allows companies to continue to account for their stock
option plans in accordance with APB Opinion 25 "Accounting for Stock Issued
to Employees," which provides for an intrinsic valuation model that
recognizes only the difference between the fair market value of a company's
stock and the price paid to acquire the stock under the stock compensation
plan. However, SFAS No. 123 encourages the adoption of the fair value
accounting method. Companies electing not to follow the new fair value based
method are required to provide expanded footnote disclosures, including pro
forma net income and earnings per share, determined as if the company had
applied the new method. SFAS No. 123 is required to be adopted prospectively
beginning January 1, 1996. The Company plans to use the intrinsic valuation
model and provide footnote disclosure with respect to the fair value of
options for fiscal years beginning after January 1, 1996.
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BUSINESS
General
The Company is engaged primarily in developing, publishing and marketing
educational, interactive computer software for children. Interactive
MovieBooks(TM), which combine animation text, photos, sound clips and actual
film footage of well recognized family films and cartoon series, are the
Company's major software products. Interactive MovieBooks(TM) are developed and
published by the Company on CD-ROM for Multimedia PCs as entertaining,
interactive reading tools for young children. The Company also produces a
variety of entertainment computer software utilities which incorporate screen
savers, sound clips known as AudioClips(R) and other content based on licensed
entertainment properties. The new entertainment utilities are marketed as
limited edition serialized collector editions. The Company has developed another
line of children's products which it refers to as Creativity Centers. This
product line combines learning activities such as painting, drawing, matching,
puzzles and mazes within a framework of three distinct skill levels. In July
1996, the Company created a "games" division, and in August 1996 signed an
agreement with Twentieth Century Fox Licensing and Merchandising to produce a
game sequel to the 1989 theatrical release The Abyss(TM).
The Company's products are based on licensed content of major motion
pictures and television shows under agreement with major entertainment studios
including Viacom Consumer Products (as agent for Paramount Pictures Corp.),
Warner Bros. Consumer Products, CBS Entertainment, MCA/Universal Merchandising,
Inc., Carolco Pictures, Inc., DC Comics, MGM/UA Merchandising, Inc. and others.
The Company's license agreements for existing products include Babe(TM),
Lassie(TM), The Little Rascals(TM), Black Beauty(TM), The Adventures of Batman
and Robin(TM), Terminator 2: Judgment Day(TM), Free Willy 2(TM), The Secret
Garden(TM), Star Trek(TM), The Twilight Zone(TM), I Love Lucy(TM) and other
popular titles. The Company also holds licenses for new products based on Star
Trek: Deep Space 9(TM), Star Trek: Voyager(TM), All Dogs Go to Heaven II(TM),
The Land Before Time(TM), DragonHeart(TM), I Love Lucy(TM) and Free Willy 3(TM).
The Company is continuing the negotiation of additional licenses for its
children's titles, 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 powerful capabilities and declining price of Multimedia PCs have
enabled them to draw acceptance as all-purpose, functional educational and
entertainment products for home and school use. Data from industry sources
indicates that the installed base of Multimedia PCs exceeds 9,000,000 units.
The technological capabilities of Multimedia PCs have allowed the Company to
produce interactive software that is "user friendly" while maintaining what
management believes are high standards in design, animation, sound quality,
three-dimensional sound effects and quality duplication of motion picture
footage.
The Company believes that as of February 28, 1997, its products were in
distribution to approximately 6,000 retail outlets. Retailers currently selling
the Company's products include Target, Tower Records, Sears, Wal-Mart,
Price/Costco, CompUSA, Best Buy, BJ's, Computer City, Egghead, Electronics
Boutique, Babbages, Etc., Kmart, Barnes & Noble, Sam's Club, Musicland and
others.
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On June 1, 1996, the Company entered into a Distribution Services
Agreement with Simon & Schuster Interactive Distribution Services ("SSIDS,"
as previously defined). SSIDS is the consumer software distribution unit of
Simon & Schuster, Inc., the publishing operation of Viacom Inc. Pursuant to
the Distribution Services Agreement, SSIDS will provide distribution,
warehousing and order fulfillment services for all of the Company's products
(subject to certain exceptions) throughout the United States and Canada. The
Company's relationship with SSIDS is exclusive within the assigned territory
except as regards the rights to distribute the Company's products in
direct-to-the-customer programs including direct mail, telemarketing and
in-box coupon fulfillment, which are nonexclusive. The Company also has
entered into separate agreements providing for the distribution of its
products internationally. See "Business - Product Distribution."
The Company's objective is to be a leading publisher of high quality,
value priced, family-oriented software. To achieve this objective, the
Company intends to (i) focus primarily on developing products with
educational and/or 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) develop alternative distribution channels,
including bundling with home video and other products, (vi) leverage its
licensed content to develop products intended for the game market, and (vii)
pursue strategic alliances and acquisitions of products and/or companies.
"Business - Strategy."
Industry Background
In recent years, the installed base of Multimedia PCs in households has
grown substantially as prices have declined significantly and as improvements in
computing power and capability have been achieved. There are a number of factors
driving the increased demand and use of Multimedia PCs in U.S. and foreign
households beyond the general impact of falling prices and increased
performance. Enabling technologies and standards, such as graphical user
interfaces and the Microsoft(R) Windows(R) operating system, and the recent
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 that CD-ROM multimedia technology will continue to impact the growth of
the consumer software market as software developers take advantage of the
multimedia capabilities of this more advanced hardware technology.
The resulting increased penetration of Multimedia PCs into domestic
households has created a large and growing mass market for consumer software as
many consumers wish to maximize the utility of their Multimedia PCs. The
distribution of consumer software has also expanded beyond traditional software
retailers and computer stores to include general mass merchandisers.
In response to these developments, increasing numbers of consumer software
products are being developed to address a broad range of consumer interests and
everyday tasks. The Company believes that consumers are more frequently
purchasing software on impulse in the same way that they often buy books, music
compact discs ("CDs") and motion picture videos. With the increasing
consumerization of the software market, the Company believes that the prices
for consumer software products may fall.
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If this occurs, the distribution channels for consumer software could continue
to expand to include book and music stores, video outlets and supermarkets.
As consumer software becomes more of a mass market product, the Company
believes it will become increasingly important for consumer software companies
to have direct relationships with retailers to effectively market their products
to consumers. Competition for retail shelf space is also likely to increase due
to the proliferation of consumer software products and companies. As a result,
the Company believes that in order to be successful, consumer software companies
must have a consumer-driven focus, a broad offering of category-leading
products, close relationships with retailers, a recognized brand name and a
cost-efficient business model.
Business Strategy
The Company's objective is to be a leading publisher of high quality,
value-priced family-oriented consumer software. The Company seeks to develop a
broad line of products in categories in which a substantial market share can be
attained. The Company also seeks to expand product franchises by upgrading
successful products and developing product line extensions and complementary
products as well as purchasing titles and products from third parties. The
Company believes that it may achieve its objectives utilizing the following
strategies:
o Maintain Consumer-Driven Focus. The Company develops what it believes
are creative and innovative products with mass market appeal,
targeting families who are familiar with the Company's licensed movie
titles, television series and comic book characters. The Company
believes that these consumers base their software purchasing decisions
largely on quality, value, ease of use, recognition and personal
affinity for recognizable motion picture and television productions
upon which the Company's products are based. As a result, the Company
is committed to providing products that are high quality, value-priced
and which require minimal computer experience to operate. The
Company's consumer-oriented marketing strategy combines attractive and
informative shrink-wrap packaging with high-impact promotional
campaigns to encourage impulse purchases. To enhance customer
satisfaction, the Company also provides technical support for all of
its products. In addition, the Company revises products in response to
consumer feedback and upgrades products to utilize new technologies as
those technologies gain broader acceptance in the consumer market. The
Company receives consumer feedback primarily from comments on product
registration cards submitted to it by customers.
o Develop Diversified Titles with Strong Franchise Value. The Company
seeks to develop a broad line of products in sustainable categories in
which a substantial market share can be achieved. The Company
currently has 21 software products available for sale in stores in the
education and entertainment categories. Hollywood content such as
motion pictures and television shows will continue to be the
foundation on which the products are based. The Company seeks to build
franchise value through its merchandising programs and seeks to create
franchises by upgrading products and developing product line
extensions and complementary products. Several of the Company's
licenses permit it to produce multiple software titles using the same
proprietary subject matter. The Company also seeks to create titles
with extended lifecycles by upgrading successful products to
incorporate new features and to adapt to new technologies.
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o Leverage Distribution Strengths. Pursuant to the new Distribution
Services Agreement between SSIDS and the Company, SSIDS will provide
distribution, warehousing and order fulfillment services for all of
the Company's products (subject to certain exceptions) throughout the
United States and Canada. The Company's relationship with SSIDS 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.
See "Business - Product Distribution - Relationship With SSIDS." The
Company's sales and marketing department will work closely with SSIDS'
sales force. The Company believes that its broad product line and
consumer-oriented marketing programs enable it effectively to market
its products. Through co-operative marketing efforts, the Company
intends to support marketing efforts, promotions and merchandising
displays at the market level.
o Leverage Studio Relationships. The Company is developing a variety of
cross-marketing promotional programs with its movie studio licensors
and other licensees of movie titles licensed by the Company for its
software products. For example, the Company has worked with the MCA
Home Video Division to include discount coupons for the Company's
Babe(TM)Interactive MovieBook(TM)in video cassettes of Babe(TM). The
Company is further working with MCA Home Video Division to include
trailers for MCA movie titles in the Company's software products. In
addition, the Company is working with the manufacturers of toy action
figures to include rebate coupons for the Company's products with the
related action figures. The Company has also developed a screen saver
for Universal Studios Florida in return for trip packages to be used
for promotional contests. The Company's goal is to run one special
promotion, such as a contest, every two to three months. Based on
currently pending negotiations with its movie studio licensors,
management believes the Company will have the opportunity to develop a
variety of new cross-promotional programs that may significantly
enhance the Company's marketing efforts.
o Promote Tradename Recognition. The Company promotes its licensed
properties in conjunction with its brand name "Sound Source
Interactive" in order to encourage customer loyalty and repeat
purchases. The Company believes that its brand name products are
recognized by consumers as high quality, full-featured software.
Drawing upon established consumer marketing techniques, the Company
uses its brand name and consistent packaging style which emphasize
high-impact design and recognizable motion picture and television
titles. The Company includes a mail-in order form with each product it
sells, which includes a list of the Company's other available products
to encourage repeat purchases. The Company believes that by promoting
a recognizable brand name and consistent packaging, satisfied
consumers are more likely to purchase additional Company-produced
products when faced with multiple options in a software category. As
the consumer software industry becomes more of a mass market, the
Company believes that tradename recognition will become an
increasingly important means of product differentiation among
retailers and consumers.
o Pursue Alternative Distribution Channels. The Company is pursuing a
number of alternative distribution channels for its products. For
example, the Company recently entered into a license and distribution
arrangement with Universal Pictures. Pursuant to such arrangement
the Company's Land Before Time(TM) activity center will be bundled
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<PAGE>
with the home video release of that motion picture. Buyers will have
the option to use the activity center product on a trial basis before
purchasing it. If they elect to purchase, they will do so by calling a
toll-free number whereby they will make the purchase and be granted an
access code that will permit them to use the entire product.
o Develop Game Products. The Company intends to develop products
intended for the game market in the future. The Company believes that
its access to motion picture and related content will enable it to
produce games that can be successfully marketed.
o Acquisitions. The Company intends to pursue acquisitions of
entertainment software companies and selected titles within existing
or new product categories. The Company believes that acquisitions may
provide diversification of revenues and enhanced revenue growth. The
Company is not currently a party to any discussion, agreement,
arrangement or understanding in connection with any such acquisition.
Products
Interactive CD-ROM
The Company has created Interactive MovieBooks(TM) for children, which are
electronic storybooks with full motion video based on the licensed property.
Interactive MovieBooks(TM) are marketed as reading aids for young children.
Research studies involving literacy have shown that children learn to read by
repetitive reading - usually with the aid of a parent or teacher. This learning
process begins at about 18 months of age and continues through the first and
second grades for many children. The targeted ages for Interactive
MovieBooks(TM) are three through ten. The Company has released ten of its
Interactive MovieBooks(TM) on CD-ROM. This product provides options for
automatic reading by the computer, user reading, a dictionary invoked by
"clicking" on a dictionary book icon, actual full motion video taken from the
motion picture that coincides with the text pages, high-quality sound, art and
animation as well as a quiz consisting of multiple choice questions on a related
topic to the story, reinforcement through a "jigsaw" puzzle which can be
printed, and a "bookmark" so the adventure can be stopped, put away and
restarted at the same point at a later date. More elaborate activities in the
Interactive MovieBook(TM) have been included in Babe(TM), The Little
Rascals(TM), Free Willy 2(TM), ExoSquad(TM), The Adventures of Batman and
Robin(TM), The Land Before Time(TM) and All Dogs Go to Heaven II(TM), and will
be further incorporated in the next generation of products.
The Company first introduced its Interactive MovieBook(TM) product line
into the marketplace in August 1994 with the release of The Secret Garden(TM)
(Warner Bros.). The Company released Black Beauty(TM) (Warner Bros.) in November
1994, Broadway Video's Lassie(TM)" (Broadway Video, a Paramount Pictures
release), in December 1994 and Little Rascals(TM) (Universal Pictures) in June
1995. The Company released Free Willy 2(TM) (Warner Bros.) in July 1995. During
November 1995, three new Interactive MovieBooks(TM) were completed and released:
Babe(TM) (Universal Pictures), ExoSquad(TM) (Universal Pictures) and The
Adventures of Batman & Robin(TM) (DC Comics). These three products, however, did
not receive widespread distribution until the first calendar quarter of 1996.
The Company released The Land Before Time(TM) (MCA/Universal) in August 1996 and
All Dogs Go to Heaven II(TM) (MGM) in November 1996. All products are Windows
'95(R) compatible. Currently, the products are sold at a suggested retail price
of up to $30 each, a price point intended to generate impulse purchases among
consumers at the retail level.
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<PAGE>
The Company intends to introduce four to five new children's titles
annually in the future. Each is expected to experience its highest sales
prices and volumes within the six to nine months following its introduction.
Although the products may continue to be sold after such period, they
typically will be sold on a discounted basis.
The Company has begun development of a game sequel to the 1989 theatrical
release The Abyss(TM), under a license from Twentieth Century Fox Licensing and
Merchandising. The Company acquired a three-dimensional "game engine" and
purchased four Windows NT(R) workstations equipped with SoftImage(R)
three-dimensional rendering graphics software to produce the product. The game,
tentatively titled Return to the Abyss, will have a development cycle of 12 to
18 months.
The following is a listing of the Company's Interactive MovieBook(TM)
products, all of which are on CD-ROM and are compatible with the Windows(R)
and Windows '95(R) formats:
MovieBook(TM) Title Licensor Release Date
------------------- -------- ------------
The Secret Garden(TM) Warner Bros. August 1994
Black Beauty(TM) Warner Bros. November 1994
Lassie(TM) Broadway Video December 1994
The Little Rascals(TM) Universal Pictures June 1995
Free Willy 2(TM) Warner Bros. July 1995
Babe(TM) Universal Pictures November 1995
ExoSquad(TM) Universal Pictures November 1995
The Adventures of DC Comics November 1995
Batman and Robin(TM)
The Land Before Time(TM) Universal Pictures August 1996
All Dogs Go to Heaven II(TM) MGM October 1996
The Company has developed a second line of interactive CD-ROM based
products which it refers to as Creativity Centers(TM). This product line
combines learning activities such as painting, drawing, matching, puzzles and
images within a framework of three distinct skill levels. The Company introduced
its first Creativity Center(TM) product in June 1996, and plans to introduce two
or three new Creativity Centers(TM) annually thereafter.
The following Creativity Center(TM) type products have been released or
are planned for release, all of which are or, when released, will be on
CD-ROM and compatible with the MacIntosh(R), Windows(TM) and Windows and
'95(R) formats:
Creativity Center Title Licensor Release Date
----------------------- -------- ------------
DragonHeart(TM) Universal Pictures June 1996
The Land Before Time(TM) Universal Pictures May 1997
Hercules and Xena (TM) Universal Picture May 1997
Free Willy 3(TM) Warner Bros. October 1997
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Entertainment Utilities
The Company was one of the first to license motion picture studio
properties to create entertainment utility software. The first product was Star
Trek AudioClips(R) and the second was a sub-license for a Star Trek(TM) Screen
Saver. The Company followed its Star Trek(TM) products with Star Wars(TM), The
Wizard of Oz(TM), Terminator 2: Judgment Day(TM) and others. The Company's
screen saver line-up now includes Terminator 2: Judgment Day(TM), The Twilight
Zone(TM) and Saturday Night Live(TM). Additionally, the sub-license for Star
Trek(TM) AudioClips(R) now extends to Star Trek: The Next Generation(TM), Star
Trek: The Motion Pictures(TM) and a Stardate Desktop Calendar.
Entertainment utility products may include AudioClips(R), screen savers
based on animation, video and still images, and wallpaper, VisualClips(R),
jigsaw puzzles and other content as applicable.
o Limited Edition Entertainment Utilities. The Company's new
entertainment computer software utilities incorporate screen
savers, AudioClips(R)and other content based on entertainment
properties. The new entertainment utilities are marketed as limited
issue, serialized collector editions. For Christmas 1995, the
Company released a Limited Edition Babylon 5(TM)(Warner Bros.)
Entertainment Utility which contains screen savers, desktop art and
AudioClips(R). Limited edition products are serialized and retail
at approximately $30 each. The limited edition products replaced
stand alone screen savers and Audioclips(R)for Christmas of 1996.
The Company plans to release two to four limited edition
entertainment utilities in 1997. The Company currently sells or
plans to sell the following limited edition entertainment
utilities, all of which are or, when released, will be on CD-ROM
and compatible with the Windows(R)and Windows '95(R)formats:
Title Licensor Release Date
----- -------- ------------
Babylon 5(TM) Warner Bros. November 1995
Terminator 2; Carolco Pictures July 1996
Judgment Day(TM)
Star Trek: Deep Space Paramount/ August 1996
Nine(TM) Viacom
Star Trek: Voyager(TM) Paramount/ November 1996
Viacom
I Love Lucy(TM) CBS November 1996
Babylon 5(TM), Vol. 2 Warner Bros. May 1997
Product Distribution
On June 1, 1996, the Company entered into a Distribution Services Agreement
with Simon & Schuster Interactive Distribution Services ("SSIDS", as previously
defined). SSIDS is the consumer software distribution unit of Simon & Schuster,
Inc., the publishing operation of Viacom Inc. Pursuant to this new distribution
agreement, SSIDS 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 within the assigned
territory 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.
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<PAGE>
SSIDS will make a monthly payment to the Company in an amount equal to
its "gross revenues" during such month from the Company's products, less a
distribution fee and reserve for returns equal to stated percentages of the
gross revenues and less certain other items, including out-of-pocket costs
associated with inventory maintenance and order fulfillment. "Gross revenues"
are defined as amounts actually billed by SSIDS to its customers for Company
products sold by it. The payments by SSIDS will be due not later than 75 days
after the calendar month. Under the Distribution Services Agreement, SSIDS
will be responsible for collection of accounts, while the Company will be
responsible for product returns. The Company intends to maintain an
appropriate reserve for product returns based upon its prior experience and
current market conditions against which credits for actual returns will be
applied.
The Company has entered into seven separate agreements providing for the
distribution of its products internationally. These agreements provide for
distribution in Australia, New Zealand, South Africa, the United Kingdom and
throughout Scandinavia and Southeast Asia.
Sales and Marketing
By offering a wide variety of products, the Company can provide retailers
with an assortment of titles in categories of interest to consumers. The Company
also supports its retailers by setting up special displays, end caps and kiosks,
executing targeted promotions and analyzing sales trends to help build
incremental sales. The Company is currently developing a variety of
cross-marketing promotional programs with its movie studio licensors and other
licensees of movie titles. These promotional programs may include discount
coupons for products in video cassettes, rebate coupons with action figures,
movie trailers in the Company's software products, and promotional contests with
various motion picture studios.
Drawing upon established consumer marketing techniques, the Company's
marketing department creates and executes high-impact merchandising programs
with the goal of maximizing each product's retail exposure. The Company believes
that its consumer-driven marketing, the high perceived value and competitive
price points of its products, and easily identifiable packaging which emphasizes
high-impact design and concise, nontechnical product information, lead to higher
visibility and impulse purchases of its products in retail stores.
The Company provides technical support by telephone at no additional
charge. The Company has installed a telephone system and a call handling center
to facilitate its response to customer inquiries. Customer feedback is shared
among other support representatives and made available to product managers for
development of product enhancements and upgrades.
Under the Distribution Services Agreement, the Company's direct retail
accounts are serviced by the SSIDS sales force with direction and assistance
from the Company. The Company works closely with SSIDS to assure that
wholesale and retail accounts are adequately serviced, inventory
levels are adequate, and merchandising programs are properly executed.
See "Business - Product Distribution."
Development
The Company seeks to develop a broad line of products in sustainable market
categories in which a leading market share can be obtained. The Company depends
on a flow of creative ideas to develop high-quality, value-priced products. The
Company believes that its efficient development model has
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certain advantages including consistent product quality, reliable delivery
schedules, cost containment and low investment risk.
The Company's product managers oversee the development of various products
from conception through completion, and control the content, design, scope and
development schedule. New product ideas are evaluated with each studio partner
based upon upcoming theatrical releases, detailed market research on the subject
matter, the type and demographics of the target consumer, and the existence and
characteristics of competitive products. The Company seeks to design new
products which incorporate all of the important functions and features of the
leading competitive products. Once a product is approved for development, a
detailed design specification is created that includes the product's features
and a user interface that is consistent with other Company products. Whenever
possible, the software is designed to incorporate technology used in existing
Company products in an effort to shorten the development cycle and improve
quality and consistency. The overall product, including documentation, is
designed to meet a manufacturing specification that will meet the Company's
margin requirements at consumer price points.
The product managers then execute the development project with a team
that includes programmers, sound engineers, artists, animators, designers,
writers and testers. The Company's internal development efforts are focused
primarily on product design and features, consistent user interfaces, and
product quality consistency. The Company supplements its internal product
development resources by utilizing existing technologies and externally
developed programming when such utilization can result in a more efficient
method of creating a higher quality product. Using this method, the Company
maintains internal control over the creative and market-driven aspects of
product development while using external resources to shorten development
time and lower development risks. Development costs associated with
externally licensed technology are generally paid by royalties based on net
sales, which lowers the Company's investment risk. The Company's agreements
with its external developers typically grant the Company an exclusive
worldwide license to use the developers' software. The agreements typically
have three-year terms, with renewal provisions upon mutual agreement of the
parties. The Company has recently decided to develop fully some of its
products in-house.
The Company currently is the licensee under technology licenses with Apple
Computer, Inc., Iterated Systems, Inc., Qsound Labs, Inc., Rock Ridge
Enterprises, EchoMedia, Inc. and Rhode Island Soft Systems, Inc. The Company
utilizes technology provided by these licensors to develop and operate several
of its products. With the exception of the Apple Computer license, there are
alternative products for each of the technologies now licensed by the Company.
Therefore, the Company believes that it could readily obtain licenses to
comparable products from other sources at comparable costs.
Products under development are extensively tested by the quality assurance
department, and must be approved by the licensor before being released for
production. The department tests for bugs, functionality, ease-of-use and
compatibility with the many popular Multimedia PC configurations that are
available to consumers.
Product managers are also responsible for reviewing customer feedback,
competitive products, product performance and market positioning in order to
introduce upgrades that keep abreast of consumer tastes and trends. The Company
has increased its development of new CD-ROM products to address the shift to
CD-ROM-based products.
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Operations
The Company controls all purchasing, inventory, scheduling, order
processing and accounting functions related to its operations, with all
production and warehousing performed by independent contractors in accordance
with the Company's specifications. The Company intends to invest in management
information systems and other capital equipment which it believes are necessary
to achieve operational efficiencies and support increasing sales volumes.
The Company prepares master software disks, user manuals and packaging
designs. Disk and CD-ROM duplication, printing of documentation and packaging,
as well as the assembly of purchased components and the shipment of finished
products, are performed by third parties in accordance with the Company's
specifications. The Company has multiple sources for all components, with
assembly and shipping currently performed by two independent fulfillment houses.
To date, the Company has not experienced any material difficulties or delays in
the production and assembly of its products.
Competition
The market for the Company's consumer software products is intensely and
increasingly competitive. The Company's competitors range from small companies
with limited resources to large companies with substantially greater financial,
technical and marketing resources than those of the Company. Existing consumer
software companies may broaden their product lines to compete with the Company's
licensed products, and potential new competitors, including computer hardware
and software manufacturers, diversified media companies and book publishing
companies, may enter or increase their focus on the consumer software market,
resulting in greater competition for the Company. See "Risk Factors -
Competition."
Only a small percentage of products introduced in the consumer software
market achieve any degree of sustained market acceptance. Principal competitive
factors in marketing consumer software include product features, quality,
reliability, tradename and licensed title recognition, ease-of-use,
merchandising, access to distribution channels and retail shelf space,
marketing, price, and the availability and quality of support services. The
Company believes that it competes effectively in these areas,
particularly in the areas of quality, brand recognition, ease-of-use,
merchandising, access to distribution channels and retail shelf space and price.
To the extent that competitors achieve performance, price or other selling
advantages, the Company could be adversely affected. There can be no assurance
that the Company will have the resources required to respond to market or
technological changes or to compete successfully in the future. In addition,
increasing competition in the consumer software market may cause prices to fall,
which could adversely affect the Company's business, operating results and
financial condition.
The Company considers Microsoft Corp., Broderbund, Inc., Knowledge
Adventure, The Learning Company, Hasbro, Mattel, Disney, Maxis, Davidson, GT
Interactive Software Corp., 7th Level, Inc. and A.D.A.M. Software, Inc. its
chief competitors in the interactive entertainment CD-ROM market. The Company
considers Microsoft, Inc. and Berkeley Systems its chief competitors in the
entertainment utility software market. Microsoft offers screen savers and
generic sounds, as well as licensed sounds from the MGM/Turner film library. The
Company considers Berkeley Systems its chief competitor in the screen saver
market. The Company developed the concept and provided the introductions that
led to the development of the Star Trek(TM) series of screen savers by Berkeley
Systems. The Company has to date received over $300,000 in earnings from this
sublicense, which terminates on August 31, 1997.
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For the fiscal year ended June 30, 1996, $9,213 was
received by the Company in earnings from this sub-license.
The Company has entered into license agreements with Viacom Consumer
Products (as agent for Paramount Pictures Corp.), Warner Bros. Consumer
Products, CBS Entertainment, MCA/Universal Merchandising, Inc., Carolco
Pictures, Inc., DC Comics, MGM/UA Merchandising, Inc. and others. Several of
the major motion picture studios now have captive interactive software
divisions. As these types of software become better known in the marketplace,
these divisions may begin to vie for their studio's product. Management
believes that Disney, Lucasfilm, Fox and Paramount/Viacom are currently the
most active studios in publishing their own product to create software
packages. Universal Pictures, Sony Pictures and Warner Bros. each have
announced the formation of divisions to publish software products using their
own license content.
Proprietary Rights and Licenses
The Company regards its software as proprietary and relies primarily on a
combination of trademark, copyright and trade secret laws, employee and third
party nondisclosure agreements and other methods to protect its proprietary
rights. All of the Company's new products are CD-ROM based, and hence are
difficult to copy. During the fiscal year ended June 30, 1996, the Company was
unaware of any of its products' unauthorized copying.
The Company's products are based upon licensed content of major motion
pictures and television shows under license and/or development agreements with
major entertainment studios. All of such license and development agreements to
which the Company currently is a party are for fixed terms which will expire
over the next one to five years. The Company anticipates that the licensor under
each agreement will extend its terms, although no licensor is required to extend
any license, provided that the Company is in compliance with all requirements of
each license, including most significantly that the Company have satisfied the
applicable minimum royalty guarantees. See "Risk Factors - Limited Time Period
of Licenses."
Employees
As of February 28, 1997, the Company had 35 full-time employees, including
seven employees in sales and marketing, 18 employees in development and customer
support, five employees in administration and finance, three employees in
licensing and two employees in production and shipping. None of the Company's
employees are represented by a labor union or are subject to a collective
bargaining agreement.
Facilities
Effective March 31, 1997, the Company relocated to a facility in Calabasas,
California, where it leases approximately 8,613 square feet of office and
warehousing space. The lease is for a 62-month term, and the current monthly
base rent is $12,058. The Company believes such space is adequate for its
existing and foreseeable requirements.
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Legal Matters
To date, the Company has received a payment of $512,134 (net of a
short-term advance of $400,000) from Acclaim pursuant to the Acclaim
distribution agreement. Nevertheless, the Company believes that further
amounts are due from Acclaim. Because the Company and Acclaim were unable to
agree as to the balance due to the Company under the distribution agreement,
on December 13, 1996, the Company filed suit against Acclaim in the Superior
Court for Los Angeles County, California, seeking compensatory damages of
$2,124,259 and consequential damages of $20,000,000 arising out of Acclaim's
alleged breach of its exclusive distribution agreement with the Company and
other related matters. There can be no assurance as to the outcome of such
litigation.
The Company is, and in the future the Company and/or its officers and
directors may be, involved in other suits and actions incidental to the
Company's business. The Company does not believe that the resolution of any of
such current suits or actions will result in any material adverse effect on the
financial condition or operations of the Company.
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MANAGEMENT
Directors and Executive Officers
The directors and executive officers of the Company, their ages and their
positions with the Company are as follows:
Name Age Position
- ---- --- --------
Vincent J. Bitetti 42 Chairman of the Board, Chief
Executive Officer and Director
Ulrich E. Gottschling 38 President, Chief Operating Officer,
Chief Financial Officer, Treasurer,
Secretary and Director
Robert S. Burke 44 Director
Dr. Ronald W. Hart 54 Director
Mark A. James 37 Director
Ernest T. Klinger 61 Director
Vincent J. Bitetti founded the Subsidiary in 1989, and served as the
President of the Subsidiary from its formation. Since the Company acquired the
Subsidiary in 1994, Mr. Bitetti has served as the Chairman of the Board and
Chief Executive Officer and as a director of the Company and the Subsidiary.
Prior to founding the Subsidiary, from 1986 to 1988, Mr. Bitetti was President
of Fantastic Planet Consultants, a sound and musical instrument design
consulting company. Mr. Bitetti is a published music composer and lyricist. From
1986 to 1993, Mr. Bitetti was a consultant to manufacturers of keyboard
synthesizers in the music industry. Mr. Bitetti developed the concepts for the
Company's Creativity Centers(TM), Interactive MovieBooks(TM), AudioClips(TM) and
VisualClips(TM) products. Mr. Bitetti has been a director of the Company since
May 1994.
Ulrich E. Gottschling was appointed as Chief Financial Officer, Treasurer
and director of the Company in October 1995, as Secretary of the Company in
November 1995 and as President and Chief Operating Officer of the Company in
February 1997. Prior to joining the Company, Mr. Gottschling was employed from
June 1991 through September 1995 as a certified public accountant with Corbin &
Wertz, the Company's independent auditors. From 1987 through May 1991, he was
employed as a certified public accountant by Deloitte & Touche. From 1980
through 1986, Mr. Gottschling held various management positions with Westin
Hotels and Marriott Corporation. Mr. Gottschling has been a director of the
Company since October 1995.
Robert S. Burke is an executive in residence at Robertson, Stephens &
Co., an investment banking concern, a position he has held since 1996. From
1995 to 1996, prior to joining Robertson, Stephens & Co., Mr. Burke was
President of Gordon Biersch Brewing Company. From 1989 through 1995 Mr. Burke
was President of Westminster Holdings, a division of Bedford Properties,
Inc., a diverse portfolio of operating companies including hotels,
restaurants and radio stations. Mr. Burke currently serves as a director of
Chicago Pizza & Brewery, Inc. Mr. Burke has been a director of the Company
since February 1997.
Dr. Ronald W. Hart has held the position of Distinguished Scientist in
Residence for the Food and Drug Administration, U.S. Public Health Service,
since 1992. From 1980 to 1992, he was the Director of the National Center for
Toxicological Research, Food and Drug Administration, Public Health Service,
Department of Health and Human Services. Dr. Hart served on the board of
directors of First Commercial Bank Corporation of Little Rock, Arkansas, from
1987 to 1993. He also is a director of Telescan, Inc. and CyberAction, Ltd. Dr.
Hart has been a director of the Company since July 1996.
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Mark A. James is a founding member of the law firm of James, Driggs & Walch
in Las Vegas, Nevada, where he has been a partner since April 1996. From 1991
until the founding of James, Driggs & Walch, he was a partner in the Las Vegas
firm of Jolley, Urga, Wirth & Woodbury. In 1992, Mr. James was elected to the
Nevada State Senate. He was reelected in 1994, and continues to serve as
Chairman of the Senate Committee on Judiciary, and on the Natural Resources and
Legislative Affairs and Operations committees. Mr. James is a director of ASSI,
Inc. Mr. James has been a director of the Company since July 1996.
Ernest T. Klinger has been the Chief Financial Officer and Vice
President, Finance and Administration of Arden Group, Inc. since 1983. He has
held various finance and operating positions at Arden Group, Inc. since 1980.
Mr. Klinger currently serves as a director of Chicago Pizza & Brewery, Inc.
Mr. Klinger has been a director of the Company since July 1996.
The term of all of the Company's directors expires at its 1997 annual
meeting of stockholders.
During the fiscal year ended June 30, 1996, the Board of Directors took
action by unanimous written consent on 22 occasions.
The Company has granted each of the Underwriters and ASSI, Inc. the
right to nominate from time to time one director of the Company or to have a
designated individual attend all Board meetings as a nonvoting advisor. In
addition, Vincent J. Bitetti and Eric H. Winston have entered into voting
agreements with each of the Underwriters and ASSI, Inc. Pursuant to these
agreements, Messrs. Bitetti and Winston have agreed to vote all of their
Common Stock for the director nominees of the Underwriters and ASSI, Inc. In
addition, ASSI, Inc. has agreed to vote all of its shares of Common Stock for
two directors nominated by Mr. Bitetti for as long as he holds at least 20
percent of the outstanding Common Stock, and for one director nominated by
Mr. Bitetti for as long as he holds at least ten percent but less than 20
percent of the outstanding Common Stock. Messrs. Bitetti and Gottschling have
granted irrevocable proxies to ASSI, Inc. and ASSI, Inc. has granted an
irrevocable proxy to Mr. Bitetti, consistent with their voting agreement. The
voting agreement with the Underwriters will terminate July 8, 2001. The
voting agreement with ASSI, Inc. will terminate when Messrs. Bitetti and
Winston together cease to own at least ten percent of the outstanding Common
Stock. See "Risk Factors-Control of The Company by Officers and Directors and
ASSI, Inc." and "Certain Transactions-Agreements With ASSI, Inc." and "-
Agreements With the Underwriters."
Pursuant to the arrangements described in the preceding paragraph, Vincent
J. Bitetti has designated himself and Ulrich E. Gottschling as his director
nominees, and ASSI, Inc. has designated Mark A. James as its director nominee.
Neither of the Underwriters has exercised its right to nominate a director or
to appoint a nonvoting advisor to the Board.
Board Committees
The Board of Directors has appointed two standing committees: the Audit
Committee and the Compensation Committee. Each of these committees was
established in July 1996, and therefore neither held any meetings during the
fiscal year ended June 30, 1996.
The Audit Committee consists of Dr. Ronald W. Hart, Mark A. James and
Ernest T. Klinger. Its purpose is to recommend the appointment of an independent
auditor for the Company, review the scope of the audit, examine the auditor's
reports, make appropriate recommendations to the Board of
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Directors as a result of such review and examination and make inquiries into the
effectiveness of the financial and accounting functions and controls of the
Company.
The Compensation Committee consists of Dr. Ronald W. Hart, Mark A. James
and Ernest T. Klinger. It is responsible for reviewing and setting the
compensation of executive officers of the Company and for administering the
Company's stock option plans.
Executive Compensation
Summary Compensation. The following table sets forth information concerning
compensation of the Company's Chief Executive Officer and each of the Company's
other executive officers who received compensation from the Company in excess of
$100,000 for the fiscal year ended June 30, 1996 (the "Named Executives"). No
other executive officer's compensation exceeded $100,000 during fiscal year
1996.
Summary Compensation Table
<TABLE>
<CAPTION>
Summary Annual
Compensation Long-Term Compensation
------------ ----------------------
Stock All
Options Other
Name and Principal Position Year Salary Bonus(1) (Shares) Compensation(2)
- --------------------------- ---- ------ -------- -------- ---------------
<S> <C> <C> <C> <C> <C>
Vincent J. Bitetti, Chairman of 1996 $187,500 $ 31,874 0 $ 19,018
the Board and Chief Executive 1995 150,000 75,000 0 6,200
Officer
Eric H. Winston, President and 1996 $168,750 $ 31,874 0 $ 21,141
Chief Operating Officer (3) 1995 150,000 75,000 0(4) 9,600
</TABLE>
- --------------------
(1) The bonuses accrued for fiscal 1995 were fully paid in December 1995.
(2) The amounts in this column consist of the following: (a) personal use of
Company car (50 percent of payment for car expenses): Mr. Bitetti - $9,576
(1996), $4,800 (1995), Mr. Winston - $9,302 (1996), $4,800 (1995); (b) life
insurance premiums: Mr. Bitetti - $4,311 (1996), $1,400 (1995), Mr. Winston
- $4,750 (1996); and (c) medical insurance premiums: Mr. Bitetti - $5,131
(1996), Mr. Winston - $7,089 (1996), $4,800 (1995).
(3) Mr. Winston resigned as an officer and director of the Company effective
November 1, 1996.
(4) Does not include an option to purchase 100,000 shares granted to Mr.
Winston by Mr. Bitetti in April 1995.
47
<PAGE>
Option Grants
The Company did not grant any options to any of the Named Executives during
its fiscal year ended June 30, 1996.
Option Exercises and Holdings
The following table sets forth information concerning each exercise of a
stock option during the fiscal year ended June 30, 1996, by each of the Named
Executives and the number and value of unexercised options granted by the
Company held by each of the Named Executives on June 30, 1996.
Aggregate Option Exercises in Last Fiscal Year and Year-End Option Values
<TABLE>
<CAPTION>
Number of Number of Shares Value of Unexercised in-
Shares Underlying Unexercised the-Money Options at
Acquired on Value Options at 6/30/96 6/30/96(1)
Name Exercise Realized Exercisable/Unexercisable Exercisable/Unexercisable
- ---- -------- -------- ------------------------- -------------------------
<S> <C> <C> <C> <C>
Vincent J. Bitetti 0 $0 0/0 $0/0
Eric H. Winston (2) 0 0 292,838/0 1,153,782/0
</TABLE>
- --------------------
(1) Based on the offering price of the Common Stock in the IPO ($4.00 per
share), which commenced on July 1, 1996, less the option exercise price.
(2) Does not include a presently exercisable option held by Mr. Winston to
purchase 100,000 shares of Common Stock from Mr. Bitetti at $2.00 per
share. Mr. Winston resigned as an officer and director of the Company
effective as of November 1, 1996.
Compensation of Directors
Prior to June 30, 1996, all of the Company's directors were employees and
received no compensation for their services as directors. In fiscal 1997, the
Company's employee directors will continue to receive no compensation for their
services as directors. However, the Company will pay each director who is not an
employee of the Company a director's fee of $15,000 per year, and reimburse them
for out-of-pocket expenses incurred in connection with their attendance at
meetings. In addition, the 1995 Stock Option Plan provides for the grant of
stock options to nonemployee directors of the Company without any action on the
part of the Board of Directors or the Compensation Committee, upon the terms and
conditions set forth in the 1995 Stock Option Plan. Each nonemployee director
shall automatically receive nonqualified stock options to acquire 10,000 shares
of Common Stock upon appointment as a director, and shall receive nonqualified
options to acquire an additional 10,000 shares of Common Stock for each
additional year that the nonemployee director continues to serve on the Board of
Directors. Each option granted to a nonemployee director shall vest and become
exercisable as to 50 percent of the shares of Common Stock subject to the option
on the first anniversary date of the grant and as to the remaining 50 percent on
the second anniversary date of the grant, and will expire on the earliest of ten
years from the date the option was granted, upon expiration of the 1995 Stock
Option Plan,
48
<PAGE>
or three weeks after the optionee ceases to be a director of the Company. The
exercise price of such options shall be equal to 100 percent of the fair market
value of the Common Stock subject to the option on the date on which such
options are granted. Each option shall be subject to the other provisions of the
1995 Stock Option Plan.
Employment Agreements
The Company has entered into an employment agreement with Vincent J.
Bitetti, Chairman of the Board and Chief Executive Officer, for a term ending
on September 15, 1998. Pursuant to that employment agreement, commencing
September 15, 1995, Mr. Bitetti was entitled to receive annual base
compensation of $200,000. The employment agreement was amended to provide
that effective July 2, 1996, Mr. Bitetti's base compensation was reduced to
$160,000 per annum, subject to an increase by $40,000 per annum at such time
as the Company realized net sales (gross sales less returns and allowances)
of $1,500,000 or more for any three consecutive calendar months. The
Company's net sales for the quarter ended December 31, 1996, exceeded
$1,500,000, and consequently Mr. Bitetti's salary has been increased by
$40,000 retroactive to October 1, 1996. Mr. Bitetti's annual base
compensation also is subject to escalation annually in accordance with the
Consumer Price Index (the "CPI"). In addition, Mr. Bitetti's employment
agreement entitles him to receive bonuses based on three criteria: attainment
of specified gross revenues, attainment of specified gross profits, and
attainment of specified pre-tax profitability. If the Company acquires any
new businesses in the future, the related revenues and profits will not be
taken into account in determining entitlements to these bonuses.
The employment agreement entitles Mr. Bitetti to receive a bonus in the
following amounts if the following gross revenues are attained for the fiscal
year ending June 30, 1997:
Gross Revenues Cumulative Cash Bonus
-------------- ---------------------
$ 12,000,000 $ 25,000
16,000,000 75,000
24,000,000 125,000
The gross revenue attainment levels required to receive each bonus level for
each subsequent fiscal year of Mr. Bitettis' employment pursuant to the
employment agreement will be increased by 60 percent annually.
The employment agreement entitles Mr. Bitetti to receive a bonus in the
following amounts if the following levels of gross profits (defined as annual
sales revenue less all costs of sales as determined by the Company's independent
public accountants) are attained for the fiscal year ending June 30, 1997:
Gross Profits Cumulative Cash Bonus
------------- ---------------------
$ 3,200,000 $ 50,000
3,600,000 $ 75,000
4,000,000 100,000
The gross profit levels required to receive each bonus level for each
subsequent fiscal year of Mr. Bitetti's employment pursuant to the employment
agreement will be increased by 60 percent annually.
49
<PAGE>
The employment agreement entitles Mr. Bitetti to the following amounts if
the following levels of pre-tax profitability (defined as annual earnings before
interest, taxes, depreciation and amortization divided by gross revenues) are
attained for each fiscal year during the term of Mr. Bitetti's employment
agreement:
Profitability Cumulative Cash Bonus
------------- ---------------------
10% $ 50,000
15% $ 100,000
Pursuant to his employment agreement, Mr. Bitetti is entitled to certain
other fringe benefits including use of a Company automobile or automobile
allowance, $5,000,000 in life insurance coverage (provided that in no event
will the Company be required to pay a premium for such insurance in excess of
$7,500 per year) and the right to participate in the Company's customary
benefit plans. Mr. Bitetti's employment agreement further provides that
following the voluntary or involuntary termination of his employment by the
Company, Mr. Bitetti is entitled to two demand registration rights with
respect to the Common Stock held by or issuable to him. These registration
rights will only become effective upon the voluntary or involuntary
termination of Mr. Bitetti's employment with the Company. Mr. Bitetti has
agreed not to sell any shares of his Common Stock during the 18-month period
beginning July 2, 1996 (except for 20,000 shares sold by Mr. Bitetti pursuant
to the over-allotment option granted to the Underwriters in connection with
the IPO) except with the consent of the Underwriters. See "Certain
Transactions - Agreements the Underwriters." Mr. Bitetti's employment
agreement further provides that if the Company employs a new Chief Executive
Officer, Mr. Bitetti's salary may not be less than that of such new Chief
Executive Officer, up to a maximum of $300,000.
The Company has entered into an agreement with Ulrich E. Gottschling,
President, Chief Operating Officer, Chief Financial Officer, Treasurer and
Secretary, for a term ending February 2, 1999. The employment agreement entitles
Mr. Gottschling to receive annual cash compensation of $130,000, subject to an
increase by $20,000 per annum commencing April 1, 1997. Mr. Gottschling's annual
base salary also is subject to escalation annually in accordance with the CPI.
Mr. Gottschling also is entitled during the term of his employment pursuant to
his employment agreement to receive bonuses in accordance with the same
provisions governing Mr. Bitetti's bonuses, except that the bonuses payable to
Mr. Gottschling are equal to 80 percent of the bonuses payable to Mr. Bitetti.
Pursuant to a prior employment agreement, on October 9, 1995, Mr. Gottschling
also was granted options to purchase 100,000 shares of Common Stock at an
exercise price of $5.00 per share. On April 30, 1996, Mr. Gottschling agreed to
the termination of his existing 100,000 share option in consideration for the
Company's agreement to grant to him a new 200,000 share option pursuant to the
Company's 1992 Stock Option Plan. The Company granted this option to Mr.
Gottschling on April 30, 1996. The option was exercisable upon the date of its
grant as to 100,000 shares at a purchase price of $3.40 per share, and will
become exercisable as to 100,000 shares on September 30, 1997, at a purchase
price of $4.00 per share.
The Company entered into an employment agreement with Eric H. Winston,
formerly its President and Chief Operating Officer, for a term ending on
September 15, 1998. Pursuant to that employment agreement, Mr. Winston was
entitled to receive an annual salary of $140,000, and to receive bonuses in
accordance with the same provisions governing Mr. Bitetti's bonuses. On
October 25, 1996, the Company entered into a Separation and Release Agreement
with Mr. Winston, which became effective on November 1, 1996. Pursuant to
that agreement, until September 15, 1998, Mr. Winston remains entitled to
receive compensation at the same level as his salary under his employment
agreement. He is
50
<PAGE>
also entitled to continue to receive certain other benefits as previously
provided pursuant to his employment agreement, but is no longer entitled to
receive any bonuses.
Pursuant to a prior employment agreement, Mr. Winston holds presently
exercisable options to purchase 292,838 shares of Common Stock at an exercise
price of $0.06 per share. Mr. Winston's employment agreement further provides
that following the voluntary or involuntary termination of his employment by the
Company, Mr. Winston is entitled to two demand registration rights with respect
to the Common Stock held by or issuable to him. One of such registration rights
has been satisfied by the inclusion of all Common Stock subject to purchase upon
exercise of the options held by Mr. Winston in this Prospectus. Mr. Bitetti has
separately granted Mr. Winston a presently exercisable option to acquire 100,000
shares of Common Stock at a purchase price of $2.00 per share. Mr. Winston has
agreed not to sell more than 10,000 shares of this Common Stock during the
18-month period ending January 2, 1998, except with the consent of the
Underwriters.
Pursuant to his employment agreement, Mr. Winston has granted Mr. Bitetti a
right of first refusal as to all Common Stock that Mr. Winston may from time to
time acquire. Such first refusal right provides that before Mr. Winston offers
to sell any such Common Stock to any third party, he must first offer to sell
such shares to Mr. Bitetti on no less favorable terms than proposed to be
offered to the third party. If Mr. Bitetti rejects such offer, Mr. Winston is
free to sell to the third party on terms no less favorable than offered to Mr.
Bitetti.
1995 Stock Option Plan
General
The Board of Directors adopted the Company's Amended and Restated 1995
Stock Option Plan on May 15, 1996. The Amended and Restated 1995 Stock Option
Plan, as amended (the "1995 Stock Option Plan") was approved by the Company's
stockholders on December 9, 1996. The following summary of the Company's 1995
Stock Option Plan is qualified in its entirety by the 1995 Stock Option Plan,
a copy of which is incorporated by reference in the Registration Statement of
which this Prospectus is a part.
The 1995 Stock Option Plan is designed to promote and advance the interests
of the Company and its stockholders by (i) enabling the Company to attract,
retain, and reward managerial and other key employees and nonemployee directors,
and (ii) strengthening the mutuality of interests between participants in the
1995 Stock Option Plan and the stockholders of the Company in its long term
growth, profitability and financial success by offering stock options.
The 1995 Stock Option Plan empowers the Company to award or grant from time
to time until September 30, 2005, to eligible participants incentive and
non-qualified stock options ("Options") authorized by the Compensation Committee
of the Board of Directors (the "Committee"), which will administer the 1995
Stock Option Plan.
Administration
The 1995 Stock Option Plan will be administered by the Committee. The 1995
Stock Option Plan provides that the Committee must consist of at least two
directors of the Company who are "disinterested directors" within the meaning of
Rule 16b-3 under the Exchange Act. The Committee has the sole
51
<PAGE>
authority to construe and interpret the 1995 Stock Option Plan, to make rules
and procedures relating to the implementation of the 1995 Stock Option Plan, to
select participants, to establish the terms and conditions of Options and to
grant Options, with broad authority to delegate its responsibilities to others,
except with respect to the selection for participation of, and the granting of
Options to, persons subject to Sections 16(a) and 16(b) of the Exchange Act.
Members of the Committee will not be eligible to receive discretionary Options
under the 1995 Stock Option Plan.
Eligibility Conditions
Incentive Stock Options may be granted only to persons who are employees
of the Company or its subsidiaries on the date of grant. Non-Qualified Stock
Options (as hereinafter defined) may be granted to any person. Nonemployee
directors are only eligible to receive Non-Qualified Stock Options under the
1995 Stock Option Plan. Except for Non-Qualified Stock Options granted to
nonemployee directors, the selection of recipients of, and the nature and
size of, Options granted under the 1995 Stock Option Plan will be wholly
within the discretion of the Committee. Subject to specific formula
provisions relating to the grant of Options to nonemployee directors and
except with respect to the exercisability of Incentive Stock Options and the
total shares available for option grants under the 1995 Stock Option Plan,
there is no limit on the number of shares of Common Stock or type of option
in respect of which Options may be granted to or exercised by any person.
Shares Subject to 1995 Stock Option Plan
The maximum number of shares of Common Stock in respect of which Options
may be granted under the Plan (the "Plan Maximum") is 500,000. See "Securities
Eligible for Future Sale." For purposes of computing the total number of shares
of Common Stock available for Options under the 1995 Stock Option Plan, the
above limitations shall be reduced by the number of shares of Common Stock
subject to issuance upon exercise or settlement of Options previously granted,
determined at the date of the grant of such Options. However, if any Options
previously granted are forfeited, terminated, settled in cash or exchanged for
other Options or expire unexercised, the shares of Common Stock previously
subject to such Options shall again be available for further grants under the
1995 Stock Option Plan. The shares of Common Stock which may be issued to
participants in the 1995 Stock Option Plan upon exercise of an Option may be
either authorized and unissued Common Stock or issued Common Stock reacquired by
the Company. No fractional shares may be issued under the 1995 Stock Option
Plan.
The maximum number of shares of Common Stock issuable upon the exercise of
Options granted under the 1995 Stock Option Plan is subject to appropriate
equitable adjustment in the event of a reorganization, stock split, stock
dividend, combination of shares, merger, consolidation or other recapitalization
of the Company. The effect of such adjustment would be to provide customary
anti-dilution protection.
Transferability
No Option granted under the 1995 Stock Option Plan, and no right or
interest therein, shall be assignable or transferable by a participant except by
will or the laws of descent and distribution.
52
<PAGE>
Term, Amendment and Termination
The 1995 Stock Option Plan will terminate on September 30, 2005, except
with respect to Options then outstanding. The Board of Directors of the
Company may amend or terminate the 1995 Stock Option Plan at any time, except
that, to the extent restricted by Rule 16b-3 promulgated under the Exchange
Act, as amended and in effect from time to time (or any successor rule), the
Board of Directors may not, without approval of the stockholders of the
Company, make any amendment that would increase the total number of shares
covered by the 1995 Stock Option Plan, change the class of persons eligible
to receive Options granted under the 1995 Stock Option Plan, reduce the
exercise price of Options granted under the 1995 Stock Option Plan or extend
the latest date upon which Options may be exercised.
Incentive Stock Options
Under the 1995 Stock Option Plan Options designated as incentive stock
options ("Incentive Stock Options"), within the meaning of Section 422 of the
Internal Revenue Code of 1986, as amended (the "Code" as previously defined),
may be granted to eligible participants in respect of up to the Plan Maximum.
The number of shares of Common Stock in respect of which Incentive Stock
Options are first exercisable by any participant in the 1995 Stock Option
Plan during any calendar year shall not have a fair market value (determined
at the date of grant) in excess of $100,000 (or such other limit as may be
imposed by the Code). To the extent the fair market value of the shares for
which options are designated as Incentive Stock Options that are first
exercisable by any optionee during any calendar year exceeds $100,000, the
excess amount shall be treated as Non-Qualified Stock Options. Incentive
Stock Options shall be exercisable for such period or periods, not in excess
of ten years after the date of grant, as shall be determined by the Committee.
Non-Qualified Stock Options
Non-Qualified stock options ("Non-Qualified Stock Options") may be
granted to eligible participants in respect of up to the Plan Maximum for
such number of shares of Common Stock and will be exercisable for such period
or periods of exercisability as the Committee shall determine.
Options to Nonemployee Directors
The 1995 Stock Option Plan also provides for the grant of Options to
nonemployee directors of the Company without any action on the part of the
Board or the Committee, only upon the terms and conditions set forth in the
1995 Stock Option Plan. Each nonemployee director shall automatically receive
Non-Qualified Stock Options to acquire 10,000 shares of Common Stock upon
appointment, and shall receive Non-Qualified Stock Options to acquire an
additional 10,000 shares of Common Stock for each additional year that the
nonemployee director continues to serve on the Board of Directors. Each
Option shall become exercisable as to 50 percent of the shares of Common
Stock subject to the Option on the first anniversary date of the grant and 50
percent on the second anniversary date of the grant, and will expire on the
earliest of ten years from the date the Option was granted, upon expiration
of the 1995 Stock Option Plan, or three weeks after the optionee ceases to be
a director of the Company. The exercise price of such Options shall be equal
to 100 percent of the fair market value of the Common Stock subject to the
Option on the date on which such Options are granted. Each Option shall be
subject to the other provisions of the 1995 Stock Option Plan.
53
<PAGE>
Option Exercise Prices
The exercise price of any Option granted under the 1995 Stock Option
Plan shall be at least 100 percent of the fair market value of the Common
Stock on the date of grant, except that the exercise price of any Option
granted to any participant in the 1995 Stock Option Plan who owns in excess
of ten percent of the outstanding voting stock of the Company shall be 110
percent of the fair market value of the Common Stock on the date of grant.
Fair market value per share of Common Stock is as quoted by the Nasdaq
SmallCap Market, or is the amount determined in good faith by the Committee
if the Common Stock is neither listed for trading on an exchange or quoted by
the Nasdaq SmallCap Market.
Exercise of Options
No Option may be exercised, except as provided below, unless the holder
thereof remains in the continuous employ or service of the Company. Options
shall be exercisable upon the payment in full of the applicable option exercise
price in cash or, if approved by the Committee, by instruction to a broker
directing the broker to sell the Common Stock for which such Option is exercised
and remit to the Company the aggregate exercise price of the Option or upon such
terms as the Committee shall approve, in shares of the Common Stock then owned
by the optionee (at the fair market value thereof at exercise date).
1992 Stock Option Plan
On May 4, 1992, the Board of Directors adopted the Company's 1992 Stock
Option Plan. The Board of Directors has resolved that no further options are to
be granted pursuant to the 1992 Stock Option Plan. All existing options
previously issued under the 1992 Stock Option Plan will remain enforceable in
accordance with their respective terms. As of February 28, 1997, options to
purchase a total of 342,337 shares of Common Stock were issued pursuant to
the 1992 Stock Option Plan. See "Securities Eligible for Future Sale."
Limitation of Liability and Indemnification of Directors
Director Exculpation
The Company's Certificate of Incorporation provides that a director of the
Company, to the maximum extent now or hereafter permitted by Section 102(b)(7)
of the Delaware GCL, will have no personal liability to the Company or its
stockholders for monetary damages for breach of fiduciary duty as a director.
Section 102(b)(7) of the Delaware GCL currently provides that directors of
corporations that have adopted such a provision will not be so liable, except
(i) for any breach of the director's duty of loyalty to the Company or its
stockholders, (ii) for acts or omissions not in good faith or that involve
intentional misconduct or a knowing violation of law, (iii) as provided under
Section 174 of the Delaware GCL for the payment of certain unlawful dividends
and the making of certain stock purchases or redemptions, or (iv) for any
transaction from which the director derived an improper personal benefit. This
provision would absolve directors of personal liability for negligence in the
performance of their duties, including gross negligence. It would not permit a
director to be exculpated, however, for liability for actions involving
conflicts of interest or breaches of the traditional "duty of loyalty" to the
Company and its stockholders, and it would not affect the availability of
injunctive or other equitable relief as a remedy.
54
<PAGE>
This provision does not eliminate or alter the duty of the Company's
directors; it merely limits personal liability for monetary damages to the
maximum extent now or as may be permitted by the Delaware GCL. Moreover, it
applies only to claims against a director arising out of his role as a
director; it does not apply to claims arising out of his role as an officer
(if such director is also an officer) or arising out of any other capacity in
which such director serves. While this provision does not affect the
availability of injunctive or other equitable relief as a remedy for breach
of duty by directors, it does limit the remedies available to a stockholder
who has an otherwise valid claim that a director acted in violation of his
duties, if the action is among those as to which liability is limited.
Because of this provision, stockholders will not have a claim for monetary
damages based on breach of the directors' duty, even if the directors'
conduct involved gross negligence (including a grossly negligent business
decision involving a takeover proposal for the Company), unless the conduct
is of a type for which the Delaware GCL does not permit limitation of
liability. If the stockholders do not have a claim for monetary damages,
their only remedy may be a suit to enjoin completion of the Board's action or
to rescind completed action. The stockholders may not be aware of a proposed
transaction that might otherwise give rise to a claim until the transaction
is completed or until it is too late to prevent its completion by injunction.
In such a case, the Company and its stockholders may have no effective remedy
for an injury resulting from the Board's action.
This provision may reduce the likelihood of stockholder derivative
litigation against directors and may discourage or deter stockholders or
management from bringing a lawsuit against directors for breach of their duties,
even though such action, if successful, might otherwise have benefited the
Company and its stockholders. The SEC has taken the position that similar
provisions added to other corporations' certificates of incorporation would not
protect those corporations' directors from liability for violations of the
federal securities laws.
The Company included this exculpation provision in its Certificate of
Incorporation to provide its directors with the maximum protection from
personal liability made available by the Delaware GCL. It is believed that
this provision will help the Company to attract and retain as directors the
persons most qualified for those positions. See "Risk Factors - Limitation on
Directors' Liability; Indemnification."
Director Indemnification
The Company's Bylaws generally require the Company to indemnify and advance
expenses to its directors, officers, employees and other agents to the fullest
extent permitted by Delaware law. The Company has purchased a directors' and
officers' liability policy insuring its directors and officers. The Company also
has entered into indemnification agreements with each of its existing directors,
and plans to enter into indemnification agreements with directors appointed in
the future, whereby the Company will indemnify each such person against certain
claims arising out of certain past, present or future acts, omissions or
breaches of duty committed by an indemnitee while serving as a Company director.
Such indemnification does not apply to acts or omissions which are knowingly
fraudulent, deliberately dishonest or arise from willful misconduct.
Indemnification will only be provided to the extent that the indemnitee has not
already received payments in respect of a claim from the Company or from an
insurance company. Under certain circumstances, such indemnification (including
reimbursement of expenses incurred) will be allowed for liability arising under
the Securities Act.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers or person controlling the Company
pursuant to the foregoing provisions, the Company has been informed that, in the
opinion of the SEC, such indemnification is against public policy as
55
<PAGE>
expressed in the Securities Act and is therefore unenforceable. See "Risk
Factors - Limitations on Directors' Liability; Indemnification."
56
<PAGE>
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information regarding the
ownership of the Common Stock as of February 28, 1997, by the following: (i)
each person or group who is known to the Company to own, of record or
beneficially, more than five percent of the Common Stock; (ii) the Company's
Chief Executive Officer and the other Named Executive; (iii) each of the
Company's directors; and (iv) all directors and executive officers of the
Company as a group. Unless otherwise indicated, each of the stockholders
shown in the table below has sole voting and investment power with respect to
the shares beneficially owned.
Name and Address(1) Number of Shares(2) Percent (2)
- ------------------- ------------------- -----------
Vincent J. Bitetti (3) ....................... 1,407,007 32.0%
Ulrich E. Gottschling(4) ..................... 100,000 2.2
Robert S. Burke .............................. 0 0.0
Ronald W. Hart ............................... 0 0.0
Mark A. James ................................ 0 0.0
Ernest T. Klinger ............................ 0 0.0
ASSI, Inc. (5) ............................... 4,856,657 52.7
Eric H. Winston (6) .......................... 392,838 8.4
All directors and executive officers
as a group (3) (4) ......................... 1,507,007 33.4
- --------------------
(1) The address of each of Messrs. Bitetti, Burke, Gottschling, Hart, James and
Klinger is c/o the Company, 26115 Mureau Road, Suite B, Calabasas,
California 91302-3126. The address of Mr. Winston is 5567 Springhill Ct.,
Westlake Village, California 91362. The address of ASSI, Inc. is 375 East
Harmon Avenue, Las Vegas, Nevada 89109.
(2) In accordance with Rule 13d-3 under the Exchange Act, a person or group is
deemed to beneficially own outstanding securities plus, for each person or
group, any securities that person or group has the right to acquire within
60 days pursuant to options, warrants or other rights.
(3) Includes: all 1,234,684 shares of Common Stock of which Mr. Bitetti is the
record owner (including 100,000 shares of Common Stock which Eric H.
Winston is entitled to acquire from Mr. Bitetti pursuant to a presently
exercisable option (see "Certain Transactions - Sales by Controlling
Stockholder"), and as to which shares, when issued, Mr. Bitetti will have a
right of first refusal (see "Management - Employment Agreements")); 10,000
and 122,323 shares of Common Stock owned of record by Martin H. Meyer and
Mark Lane, respectively, for which Mr. Bitetti holds an irrevocable voting
proxy (see "Certain Transactions - 1994 Acquisition"); 10,000 shares of
Common stock owned of record by Mr. Winston, as to which Mr. Bitetti has a
right of first refusal (see "Management - Employment Agreements"); and
40,000 shares of Common Stock owned of record by ASSI, Inc., as to which
Mr. Bitetti has shared voting rights (see "Management - Directors and
Executive Officers" and "Certain Transactions - Agreements With ASSI,
Inc."). Excludes 282,838 shares of Common Stock that may be acquired by Mr.
Winston from the Company pursuant to a presently exercisable option, as to
which shares,
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<PAGE>
when issued, Mr. Bitetti will have a right of first refusal (see
"Management - Employment Agreements"); and 4,816,657 shares of Common Stock
that may be acquired by ASSI, Inc. pursuant to presently exercisable ASSI
Warrants, as to which shares, when issued, Mr. Bitetti will have shared
voting rights (see "Certain Transactions - Agreements With ASSI, Inc.").
(4) Includes 100,000 shares of Common Stock issuable to Mr. Gottschling under a
presently exercisable option granted by the Company. See "Management -
Employment Agreements."
(5) Includes: all 40,000 shares of Common Stock of which ASSI, Inc. is the
record owner; and 4,816,657 shares of Common Stock issuable to ASSI, Inc.
under the presently exercisable ASSI Warrants. Excludes any Company
securities owned by Vincent J. Bitetti or Eric H. Winston, as to which
ASSI, Inc. holds an irrevocable proxy as described under "Management -
Directors and Executive Officers." ASSI, Inc. has advised the Company that
all of its equity securities are beneficially owned by Louis Habash, whose
address is 375 East Harmon Avenue, Las Vegas, Nevada 89122, who thus is the
ultimate beneficial owner of the Common Stock and ASSI Warrants owned by
ASSI, Inc. See "Certain Transactions - Agreements with ASSI, Inc."
(6) Includes 282,838 shares of Common Stock issuable under stock options
granted by the Company to Mr. Winston which are presently exercisable. See
"Management - Employment Agreements." Also includes 100,000 shares of
Common Stock which Mr. Winston is entitled to acquire from Mr. Bitetti
pursuant to a presently exercisable option. See "Certain Transactions -
Sales by Controlling Stockholder."
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<PAGE>
SELLING SECURITY HOLDERS
An aggregate of 690,338 shares of Common Stock and 5,058,307 Redeemable
Warrants are being registered in this offering for the account of the Selling
Security Holders. The Selling Security Holders' Securities may be sold by the
Selling Security Holders or their respective transferees commencing on the date
of this Prospectus. Sales of such shares of Common Stock and Redeemable Warrants
by the Selling Security Holders or their respective transferees may depress the
price of the Common Stock and Redeemable Warrants. See "Risk Factors -
Securities Eligible for Future Sale" and "Securities Eligible for Future Sale."
The following table sets forth certain information with respect to persons
for whom the Company is registering such shares of Common Stock and Redeemable
Warrants for resale to the public. The Company will not receive any of the
proceeds from the sale of such shares of Common Stock and Redeemable Warrants.
None of the Selling Security Holders has had any position, office or material
relationship with the Company or its affiliates during the last three years
except for the following: (i) ASSI, Inc., which has served as a consultant to
the Company (see "Certain Transactions - Agreements With ASSI, Inc."); (ii) Eric
H. Winston, who served as the President and Chief Operating Officer of the
Company from May 1994 until November 1, 1996 (see "Management" and "Principal
Stockholders"); (iii) Vincent J. Bitetti, the Company's Chairman of the Board
and Chief Executive Officer and its largest stockholder (see "Management" and
"Principal Stockholders"); and (iv) Paradox Holdings, which is an affiliate of
Financial West Group, Inc., the dealer manager for the Company's 1995 Bridge
Financing and 1995 Private Placement (each as hereinafter defined).
Number of Number of
Shares/Warrants Shares/Warrants
Name of Selling Security Holder(1) Owned Before Offering Being Registered(2)
- ---------------------------------- --------------------- -------------------
Lester C. Arzh 5,000(3) 5,000(sh)
ASSI, Inc. 800,000(4) 800,000(Awt)
2,000,000(5) 2,000,000(Awt)
2,016,657(6) 2,016,657(Awt)
40,000(3) 40,000(sh)
Harvey Bibicoff 5,000(3) 5,000(sh)
Vincent J. Bitetti 1,234,684(7) 200,000(sh)
Arlene Colman-Schwimmer, 5,000(3) 5,000(sh)
Grantor and Trustee for Arlene
Colman-Schwimmer APC Profit
Sharing Plan and Trust
David B. Coward and Linda J. 2,500(3) 2,500(sh)
Coward, Grantors and Trustees for
David B. and Linda J. Coward Trust
Robert Gault and Thelma Gault, 25,000(3) 25,000(sh)
Joint Tenants with Right of
Survivorship
Gabriel Kaplan 10,000(3) 10,000(sh)
David A. Mulkey, Trustee of the 5,000(3) 5,000(sh)
David A. Mulkey 1987 Living Trust
Paradox Holdings 237,550(8) 237,550(wt)
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David H. Smith 4,000(9) 4,100(wt)
Eric H. Winston 392,838(10) 392,838(sh)
- ----------
(1) Information set forth in the table regarding the Selling Security Holders'
Securities is provided to the best knowledge of the Company based on
information furnished to the Company by such respective Selling Security
Holders and/or available to the Company through its stock ledgers or
inquiries to brokers.
(2) Since the Selling Security Holders may offer all or part of the Common
Stock and/or Redeemable Warrants held thereby (subject to the
limitations contained in agreements with the Underwriters with respect
to the shares of Common Stock being offered by Messrs. Bitetti and
Winston), and since this offering is not being underwritten on a firm
commitment basis, no estimate can be given as to the amount of Common
Stock and/or Redeemable Warrants to be offered for sale by the Selling
Security Holders or as to the amount of Common Stock and/or Redeemable
Warrants that will be held by the Selling Security Holders upon
termination of this offering.
(3) Represents Common Stock privately acquired in the Concurrent Private
Placement. See "Certain Transactions - Sales by Controlling Stockholder."
(4) Represents Warrants privately acquired pursuant to the 1995 Private
Placement. See "Certain Transactions - 1995 Private Placement."
(5) Represents Warrants privately acquired in consideration for consulting
services. See "Certain Transactions - Agreements With ASSI, Inc."
(6) Represents Warrants privately acquired upon conversion of the ASSI
Convertible Note (as hereinafter defined). See "Certain Transactions -
Agreements with ASSI, Inc.
(7) Represents Common Stock privately acquired in connection with the 1994
Acquisition (as hereinafter defined). See "Certain Transactions - 1994
Acquisition."
(8) Represents Warrants privately issued to the dealer manager in connection
with the 1995 Bridge Financing and 1995 Private Placement. See "Certain
Transactions - 1995 Bridge Financing "and" - 1995 Private Placement."
(9) Represents Warrants privately acquired pursuant to the 1995 Bridge
Financing. See "Certain Transactions - 1995 Bridge Financing."
(10) Includes 100,000 shares of Common Stock as to which Mr. Winston holds a
presently exercisable purchase option from Vincent J. Bitetti, and 282,838
shares of Common Stock as to which Mr. Winston holds a presently
exercisable purchase option from the Company. See "Management - Employment
Agreements."
(sh) Shares of Common Stock.
(wt) Redeemable Warrants, each Warrant to purchase one share of Common Stock.
(Awt) ASSI Warrants, each Warrant to purchase one share of Common Stock.
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CERTAIN TRANSACTIONS
1994 Acquisition
On May 16, 1994, the Company consummated the 1994 Acquisition, whereby
the Company acquired all of the issued and outstanding capital stock of the
Subsidiary in exchange for newly issued stock of the Company. The 1994
Acquisition was accomplished by the issuance of 1,278,515 shares of Common
Stock and 1,000,000 shares of the Company's Series A Preferred Stock to
Vincent J. Bitetti, 73,394 shares of Common Stock to Martin H. Meyer, and
122,323 shares of Common Stock to Mark Lane, and the simultaneous
cancellation of 60,241 shares of Common Stock held by former directors and
officers of the Company, the cancellation of an option to purchase 3,347
shares of Common Stock held by a former director and officer of the Company,
which option was to become exercisable only upon the satisfaction of certain
contingencies, and the cancellation of an option to purchase 3,347 shares of
Common Stock held by a former director of the Company, which option was to
become exercisable only upon the satisfaction of certain contingencies.
Effective upon the closing of the 1994 Acquisition, all of the Company's
former directors and officers resigned and were replaced by Vincent J.
Bitetti, Joseph Urquidi, Eric H. Winston and Martin H. Meyer. Mr. Urquidi
resigned as an officer and director as of June 29, 1994. Mr. Meyer resigned
as a director as of August 5, 1994. Mr. Winston resigned as an officer and
director as of November 1, 1996. Subsequent to the 1994 Acquisition, Mr.
Bitetti exchanged his 1,000,000 shares of Series A Preferred Stock for 83,669
shares of Common Stock issued by the Company. All such shares so acquired by
Mr. Bitetti have been included in this Prospectus and comprise a portion of
the Selling Security Holders' Securities. See "Selling Security Holders."
Simultaneously with the 1994 Acquisition, Martin H. Meyer and Mark Lane
each granted to Vincent J. Bitetti a right of first offer to purchase their
Common Stock, which Mr. Winston waived in 1996 subsequent to the IPO. Messrs.
Meyer and Lane also have granted Mr. Bitetti an irrevocable proxy to vote all
their shares of Common Stock on all matters coming before the holders of the
Common Stock for a vote. See "Risk Factors - Control of the Company" and
"Principal Stockholders."
1994 Private Placement
During May through August 1994, the Company conducted a private offering
of its Common Stock (the "1994 Private Placement"). Pursuant to that
offering, a total of 113,036 shares of Common Stock were sold for total cash
consideration of approximately $1,492,000. An additional 1,841 shares were
issued to the brother of Vincent J. Bitetti, Chairman of the Board and Chief
Executive Officer, in payment of a $22,000 note payable. An additional 81,997
shares of Common Stock were issued to the placement agent for the 1994
Private Placement in partial payment for its services as such. Subsequently,
the Company's founders, who also were affiliates of the placement agent,
distributed all 81,997 such shares plus an additional 26,772 shares held by
them to the investors in the 1994 Private Placement in settlement of
litigation initiated by one of such investors, and returned 15,120 shares of
Common Stock to the Company which were cancelled. See "Selling Security
Holders."
1995 Bridge Financing
During June through August of 1995, the Company conducted a private
offering (the "1995 Bridge Financing") of Units consisting of notes and
warrants. Pursuant to that offering, a total of 32 Units were sold at a price of
$10,000 per Unit. Each Unit consisted of $9,975 principal amount of the
Company's 10% Secured Promissory Notes due August 15, 1995 (the "Bridge Notes")
and
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<PAGE>
warrants to purchase 586 shares of Common Stock (the "Bridge Warrants"). The
gross offering proceeds of the 1995 Bridge Financing were $320,000. Pursuant to
the 1995 Bridge Financing, $319,200 in aggregate principal amount of the Bridge
Notes were issued. The Bridge Notes were repaid in full out of the proceeds of
the 1995 Private Placement. Such repayment was in the amount of $332,320.
Pursuant to the 1995 Bridge Financing, the Company also issued 18,747
Bridge Warrants to investors, and issued 20,918 Bridge Warrants to Financial
West Group, Inc. in partial consideration for its services as dealer manager for
the 1995 Bridge Financing. Subsequent to the completion of the 1995 Bridge
Financing, the Company and the Subsidiary agreed with the holders of all of the
Bridge Warrants as to certain changes to the terms of the Bridge Warrants. As
amended, the terms of the Bridge Warrants, including the registration rights
applicable thereto, became identical to those of the Private Warrants as
described below. See "Certain Transactions - 1995 Private Placement." The Bridge
Warrants, in accordance with their terms, were automatically converted into
Redeemable Warrants to purchase an aggregate of 39,665 shares of Common Stock
upon completion of the Company's IPO. The holders of the Bridge Warrants and
Common Stock issued or issuable upon the conversion of the Bridge Warrants are
entitled to one demand registration right and unlimited piggyback registration
rights during the five-year period commencing July 1, 1996, and ending June 30,
2001. Pursuant to such registration rights, the unsold portion of the Redeemable
Warrants into which the Bridge Warrants were converted and the underlying shares
of Common Stock have been included in this Prospectus. See "Selling Security
Holders." The Company has agreed to maintain the effectiveness of the
Registration Statement of which this Prospectus is a part as described under
"Certain Transactions - Agreements with the Underwriters."
1995 Private Placement
In September and October 1995, the Company conducted a private offering
(the "1995 Private Placement"). Pursuant to that offering, a total of 52.5 Units
were sold at a price of $100,000 per Unit. Each Unit consisted of $95,000
principal amount of the Company's 10% Secured Promissory Notes due 1996 (the
"Private Notes") and warrants to purchase 100,000 shares of Common Stock (the
"Private Warrants"). The gross offering proceeds of the 1995 Private Placement
were $5,250,000.
Pursuant to the 1995 Private Placement, $4,987,500 in aggregate
principal amount of the Private Notes were issued. The Private Notes were
repaid in full out of the proceeds of the IPO. Such repayment was in the
amount of $5,361,253.
Pursuant to the 1995 Private Placement, the Company also issued 5,250,000
Private Warrants to investors, and issued 400,000 Private Warrants to Financial
West Group, Inc. in partial consideration for its services as dealer manager for
the 1995 Private Placement. The Private Warrants, in accordance with their
terms, were automatically converted into Redeemable Warrants to purchase an
aggregate of 5,250,000 shares of Common Stock upon completion of the Company's
IPO, and such Redeemable Warrants, as well as the underlying shares of Common
Stock, have been included in this Prospectus, and comprise a portion of the
Selling Security Holders' Securities. See "Selling Security Holders." The
holders of the Private Warrants and Common Stock issued or issuable upon the
conversion of the Private Warrants are entitled to one demand registration right
and unlimited piggyback registration rights during the five-year period
commencing July 1, 1996, and ending June 30, 2001. Pursuant to such registration
rights, the unsold portion of the Redeemable Warrants into which the Private
Warrants were converted and the underlying shares of Common Stock have been
included in this Prospectus. See "Selling Security Holders." The Company has
agreed to maintain the effectiveness of the Registration Statement of which this
Prospectus is a part as described under "Certain Transactions - Agreements with
the Underwriters."
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Sales by Controlling Stockholder
Contemporaneously with the 1995 Private Placement, Vincent J. Bitetti, the
Company's Chairman of the Board and Chief Executive Officer, privately sold
107,500 shares of Common Stock for total cash consideration of $537,500 (the
"Concurrent Private Placement"). The holders of the Common Stock sold in the
Concurrent Private Placement are entitled to the same registration rights as the
holders of the Private Warrants, as described under "Certain Transactions - 1995
Private Placement." The unsold portion of the shares of Common Stock issued in
the Concurrent Private Placement have been included in this Prospectus, and
comprise a portion of the Selling Security Holders' Securities. See "Selling
Security Holders."
On April 3, 1995, Vincent J. Bitetti, for nominal consideration, granted
Eric H. Winston, who was then the Company's President, an option to purchase
100,000 shares of the Common Stock owned by Mr. Bitetti at an exercise price
of $2.00 per share, such price determined to be the fair market value of the
Common Stock by management. Such shares have been included in this
Prospectus, and comprise a portion of the Selling Security Holders'
Securities. Mr. Winston is entitled to certain registration rights in respect
of such shares as described under "Management - Employment Agreements." See
"Selling Security Holders."
Pursuant to the over-allotment option granted to the Underwriters in
connection with the IPO, Vincent J. Bitetti sold 20,000 shares of Common Stock
for net proceeds of $69,000.
Agreements With ASSI, Inc.
The Company entered into a Consulting Agreement with ASSI, Inc. dated
April 30, 1996. Pursuant to the Consulting Agreement, ASSI, Inc. provided
certain consulting services to the Company, including advising the Company
regarding executive recruiting. In consideration of the services to be
provided by ASSI, Inc. under the Consulting Agreement, on April 30, 1996, the
Company issued to ASSI, Inc. warrants to purchase 2,000,000 shares of Common
Stock at an exercise price of $4.40 per share. Pursuant to the Consulting
Agreement, the Company also agreed to certain changes to the terms of the
Private Warrants held by ASSI, Inc. as described below.
Pursuant to a Stockholder Voting Agreement dated April 30, 1996, the
Company has also agreed to grant ASSI, Inc. the right to nominate from time to
time one director of the Company, and Vincent J. Bitetti and Eric H. Winston
have agreed to vote all of their shares of Common Stock for the election of such
nominee. In addition, ASSI, Inc. has agreed to vote all of its shares of Common
Stock for two directors nominated by Mr. Bitetti for as long as he holds 20
percent or more of the Common Stock, and for one director nominated by Mr.
Bitetti for as long as he holds at least ten percent but less than 20 percent of
the issued and outstanding Common Stock. The voting agreements with ASSI, Inc.
will terminate on the earlier of July 8, 2001, or the date when Messrs. Bitetti
and Winston together cease to own at least ten percent of the Common Stock. See
"Management - Directors and Executive Officers."
On May 30, 1996, the Company entered into a Note Purchase Agreement with
ASSI, Inc. pursuant to which ASSI, Inc. loaned the Company $500,000 (the "ASSI
Convertible Loan"). The ASSI Convertible Loan bore interest at the rate of eight
percent per annum. The principal of and all accrued interest on the ASSI
Convertible Loan were due in full on the earlier of September 1, 1996, or the
closing date of the Company's IPO. Upon the closing of the IPO, ASSI, Inc. was
entitled to convert all or any part of the ASSI Convertible Loan into warrants
to purchase Common Stock at a conversion price of $.25 per warrant. ASSI, Inc.
exercised such conversion option, and on July 7, 1996, the Company
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<PAGE>
issued 2,016,657 warrants in connection with the conversion of the ASSI
Convertible Loan of $500,000 plus accrued interest of $4,164 as of the
conversion date. Upon the completion of the IPO, the terms of all of the
warrants then held by ASSI, Inc. (including 1,100,000 Private Warrants acquired
pursuant to the 1995 Private Placement, 2,000,000 warrants acquired pursuant to
the Consulting Agreement, and 2,016,657 warrants acquired pursuant to conversion
of the ASSI Convertible Note) were automatically conformed to the terms of the
Redeemable Warrants, subject to the following exceptions: (i) they became
exercisable October 1, 1996; (ii) they are not mandatorily redeemable by the
Company; and (iii) they are subject to separate registration rights, including
one demand registration right and unlimited piggyback registration rights. Upon
transfer by ASSI, Inc. of any of the ASSI Warrants or to any nonaffiliate of
ASSI, Inc., the terms of such transferred ASSI Warrants will become identical to
those of the Redeemable Warrants. Until and unless exercised, the holders of the
ASSI Warrants will have no voting, dividend or other rights as stockholders of
the Company.
On October 10, 1996, ASSI, Inc. sold 300,000 warrants it initially acquired
pursuant to the 1995 Private Placement at a price of $1.125 per warrant in an
off-market, negotiated transaction. The remaining 4,816,657 warrants owned by
ASSI, Inc. are herein referred to as the "ASSI Warrants" (as previously
defined).
The ASSI Warrants and underlying Common Stock have been included in this
Prospectus and comprise a portion of the Selling Security Holders' Securities.
See "Selling Security Holders."
Agreements With the Underwriters
In connection with the IPO, the Company, Vincent J. Bitetti, Ulrich E.
Gottschling and Eric H. Winston entered into an Underwriting Agreement with the
Underwriters. Pursuant to the Underwriting Agreement, the Company granted each
of the Underwriters the right to nominate from time to time one director of the
Company or to have an individual designated thereby attend all Board meetings as
a nonvoting advisor, and Vincent J. Bitetti and Eric H. Winston agreed to vote
all of their Common Stock for such director nominees. See "Management -
Directors and Executive Officers." The Company also agreed to indemnify and hold
harmless such directors or advisors to the maximum extent permitted by law in
connection with such individuals' services as a director or advisor.
Upon completion of the IPO, the Company sold the Underwriters for an
aggregate of $50 the Underwriters' Warrants to purchase up to 240,000 shares of
Common Stock at an exercise price of $5.80 per share of Common Stock. The
Underwriters' Warrants may not be transferred prior to July 2, 1997, except
basically to officers or partners of the Underwriters, any member of the NASD
participating in the offering hereunder, officers or partners of such member or
any successor of any of the foregoing, and are exercisable during the four-year
period commencing July 2, 1997, and ending July 1, 2001 (the "Underwriters'
Warrant Exercise Term"). The Company has granted one demand registration right
and unlimited piggyback registration rights to the holders of the Underwriters'
Warrants. The demand registration right requires the Company to file a
registration statement pertaining to the Underwriters' securities and to
maintain the effectiveness of such registration statement for the period
commencing July 2, 1997, and continuing until the earlier of the sale of all the
registered securities or July 1, 2001. The piggyback registration rights are
applicable during the five-year period commencing July 2, 1997. The Common Stock
underlying the Underwriters' Warrants has been included in this Prospectus and
comprises a portion of the Selling Security Holders' Securities. See "Selling
Security Holders."
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The Company has agreed, in connection with the exercise of Redeemable
Warrants pursuant to solicitation by the Underwriters (commencing July 2,
1997), to pay to the Underwriters a fee of five percent ($.22) for each
Redeemable Warrant exercised; provided, however, that the Underwriters will
not be entitled to receive such compensation for any Redeemable Warrant
exercise transactions in which (i) the market price of the Common Stock at
the time of exercise is lower than the exercise price of the Redeemable
Warrants; (ii) the Redeemable Warrants are held in any discretionary account;
(iii) disclosure of compensation arrangements is not made, in addition to the
disclosure provided in this Prospectus, in documents provided to holders of
the Redeemable Warrants at the time of exercise; (iv) the exercise of the
Redeemable Warrants is unsolicited; (v) after the Company has called the
Redeemable Warrants for redemption; or (vi) the solicitation of exercise of
the Redeemable Warrants was in violation of Rule 10b-6 promulgated under the
Exchange Act. In addition, unless granted an exemption by the SEC from Rule
10b-6, before the solicitation of the exercise of any Redeemable Warrant and
until the later of (i) the termination of such solicitation activity, or (ii)
the termination by waiver or otherwise of any right the Underwriters may have
to receive a fee for the exercise of the Redeemable Warrants following such
solicitations. The Company has agreed not to solicit the exercise of
Redeemable Warrants other than through the Underwriters.
Vincent J. Bitetti, Ulrich E. Gottschling and Eric H. Winston have
agreed not to directly or indirectly offer, offer to sell, sell, grant an
option to purchase or sell, transfer, assign, pledge, hypothecate or
otherwise encumber (either pursuant to Rule 144 or otherwise) any shares of
Common Stock owned by them during the 18-month period ending January 2, 1998,
without the prior written consent of the Company and Underwriters (provided,
that Eric H. Winston may sell up to 10,000 shares of Common Stock during such
18-month period without the consent of the Underwriters).
The Company has agreed with the Underwriters to undertake its best efforts
to maintain the effectiveness of the Registration Statement of which this
Prospectus is a part until the earlier of June 30, 2001, and the date on which
all Redeemable Warrants sold in the IPO have been exercised or redeemed and all
of the warrants, underlying Common Stock, and Common Stock issued in the 1995
Bridge Financing, the 1995 Private Placement and the Concurrent Private
Placement have been sold.
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DESCRIPTION OF SECURITIES
General
Under the Company's Restated Certificate of Incorporation, the authorized
capital stock of the Company consists of 20,000,000 shares of Common Stock. As
of February 28, 1997, the Company had 4,409,099 shares of Common Stock
outstanding which were held of record by approximately 150 persons, and had
11,078,097 Redeemable Warrants outstanding which were held of record by
approximately 20 persons (including for such purpose all 4,816,657 ASSI Warrants
held by ASSI, Inc.).
Common Stock
Holders of shares of Common Stock are entitled to one vote for each share
on all matters to be voted on by the stockholders. Holders of shares of Common
Stock are entitled to share ratably in dividends, if any, as may be declared
from time to time by the Board of Directors in its discretion, from funds
legally available therefor. In the event of a liquidation, dissolution or
winding up of the Company, the holders of shares of Common Stock are entitled to
share pro rata all assets remaining after payment in full of all liabilities.
Holders of Common Stock have no preemptive rights to purchase Common Stock.
There are no conversion rights or redemption or sinking fund provisions with
respect to the Common Stock. All of the outstanding shares of Common Stock
issuable upon exercise of the Warrants will be, when issued and delivered, fully
paid and non-assessable.
As a quasi-California corporation, the Company will be subject to certain
provisions of the California GCL, as more fully described under "Description of
Securities - Application of California GCL." Amongst other consequences of the
Company's status as a quasi-California corporation, at the request of any
stockholder, the election of the Company's directors will be determined by
cumulative voting procedures. Consequently, if cumulative voting is exercised
(and without regard to the various voting agreements described herein), the
Company's stockholders other than its current officers and directors have
sufficient votes to elect four of its six directors assuming no exercise of the
Redeemable Warrants, and to elect five of its six directors assuming exercise of
the Redeemable Warrants in full. See "Risk Factors - Control of the Company by
Officers and Directors" and "Management - Directors and Executive Officers."
Redeemable Warrants
The following is a brief summary of certain provisions of the Redeemable
Warrants, but such summary does not purport to be complete and is qualified in
all respects by reference to the actual text of the Warrant Agreement between
the Company and Corporate Stock Transfer Company as warrant agent (the "Warrant
Agreement"). A copy of the Warrant Agreement has been filed as an exhibit to the
Registration Statement of which this Prospectus is a part. See "Additional
Information."
Each Redeemable Warrant entitles the holder thereof to purchase, at any
time during the 54-month period commencing July 1, 1997, one share of Common
Stock at a price of $4.40 per share, subject to adjustment in accordance with
the anti-dilution and other provisions referred to below.
The Redeemable Warrants are subject to redemption by the Company, at any
time, commencing July 1, 1997, at a price of $.25 per Redeemable Warrant if the
average closing bid price of the Common
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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 notice of redemption. If the Redeemable Warrants were redeemed prior to their
exercise, the holders thereof would lose the benefit of the difference between
the market price of the underlying Common Stock as of such date and the exercise
price of such Warrants, as well as any possible future price appreciation in the
Common Stock.
The exercise price and the terms of the Redeemable Warrants bear no
relation to any objective criteria of value and should in no event be regarded
as an indication of any future market price of the Securities offered hereby.
The exercise price and the number of shares of Common Stock purchasable
upon the exercise of the Redeemable Warrants are subject to adjustment upon the
occurrence of certain events, including stock dividends, stock splits,
combinations or reclassification on or of the Common Stock and issuances of
shares of Common Stock for a consideration less than the exercise price of the
Redeemable Warrants. Additionally, an adjustment would be made in the case of a
reclassification or exchange of Common Stock, consolidation or merger of the
Company with or into another corporation or sale of all or substantially all of
the assets of the Company in order to enable holders of Redeemable Warrants to
acquire the kind and number of shares of stock or other securities or property
receivable in such event by a holder of the number of shares that might
otherwise have been purchased upon the exercise of the Redeemable Warrant. No
adjustments will be made unless such adjustment would require an increase or
decrease of at least $.10 or more in such exercise price. No adjustment to the
exercise price of the shares subject to the Redeemable Warrants will be made for
dividends (other than stock dividends), if any, paid on the Common Stock.
The Redeemable Warrants may be exercised upon surrender of the warrant
certificate on or prior to January 1, 2002 at the offices of the Warrant Agent,
with the exercise form on the reverse side of the certificate completed and
executed as indicated, accompanied by full payment of the exercise price (by
certified check payable to the Company) to the Warrant Agent for the number of
Redeemable Warrants being exercised. The holders of Redeemable Warrants do not
have the rights or privileges of holders of Common Stock.
No Redeemable Warrant will be exercisable unless at the time of exercise
the Company has filed a current prospectus with the SEC covering the shares of
Common Stock issuable upon exercise of such Redeemable Warrant and such shares
have been registered or qualified or deemed to be exempt under the securities
laws of the jurisdiction of residence of the holder of such Redeemable Warrant.
The Company will use its best efforts to have all such shares so registered or
qualified on or before the exercise date and to maintain a current prospectus
relating thereto until the expiration of the Redeemable Warrants, subject to the
terms of the Warrant Agreement. While it is the Company's intention to do so,
there is no assurance that it will be able to do so. See "Risk Factors - Current
Prospectus and State Registration to Exercise Warrants" and "Certain
Transactions - Agreements With the Underwriters."
Application of California GCL
Although incorporated in Delaware, the business of the Company has been
conducted through its operating subsidiary which is domiciled and headquartered
in the State of California. Section 2115 of the California GCL ("Section 2115")
provides that certain provisions of the California GCL shall be applicable to a
corporation organized under the laws of another state to the exclusion of the
law of the
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state in which it is incorporated, if the corporation meets certain tests
regarding the business done in California and the number of its California
stockholders.
An entity such as the Company can be subject to Section 2115 even though
it does not itself transact business in California if, on a consolidated
basis, the average of the property factor, payroll factor and sales factor is
more than 50 percent deemed to be in California during its latest full income
year and more than one-half of its outstanding voting securities are held of
record by persons having addresses in California. Section 2115 does not apply
to corporations with outstanding securities listed on the New York Stock
Exchange or American Stock Exchange, or with outstanding securities
designated as qualified for trading as a national market security on NASDAQ,
if such corporation has at least 800 beneficial holders of its equity
securities. Since the Company currently would be deemed to meet these factors
and does not currently qualify as a national market security on NASDAQ, it is
subject to Section 2115.
During the period that the Company is subject to Section 2115, the
provisions of the California GCL regarding the following matters are made
applicable to the exclusion of the law of the State of Delaware: (i) general
provisions and definitions; (ii) annual election of directors; (iii) removal of
directors without cause; (iv) removal of directors by court proceedings; (v)
filling of director vacancies where less than a majority in office were elected
by the stockholders; (vi) directors' standard of care; (vii) liability of
directors for unlawful distributions; (viii) indemnification of directors,
officers and others; (ix) limitations on corporate distributions of cash or
property; (x) liability of a stockholder who receives an unlawful distribution;
(xi) requirements for annual stockholders meetings; (xii) stockholders' right to
cumulate votes at any election of directors; (xiii) supermajority vote
requirements; (xiv) limitations on sales of assets; (xv) limitations on mergers;
(xvi) reorganizations; (xvii) dissenters' rights in connection with
reorganizations; (xviii) required records and papers; (xix) actions by the
California Attorney General; and (xx) rights of inspection.
Transfer Agent and Warrant Agent
The Transfer Agent and Registrar for the Common Stock and the Warrant Agent
for the Redeemable Warrants is Corporate Stock Transfer, Inc., 370 17th Street,
Suite 2350, Denver, Colorado 80202.
68
<PAGE>
SECURITIES ELIGIBLE FOR FUTURE SALE
As of February 28, 1997, a total of 4,409,099 shares of Common Stock and
11,078,097 Redeemable Warrants (including the 4,816,657 ASSI Warrants) were
issued and outstanding. An additional 12,433,272 shares of Common Stock were
issuable pursuant to the following outstanding options and warrants: (a) 342,337
shares of Common Stock underlying options granted pursuant to the Company's 1992
Stock Option Plan; (b) 500,000 shares of Common Stock underlying options which
have been or may be granted pursuant to the Company's 1995 Stock Option Plan;
(c) 282,838 shares of Common Stock underlying options granted to a Selling
Security Holder; and (d) an aggregate of 11,318,097 shares of Common Stock
issuable upon the exercise of (i) the Redeemable Warrants (11,078,097 shares)
and (ii) the Underwriters' Warrants (240,000 shares).
Of the 4,409,099 shares of Common Stock and 11,078,097 Redeemable Warrants
issued and outstanding as of February 28, 1997 (subject to the assumptions in
the preceding paragraph), 3,012,469 shares and 6,019,790 Redeemable Warrants are
freely tradeable without further registration under the Securities Act (except
for any such shares of Common Stock held by an "affiliate" of the Company), and
the remaining 1,396,630 outstanding shares and 5,058,307 Redeemable Warrants are
"restricted securities" as defined in Rule 144 under the Securities Act and may
not be sold without registration under the Securities Act unless pursuant to an
applicable exemption therefrom. Of such restricted securities, 407,500 shares of
Common Stock and all 5,058,307 Redeemable Warrants may be sold pursuant to this
Prospectus, and upon such sale will become freely tradeable (except for any such
shares or Redeemable Warrants held by an "affiliate" the Company). See "Selling
Security Holders." Further, the 11,318,097 shares of Common Stock issuable by
the Company upon exercise of the Redeemable Warrants and Underwriters' Warrants
and the 282,838 shares issuable by the Company upon exercise of an option held
by a Selling Security Holder may likewise be sold pursuant to this Prospectus
and upon such sale will become freely tradeable (except for any such shares held
by an "affiliate" of the Company).
In general, under Rule 144, a person (or persons whose shares are required
to be aggregated) who has satisfied a holding period of two years (one year
commencing April 29, 1997) may, under certain circumstances, commencing 90 days
after the date hereof, sell within any three-month period, in ordinary brokerage
transactions or in transactions directly with a market maker, a number of shares
of Common Stock equal to the aggregate of one percent of the then outstanding
Common Stock or the average weekly trading volume during the four calendar weeks
prior to such sale. Rule 144 also permits the sale of shares of Common Stock
without any quantity limitations by a person who is not an "affiliate" of the
Company and who has owned the shares for at least three years (two years
commencing April 29, 1997). The foregoing summary of Rule 144 is not intended to
be a complete description thereof.
Vincent J. Bitetti, Eric H. Winston and Ulrich E. Gottschling have
agreed not to directly or indirectly offer, offer to sell, grant an option
for the purchase or sale of, transfer, assign, pledge hypothecate or
otherwise encumber (either pursuant to Rule 144 or otherwise) any shares of
Common Stock owned by them during the 18-month period ending January 2, 1998,
without the prior written consent of the Underwriters (provided, that Eric H.
Winston may sell up to 10,000 shares of Common Stock during such period
without the consent of the Underwriters). See "Certain
Transactions-Agreements with the Underwriters." Thus, without the prior
consent of the Underwriters, prior to January 2, 1998, Vincent J. Bitetti may
not sell any of the 200,000 shares of Common Stock which he is offering
hereby, and Eric H. Winston may not sell more than 10,000 of the 392,838
shares of Common Stock which he is offering hereby. The Company intends to
make a public announcement in the event that a material amount of securities
subject to a lock-up arrangement described in this paragraph
69
<PAGE>
are released prior to the expiration of the term of such arrangement if such
announcement is required by the federal securities laws.
As of February 28, 1997, options for the purchase of 342,337 shares of
Common Stock were issued pursuant to the Company's 1992 Stock Option Plan.
The Company has determined not to issue any further options under its 1992
Stock Option Plan, but all outstanding options under such plan will remain
valid. Of the 342,337 options granted under the 1992 Stock Option Plan,
258,668 are presently exercisable, 41,834 will become exercisable later in
fiscal 1997 and the balance will become exercisable in fiscal 1998. The
Company also has reserved 500,000 shares of Common Stock for issuance to key
employees, officers, directors and consultants pursuant to the Company's 1995
Stock Option Plan. As of February 28, 1997, the Company had granted options
for the purchase of 404,607 shares of Common Stock pursuant to the 1995 Stock
Option Plan, of which 5,054 are presently exercisable, 3,401 will become
exercisable later in fiscal 1997, 148,652 will become exercisable in fiscal
1998, 147,000 will become exercisable in fiscal 1999, 100,250 will become
exercisable in fiscal 2000 and 250 will become exercisable in fiscal 2001.
The Company has filed separate registration statements pertaining to all of
the Common Stock issuable upon exercise of options granted or to be granted
pursuant to the 1992 Stock Option Plan and the 1995 Stock Option Plan. All
Common Stock issuable upon exercise of the options will be freely tradeable
(except for any such shares held by an "affiliate" of the Company). See
"Management - 1995 Stock Option Plan" and "- 1992 Stock Option Plan."
Certain of the Company's security holders are entitled to registration
rights as described under "Management - Employment Agreements" (as to Vincent J.
Bitetti and Eric H. Winston), "Certain Transactions - 1995 Bridge Financing" (as
to holders of Redeemable Warrants issued upon conversion of the Bridge Warrants
and the underlying Common Stock), "Certain Transactions - 1995 Private
Placement" (as to holders of Redeemable Warrants issued upon conversion of the
Private Warrants and the underlying Common Stock, and Common Stock issued in the
Concurrent Private Placement), "Certain Transactions - Agreements with ASSI,
Inc. (as to the ASSI Warrants and underlying Common Stock), and "Certain
Transactions - Agreements with the Underwriters" (as to the Underwriters'
Warrants and underlying Common Stock).
An additional 3,157,629 shares of Common Stock remain available for
issuance at the discretion of the Board of Directors. The potential issuance of
such authorized and unissued Common Stock may have the effect of delaying,
deferring or preventing a change in control of the Company, may discourage bids
for the Common Stock at a premium over the market price of the Common Stock and
may materially adversely affect the market price of, and the voting and other
rights of the holders of the Common Stock. Although the Company has no present
intention to issue any such shares of its authorized and unissued Common Stock,
there can be no assurance the Company will not do so in the future. See
"Description of Securities - Common Stock."
The Company is unable to predict the effect that any subsequent sales of
the Company's securities, under this Registration Statement, other registration
statements, Rule 144 or otherwise, may have on the then-prevailing market price
of the Common Stock, although such sales could have a depressive effect on such
market price. See "Risk Factors - Securities Eligible for Future Sale."
70
<PAGE>
PLAN OF DISTRIBUTION
The Common Stock issuable upon the exercise of the Redeemable Warrants and
the Underwriters' Warrants will be distributed when and as such warrants are
exercised by the holders thereof. No such warrants have been exercised as of the
date of this Prospectus.
The Selling Security Holders may effect transactions in their Selling
Security Holders' Securities by selling such Securities directly to purchasers,
through broker-dealers acting as agents for the Selling Security Holders or to
broker-dealers who may purchase the Selling Security Holders' Securities as
principals and thereafter sell such Securities from time to time in the
over-the-counter market, in negotiated transactions, or otherwise. Such
broker-dealers, if any, may receive compensation in the form of discounts,
concessions or commissions from the Selling Security Holders and/or the
purchasers for whom such broker-dealers may act as agents or to whom they may
sell as principals or both.
The sale of the Selling Security Holders' Securities may be effected from
time to time in transactions (which may include block transactions by or for the
account of the Selling Security Holders) in the over-the-counter market or in
negotiated transactions, through a combination of such methods of sale or
otherwise. Sales may be made at fixed prices which may be changed, at market
prices prevailing at the time of sale or at negotiated prices. If any Selling
Security Holder sells his, her or its Selling Security Holders' Securities,
pursuant to this Prospectus at a fixed price or at a negotiated price which is,
in either case, other than the prevailing market price or in a block transaction
to a purchaser who resells, or if any Selling Security Holder pays compensation
to a broker-dealer that is other than the usual and customary discounts,
concessions or commissions, or if there are any arrangements either individually
or in the aggregate that would constitute a distribution of the Selling Security
Holders' Securities, a post-effective amendment to the Registration Statement of
which this Prospectus is a part would need to be filed and declared effective by
the SEC before such Selling Security Holder could make such sale, pay such
compensation or make such a distribution. The Company is under no obligation to
file a post-effective amendment to the Registration Statement of which this
Prospectus is a part under such circumstances.
The Selling Security Holders and broker-dealers, if any, acting in
connection with such sales might be deemed to be "underwriters" within the
meaning of Section 2(11) of the Securities Act and any commission received by
them and any profit on the resale of such securities might be deemed to be
underwriting discounts and commissions under the Securities Act.
LEGAL MATTERS
The validity of the Securities offered hereby will be passed upon for the
Company by McDermott, Will & Emery, Washington, D.C.
EXPERTS
The financial statements included in this Prospectus have been audited by
Corbin & Wertz, Irvine, California, independent certified public accountants, to
the extent and for the periods set forth in their report appearing elsewhere
herein and are included in reliance upon such report.
71
<PAGE>
SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY
CONSOLIDATED FINANCIAL STATEMENTS
with
INDEPENDENT AUDITORS' REPORT THEREON
INDEX
<TABLE>
<CAPTION>
<S> <C>
Independent Auditor's Report......................................................... F-2
Consolidated Balance Sheets at June 30, 1996 and December 31, 1996 (unaudited)....... F-3
Consolidated Statements of Operations for each of the years in the two-year period
ended June 30, 1996 and for the six-month periods ended December 31, 1996
(unaudited) and 1995 (unaudited)................................................... F-4
Consolidated Statements of Stockholders' Equity (Deficit) for each of the years in
the two-year period ended June 30, 1996 and for the six-month period ended December
31, 1996 (unaudited)............................................................... F-6
Consolidated Statements of Cash Flows for each of the years in the two-year period
ended June 30, 1996 and for the six-month periods ended December 31, 1996
(unaudited) and 1995 (unaudited)................................................... F-8
Notes to Consolidated Financial Statements for each of the years in the two-year
period ended June 30, 1996 and for the six-month periods ended December 31, 1996
(unaudited) and 1995 (unaudited)................................................... F-11
</TABLE>
F-1
<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
audit.
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.
/s/ Corbin & Wertz
CORBIN & WERTZ
Irvine, California
September 16, 1996
F-2
<PAGE>
SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1996 1996
-------------- --------------
<S> <C> <C>
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents....................................................... $ 181,985 $ 1,687,433
Accounts receivable, net of allowance for doubtful accounts and sales returns of
$703,421 at June 30, 1996 and $847,871 at December 31, 1996 (unaudited)....... 912,904 1,356,187
Inventories, net of valuation allowance of $201,499 at June 30, 1996 and
$102,844 at December 31, 1996 (unaudited)..................................... 262,657 313,545
Prepaid royalties............................................................... 628,676 730,389
Deferred offering costs......................................................... 620,904 --
Prepaid expenses and other...................................................... 15,864 72,717
-------------- --------------
Total current assets........................................................ 2,622,990 4,160,271
Property and equipment, net of accumulated depreciation of $129,954 at June 30,
1996 and $174,407 at December 31, 1996 (unaudited).............................. 177,067 398,922
Other assets...................................................................... 12,900 --
-------------- --------------
$ 2,812,957 $ 4,559,193
-------------- --------------
-------------- --------------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Notes payable................................................................... $ 4,987,500 $ --
Accrued interest................................................................ 367,695 --
Accounts payable and accrued expenses........................................... 664,936 584,869
Accrued legal fees.............................................................. 347,710 68,001
Accrued compensation and related taxes, current portion......................... 74,901 227,992
Note payable to related party................................................... 500,000 --
Accrued royalties............................................................... 542,804 686,905
Short-term advance.............................................................. 400,000 --
Deferred revenue................................................................ 84,360 16,655
Current portion of capital lease obligations.................................... 27,058 20,468
-------------- --------------
Total current liabilities................................................... 7,996,964 1,604,890
Capital lease obligations, net of current portion................................. 13,811 7,119
Accrued compensation, net of current portion...................................... -- 117,483
-------------- --------------
Total liabilities........................................................... 8,010,775 1,729,492
-------------- --------------
Commitments and contingencies
Stockholders' equity (deficit): Common stock, $.001 par value; 20,000,000 shares
authorized; 1,807,824 and 4,377,824 shares issued and outstanding at June 30,
1996 and December 31, 1996, respectively........................................ 1,808 4,378
Warrants........................................................................ 263,350 1,104,925
Additional paid-in capital...................................................... 5,124,576 13,249,586
Accumulated deficit............................................................. (10,587,552) (11,529,188)
-------------- --------------
Total stockholders' equity (deficit)........................................ (5,197,818) 2,829,701
-------------- --------------
$ 2,812,957 $ 4,559,193
-------------- --------------
-------------- --------------
</TABLE>
F-3
<PAGE>
SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED JUNE 30, FOR THE SIX
MONTHS ENDED DECEMBER 31,
---------------------------- ----------------------------
1995 1996 1995 1996
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
(UNAUDITED) (UNAUDITED)
Revenues:
Product sales............................................. $ 1,255,230 $ 2,161,351 $ 1,077,547 $ 2,362,542
Development fees.......................................... 343,250 -- -- 12,000
Original equipment manufacturing.......................... 479,675 70,895 21,466 --
Royalties................................................. 76,771 32,387 21,678 55,704
------------- ------------- ------------- -------------
Net revenues.......................................... 2,154,926 2,264,633 1,120,691 2,430,246
Cost of sales............................................... 1,072,691 1,382,999 682,510 953,002
------------- ------------- ------------- -------------
Gross profit.......................................... 1,082,235 881,634 438,181 1,477,244
------------- ------------- ------------- -------------
Operating costs and expenses:
Marketing and sales....................................... 516,886 1,054,602 572,778 692,752
Compensation in connection with common stock and common
stock options issued for services rendered.............. 733,165 -- -- 178,607
Other general and administrative.......................... 1,009,858 1,530,434 826,528 1,014,854
Reserve for bad debts..................................... 40,000 663,421 382,310 --
Research and development.................................. 378,471 717,994 266,153 568,874
------------- ------------- ------------- -------------
Total operating costs and expenses.................... 2,678,380 3,966,451 2,047,769 2,455,087
------------- ------------- ------------- -------------
Operating loss........................................ (1,596,145) (3,084,817) (1,609,588) (977,843)
Interest income............................................. 16,994 35,430 22,172 54,871
Interest expense............................................ (7,045) (374,175) (118,176) (13,734)
Amortization of deferred loan costs......................... -- (1,035,200) (262,732) --
Other income (expense)...................................... (3,258) (14,614) (40,848) (4,130)
------------- ------------- ------------- -------------
Loss before provision for income taxes................ (1,589,454) (4,473,376) (2,009,172) (940,836)
Provision for income taxes.................................. 1,600 1,600 1,200 800
------------- ------------- ------------- -------------
Loss from continuing operations....................... (1,591,054) (4,474,976) (2,010,372) (941,636)
------------- ------------- ------------- -------------
See accompanying notes to consolidated financial statements
F-4
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
FOR THE YEARS ENDED JUNE 30, FOR THE SIX
MONTHS ENDED DECEMBER 31,
---------------------------- ----------------------------
1995 1996 1995 1996
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Discontinued operations:
Loss from operations of discontinued music division....... (111,106) -- -- --
Estimated operating loss and loss on disposal of
discontinued music division during phase-out period..... (32,000) -- -- --
------------- ------------- ------------- -------------
Loss from discontinued operations..................... (143,106) -- -- --
------------- ------------- ------------- -------------
Net loss.............................................. $ (1,734,160) $ (4,474,976) $ (2,010,372) $ (941,636)
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
Net loss per common share:
Loss from continuing operations........................... $ (0.85) $ (2.44) $ (1.08) $ (0.22)
Loss from discontinued operations......................... (0.08) -- -- --
------------- ------------- ------------- -------------
Net loss per common share............................. $ (0.93) $ (2.44) $ (1.08) $ (0.22)
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
Weighted average number of common shares
outstanding............................................... 1,862,908 1,837,759 1,868,145 4,318,096
</TABLE>
See accompanying notes to consolidated financial statements
F-5
<PAGE>
SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
For Each Of The Years In The Two-Year Period Ended June 30, 1996
And For The Six-Month Period Ended December 31, 1996 (Unaudited)
<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 valid consideration............... (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 for cash at $4.00 per
share and warrants for cash at $0.25 per
warrant, in connection with initial public
offering, net of offering costs of
$2,297,408..................................... 2,560,000 2,560 337,411 7,945,813 -- 8,285,784
Issuance of warrants in connection with the
conversion of a note payable and accrued
interest to related party...................... -- -- 504,164 -- -- 504,164
Issuance of common stock in connection with the
exercise of stock options for cash at $0.06 per
share.......................................... 10,000 10 -- 590 -- 600
Issuance of stock options for services........... -- -- -- 178,607 -- 178,607
Net loss......................................... -- -- -- -- (941,636) (941,636)
--------- --------- ----------- ----------- ------------ ----------
Balances, December 31, 1996 (unaudited).......... 4,377,824 $ 4,378 $1,104,925 $13,249,586 ($11,529,188) $2,829,701
--------- --------- ----------- ----------- ------------ ----------
--------- --------- ----------- ----------- ------------ ----------
</TABLE>
See accompanying notes to consolidated financial statements
F-6
<PAGE>
SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED JUNE FOR THE SIX
30, MONTHS ENDED DECEMBER 31,
--------------------------- ----------------------------
1995 1996 1995 1996
------------ ------------- ------------- -------------
<S> <C> <C> <C> <C>
(UNAUDITED) (UNAUDITED)
Cash flows from operating activities:
Net loss from continuing operations........................ $ (1,591,054) $ (4,474,976) $ (2,010,372) $ (941,636)
Adjustments to reconcile net loss to net cash used by
operating activities:
Depreciation and amortization............................ 27,541 45,230 19,437 44,453
Allowance for sales returns.............................. (8,732) (64,250) (39,250) 144,450
Allowance for credit losses.............................. 40,000 663,421 382,310 --
Allowance for inventories................................ -- 201,499 35,648 (98,655)
Common stock and stock options issued for services
rendered............................................... 733,165 -- -- 178,607
Changes in operating assets and liabilities:
Accounts receivable.................................... (30,214) (1,451,247) (687,511) (987,733)
Inventories............................................ (99,576) (313,836) (342,560) 47,767
Prepaid royalties...................................... 1,537 (147,264) (192,091) (101,713)
Prepaid expenses and other............................. -- (15,864) (94,882) (56,853)
Other assets........................................... -- -- (9,340) 12,900
Accounts payable and accrued expenses.................. (206,037) 210,241 210,384 (80,067)
Accrued legal fees..................................... 80,351 267,359 -- (279,709)
Accrued compensation and related taxes................. 92,394 (169,138) (190,353) 270,574
Accrued interest....................................... -- 367,695 118,176 (363,531)
Commissions payable.................................... 114,786 (159,593) (124,038) --
Accrued royalties...................................... (20,697) 291 (105,389) 144,101
Deferred revenue....................................... (8,795) 20,360 2,000 (67,705)
------------ ------------- ------------- -------------
Net cash used by continuing operations....................... (875,331) (5,020,072) (3,027,831) (2,134,750)
------------ ------------- ------------- -------------
Net loss from discontinued operations........................ (143,106) -- -- --
Reserve for estimated loss on disposal....................... 32,000 -- -- --
Depreciation................................................. 8,878 -- -- --
Changes in operating assets and liabilities of discontinued
operations:
Accounts receivable........................................ (2,471) -- -- --
Inventories................................................ 1,351 -- -- --
Accounts payable and accrued expenses...................... 3,098 -- -- --
Accrued royalties.......................................... 3,415 -- -- --
Commissions payable........................................ 12,498 -- -- --
------------ ------------- ------------- -------------
Net cash used by discontinued operations..................... (84,337) -- -- --
------------ ------------- ------------- -------------
Cash flows from investing activities of continuing
operations:
Purchases of property and equipment........................ (38,876) (90,985) (81,152) (266,308)
Other assets............................................... -- (9,840) -- --
------------ ------------- ------------- -------------
Net cash used in investing activities........................ (38,876) (100,825) (81,152) (266,308)
------------ ------------- ------------- -------------
Cash flows from investing activities of discontinued
operations --
Purchases of property and equipment (6,665) -- -- --
------------ ------------- ------------- -------------
</TABLE>
F-7
<PAGE>
SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS -- CONTINUED
<TABLE>
<CAPTION>
FOR THE YEARS ENDED JUNE FOR THE SIX
30, MONTHS ENDED DECEMBER 31,
--------------------------- ----------------------------
1995 1996 1995 1996
------------ ------------- ------------- -------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Cash flows from financing activities:
Proceeds from issuance of common stock..................... 684,107 -- -- 8,569,877
Proceeds from issuance of warrants......................... -- 263,350 263,350 337,411
Proceeds from issuance of notes payable.................... -- 5,306,700 4,987,500 --
Repayments of notes payable................................ -- (319,200) -- (4,987,500)
Notes payable to officers.................................. 13,500 (13,500) (13,500) --
Note payable to related party.............................. -- 500,000 -- --
Payments on note payable................................... (19,587) -- -- --
Deferred financing costs................................... -- -- (730,868) --
Deferred offering costs.................................... -- (620,904) (106,160) --
Payments on capital lease obligation....................... (13,678) (27,294) (12,562) (13,282)
Short-term advance......................................... 400,000 -- -- --
------------ ------------- ------------- -------------
Net cash provided by financing activities.................... 1,064,342 5,089,152 4,387,760 3,906,506
------------ ------------- ------------- -------------
Net change in cash........................................... 59,133 (31,745) 1,278,777 1,505,448
Cash, beginning of period.................................... 154,597 213,730 213,730 181,985
------------ ------------- ------------- -------------
Cash, end of period.......................................... $ 213,730 $ 181,985 $ 1,492,507 $ 1,687,433
------------ ------------- ------------- -------------
------------ ------------- ------------- -------------
Supplemental disclosure of cash flow information --
Cash paid during the period for:
Interest................................................... $ 9,742 $ 6,480 $ -- $ 377,265
------------ ------------- ------------- -------------
------------ ------------- ------------- -------------
Income taxes............................................... $ 1,600 $ 1,600 $ 1,600 $ 800
------------ ------------- ------------- -------------
------------ ------------- ------------- -------------
</TABLE>
See the accompanying notes to consolidated financial statements for supplemental
disclosure of noncash investing and financing activities.
F-8
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 1995 AND 1996 AND FOR THE
SIX MONTHS ENDED DECEMBER 31, 1995 (UNAUDITED) AND 1996 (UNAUDITED)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
Sound Source Interactive, Inc., (a California corporation) was incorporated
on March 8, 1990, under the name Sound Source Unlimited, Inc.
("SSI-California"). On May 16, 1994, SSI-California consummated a
stock-for-stock exchange with Basic Science Associates, Inc. ("BSA"), a
publicly-held Delaware corporation. As part of the exchange, BSA issued
1,474,232 shares of its common stock and 1,000,000 shares of its Series A
preferred stock (see Note 10) in exchange for all of the outstanding shares of
SSI-California. The exchange has been accounted as a reverse acquisition because
stockholders of SSI-California maintained control of the surviving entity, BSA.
Accordingly, for financial reporting purposes, the shares issued by BSA are
considered outstanding since the date of incorporation of SSI-California, and
the 99,992 shares of common stock retained by the stockholders of BSA are
reflected as consideration issued to consummate the stock-for-stock exchange. No
value was ascribed to the shares of common stock retained by the stockholders of
BSA since as of the date of the exchange, BSA had nominal assets and
stockholders' equity and was an inactive company. Concurrent with the
stock-for-stock exchange, BSA changed its name to Sound Source Interactive, Inc.
(a Delaware corporation) ("SSI-Delaware").
SSI-Delaware, through its wholly-owned subsidiary, SSI-California
(collectively called the "Company"), is in the business of developing,
publishing and distributing entertainment software, specializing in interactive
educational software, entertainment computer software utilities and sound clips
for customers primarily in North America.
CONSOLIDATED INTERIM FINANCIAL INFORMATION
The accompanying interim consolidated financial statements have been
prepared without audit, and certain information and footnote disclosures
normally included in consolidated financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted,
although the Company believes that the disclosures herein are adequate to make
information presented not misleading. In the opinion of management, the
accompanying interim consolidated financial statements contain all adjustments
of a normal and recurring nature necessary for a fair presentation of the
Company's consolidated financial position as of December 31, 1996, and the
results of their operations and their cash flows for each of the six-month
periods ended December 31, 1995 and 1996. The consolidated results of operations
for the six-month period is not necessarily indicative of results for the full
year.
HISTORICAL LOSSES AND DISTRIBUTOR RELATIONSHIPS
As shown in the accompanying consolidated financial statements, the Company
has incurred net losses of $1,734,160 and $4,474,976 for the years ended June
30, 1995 and 1996, respectively, and net losses of $2,010,372 (unaudited) and
$941,636 (unaudited) for the six months ended December 31, 1995 and 1996,
respectively. The Company has not historically generated sufficient cash flows
to fund operations due in part to its problems with its former distributor,
Acclaim Entertainment, Inc. ("Acclaim") (see Notes 8 and 14). The Company
entered into a new distributor agreement effective June 1, 1996 (see Note 14).
The Company has historically had to rely on debt and equity financings to fund
operations. The Company effected an initial public offering on July 1, 1996 and
raised proceeds to repay certain of its debt and to fund its working capital
requirements (see Notes 4, 5 and 9). The future success of the Company is
largely
F-9
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED JUNE 30, 1995 AND 1996 AND FOR THE
SIX MONTHS ENDED DECEMBER 31, 1995 (UNAUDITED) AND 1996 (UNAUDITED)
CONSOLIDATED INTERIM FINANCIAL INFORMATION (CONTINUED)
dependent upon its distributor relationship and the Company's ability to
generate revenues sufficient to fund operations.
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of
the SSI-Delaware and its wholly-owned subsidiary SSI-California. All significant
intercompany transactions and balances have been eliminated in consolidation.
DISCONTINUED OPERATIONS
In July 1995, the Company approved a formal plan to license the rights to
its music division (which developed and sold sound patches for electronic
keyboards and synthesizers) and sold the related inventory and property and
equipment to an unrelated third party (see Note 12). Accordingly, the Company
has classified such as discontinued operations in the accompanying consolidated
financial statements for both years presented.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the periods
reported. Actual results could materially differ from those estimates.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The consolidated financial statements contain financial instruments whereby
the fair value of the financial instruments could be different than those
recorded on a historical basis in the accompanying consolidated financial
statements. The Company's financial instruments consist of cash and cash
equivalents, accounts receivable, notes payable, accounts payable, note payable
to related party and short-term advance. The carrying amounts of the Company's
financial instruments approximated their fair values at June 30, 1996 and
December 31, 1996 (unaudited).
CONCENTRATIONS OF CREDIT RISK
The Company at times maintains cash balances at certain financial
institutions in excess of the federally insured deposits.
The Company performs periodic credit evaluations of its customers and
maintains allowances for potential credit losses and returns. The Company
estimates credit losses and returns based on management's evaluation of
historical experience and current industry trends. Although the Company expects
to collect amounts due, actual collections may differ from the estimated
amounts. The Company is subject to rapid changes in technology and shifts in
consumer demand which could result in product returns which differ from
estimates.
F-10
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED JUNE 30, 1995 AND 1996 AND FOR THE
SIX MONTHS ENDED DECEMBER 31, 1995 (UNAUDITED) AND 1996 (UNAUDITED)
CONSOLIDATED INTERIM FINANCIAL INFORMATION (CONTINUED)
As of June 30, 1996, reserves for credit losses totaled $703,421. Reserves
for sales returns were not deemed necessary by management of the Company. Such
reserves relate solely to Acclaim (see Notes 6 and 14). As of December 31, 1996,
reserves for credit losses and sales returns amounted to $703,421 (unaudited)
and $144,450 (unaudited), respectively.
One customer accounted for 18% of consolidated total revenues for the year
ended June 30, 1995. Acclaim accounted for 83% of consolidated total revenues
for the year ended June 30, 1996. The Company's accounts receivable at June 30,
1996 are primarily from Acclaim (see Notes 6 and 14).
Three customers accounted for 49% (unaudited), 12% (unaudited) and 11%
(unaudited), respectively, of consolidated revenues for the six months ended
December 31, 1996. One customer accounted for 73% (unaudited) of consolidated
revenues for the six months ended December 31, 1995. Accounts receivable from
three customers accounted for 52% (unaudited), 19% (unaudited) and 19%
(unaudited), respectively, of consolidated accounts receivable as of December
31, 1996.
No one company accounted for more than 10% of consolidated purchases for the
year ended June 30, 1995. The Company purchased certain products from two
companies, which accounted for 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.
The Company purchased certain products from one vendor which accounted for
10% (unaudited) of consolidated purchases for the six months ended December 31,
1996. Accounts payable to two companies accounted for 29% (unaudited) and 13%
(unaudited), respectively, of consolidated accounts payable as of December 31,
1996.
RISKS AND UNCERTAINTIES
TECHNOLOGICAL OBSOLESCENCE
The entertainment software industry is characterized by rapid technological
advancement and change. Should demand for the Company's products prove to be
significantly less than anticipated, the ultimate realizable value of such
products could be substantially less than the amount shown in the consolidated
balance sheet. Included in the accompanying consolidated balance sheets are
inventories at a carrying value of $262,657 and $313,545 (unaudited) as of June
30, 1996 and December 31, 1996, respectively, which represents management's
estimate of its net realizable value. Such value is based on forecasts for sales
of such inventories.
LICENSES
The Company's products are based upon the licensed content of major motion
pictures and television shows and/or development agreements with major
entertainment studios. All of such license and development agreements to which
the Company currently is a party are for fixed terms which will expire over the
next one to five years. Although no licensor is required to extend any license,
the Company anticipates that the licensor under each agreement will extend its
terms, provided that the Company is in compliance with all requirements of each
license, including most significantly that the Company has satisfied the
applicable minimum royalty guarantees. In the event that any licensor fails to
renew its license agreement, then the subject license will terminate and the
Company will no longer be entitled to sell the licensed product. The
F-11
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED JUNE 30, 1995 AND 1996 AND FOR THE
SIX MONTHS ENDED DECEMBER 31, 1995 (UNAUDITED) AND 1996 (UNAUDITED)
CONSOLIDATED INTERIM FINANCIAL INFORMATION (CONTINUED)
loss of one or more of the licenses could have a material adverse effect on the
Company's revenues and operating results. There can be no assurance that the
Company will satisfy its performance obligations under any license or
development agreement or, that even if such requirements are satisfied, all
material licenses will be renewed. Generally, the terms of a license agreement
state that, upon any bankruptcy or liquidation of the Company, licensing rights
revert to the license holder.
DISTRIBUTION
As discussed in Note 14, the Company entered into a distribution agreement
which is exclusive except for sales in the direct-to-the-customer programs, as
defined. The term of the agreement is for two years. The Company will be
substantially dependent upon such distributor for the marketing and selling of
its products throughout North America during the term of this agreement. The
distributor, however, will not be obligated to sell any specified minimum
quantity of the Company's products. There can be no assurance as to the volume
of product sales that may be achieved by the distributor. Because the Company's
rights to market and sell its products are limited, the Company's ability to
realize cash flow necessary to fund its ongoing operations and to achieve
profitability will be largely dependent upon the success of the distributor in
marketing and selling the Company's products.
SEASONALITY
Traditionally, the consumer software business has been seasonal. Typically,
net revenues are highest during the fourth calendar quarter and decline
sequentially in the first three calendar quarters. The seasonal pattern is due
primarily to the increased demand for consumer software during the holiday
season. The Company expects its net sales and operating results to reflect such
seasonality.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with a remaining
maturity of 90 days or less when purchased to be cash equivalents.
INVENTORIES
Inventories, which consist primarily of software media, manuals and related
packaging materials, are stated at the lower of cost or market (estimated net
realizable value) with cost determined on a first-in, first-out (FIFO) basis.
Such net realizable value is based on forecasts for sales of the Company's
products in the ensuing years. The industry in which the Company operates 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 the Company's inventories could be substantially
less than the amount shown on the accompanying consolidated balance sheets.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost less accumulated depreciation.
Property and equipment are depreciated using the straight-line method over the
estimated useful lives of the related assets, generally ranging from five to
seven years. Repairs and maintenance are charged to expense as incurred;
replacements and betterments are capitalized.
F-12
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED JUNE 30, 1995 AND 1996 AND FOR THE
SIX MONTHS ENDED DECEMBER 31, 1995 (UNAUDITED) AND 1996 (UNAUDITED)
CONSOLIDATED INTERIM FINANCIAL INFORMATION (CONTINUED)
Depreciation expense related to continuing operations totaled $27,541 and
$45,230 for the years ended June 30, 1995 and 1996, respectively, and $19,437
(unaudited) and $44,453 (unaudited) for the six months ended December 31, 1995
and 1996, respectively, and is included in other general and administrative
expense in the accompanying consolidated statements of operations.
DEFERRED OFFERING COSTS
Deferred offering costs represent costs associated with the Company's
Initial Public Offering ("IPO"). Deferred offering costs have been reflected as
a reduction of proceeds in connection with the completion of the IPO (see Note
9).
REVENUE RECOGNITION
Direct-to-the-customer sales are recognized at the time the products are
shipped, in accordance with the provisions of Statement of Position 91-1,
"Software Revenue Recognition". While the Company has no obligations to perform
future services subsequent to shipment, the Company provides telephone customer
support as an accommodation to purchasers of its products for a limited time.
Costs associated with this effort are expensed as incurred and charged to cost
of sales in the accompanying consolidated statements of operations.
Through June 30, 1996, the Company recognized revenue, net of
distribution fees, for product shipped to Acclaim on the date that Acclaim
purchased such product and shipped it to its customers. Acclaim was obligated
to pay the Company on the earlier of the month following the date of receipt
of payment by Acclaim or 120 days following the end of the month that the
product was shipped. The Company was responsible for product returns through
June 30, 1996, and records a reserve for returns based on management's
evaluation of historical experience and current industry trends, as discussed
above (see Notes 6, 14 and 15).
ROYALTIES
The Company enters into license agreements with movie studios, actors and
sound developers for recognizable movie and television properties which require
the Company to pay royalties to such movie studios, actors and sound developers.
The license agreements generally require the Company to pay a percentage of
sales of the products but no less than a specified amount (the minimum
guaranteed royalty). The Company records the minimum guaranteed royalty as a
liability and a related asset at the time the agreement is consummated. The
liability is extinguished as payments are made to the license holders and the
asset is amortized on a straight-line basis over the expected number of units to
be sold. Royalty liabilities are recognized upon the sale of the related
product. Royalty liabilities in excess of the minimum guaranteed amount are
recorded when such amounts are earned by the license holders. Royalties for the
years ended June 30, 1995 and 1996 and the six months ended December 31, 1995
and 1996, amounted to $325,981 and $535,065, respectively, and $190,977
(unaudited) and $436,344 (unaudited), respectively, and are included in cost of
sales on the accompanying consolidated statements of operations.
The Company assesses the recoverability of royalty assets by determining
whether the amortization of the minimum guarantee will be recovered through
anticipated sales on a per unit basis. Any amounts not expected to be recovered
are charged to operations in the period assessed by management. For the years
F-13
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED JUNE 30, 1995 AND 1996 AND FOR THE
SIX MONTHS ENDED DECEMBER 31, 1995 (UNAUDITED) AND 1996 (UNAUDITED)
CONSOLIDATED INTERIM FINANCIAL INFORMATION (CONTINUED)
ended June 30, 1995 and 1996, and the six months ended December 31, 1995 and
1996, management made such an assessment and charged $66,559 and $99,798, and
$80,000 (unaudited) and $61,123 (unaudited), respectively, to cost of sales on
the accompanying consolidated statements of operations.
SOFTWARE DEVELOPMENT COSTS
In accordance with Statement of Financial Accounting Standards No. 86,
"Accounting for the Cost of Capitalized Software to be Sold, Leased or Otherwise
Marketed," ("SFAS No. 86"), the Company examines its software development costs
after technological feasibility has been established to determine if
capitalization is required. Through December 31, 1996, all software development
costs have been expensed.
INCOME TAXES
The Company accounts for income taxes under Statement of Financial
Accounting Standards No. 109, "Accounting for Incomes Taxes" ("SFAS No. 109"),
which requires that deferred income taxes be recognized for the tax consequences
in future years of differences between the tax basis of assets and liabilities
and their financial reporting basis at rates based on enacted tax laws and
statutory tax rates applicable to the periods in which the differences are
expected to affect taxable income.
Valuation allowances are established when necessary to reduce deferred tax
assets to the amount expected to be realized. Current income tax expense
represents the tax payable for the period. The deferred income tax expense
(benefit) represents the change during the period in the balance of deferred
taxes (see Note 13).
STOCK OPTIONS AND WARRANTS
During 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 123 ("SFAS 123"), "Accounting for Stock-Based
Compensation," which defines a fair value based method of accounting for
stock-based compensation. However, SFAS 123 allows an entity to continue to
measure compensation cost related to stock and stock options issued to employees
using the intrinsic method of accounting prescribed by Accounting Principles
Board Opinion No. 25 ("APB 25"), "Accounting for Stock Issued to Employees."
Entities electing to remain with the accounting method of APB 25 must make pro
forma disclosures of net income and earnings per share, as if the fair value
method of accounting defined in SFAS 123 had been applied. The Company has
elected to account for its stock-based compensation to employees under APB 25.
STOCK SPLIT
In September, 1995, the Company effectuated a 1-for-5.976 reverse stock
split of issued and outstanding common shares and common shares reserved for
options in connection with the August 1995 private placement (see Note 4). The
accompanying consolidated financial statements have been adjusted to reflect the
reverse stock split for all periods presented.
F-14
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED JUNE 30, 1995 AND 1996 AND FOR THE
SIX MONTHS ENDED DECEMBER 31, 1995 (UNAUDITED) AND 1996 (UNAUDITED)
CONSOLIDATED INTERIM FINANCIAL INFORMATION (CONTINUED)
NET LOSS PER COMMON SHARE
Net loss per common share is computed by dividing net loss by the weighted
average number of shares of common stock and common stock equivalents
outstanding during the respective period. Common stock equivalents include
shares issuable upon the exercise of the Company's stock options. For the year
ended June 30, 1996 and the six months ended December 31, 1996, common stock
equivalents were excluded from the computation of loss per common share because
the effect of including such in the computation would have been anti-dilutive
(see Notes 4, 5, 9 and 11), except as discussed below.
Pursuant to Securities and Exchange Commission Staff Bulletin No. 83, common
shares issued for consideration below an assumed initial public offering price
($4.00 per share) and stock options granted (see Note 11) with exercise prices
below the IPO price during the twelve-month period preceding the date of the
filing of the Registration Statement have been included in the calculation of
common share equivalents, using the treasury stock method, as if they were
outstanding for all periods presented, including loss years where the impact is
anti-dilutive.
The only securities issued within twelve months of the Registration
Statement, which effect the computation of the weighted average common shares,
are vested options to purchase 100,000 shares granted at $3.40 per share (see
Note 11).
The computations of the weighted average common shares and equivalents
outstanding follows:
<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED JUNE 30, ENDED DECEMBER 31,
---------------------- ------------------------
1995 1996 1995 1996
---------- ---------- ----------- -----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Weighted average common shares outstanding during the
period..................................................... 1,847,908 1,822,759 1,853,145 4,303,096
---------- ---------- ----------- -----------
Incremental shares assumed to be outstanding related to stock
options granted............................................ 15,000 15,000 15,000 15,000
---------- ---------- ----------- -----------
Weighted average common shares and equivalents outstanding... 1,862,908 1,837,759 1,868,145 4,318,096
---------- ---------- ----------- -----------
---------- ---------- ----------- -----------
</TABLE>
RECLASSIFICATIONS
Certain reclassifications have been made to the 1995 amounts to conform with
the 1996 presentation.
F-15
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED JUNE 30, 1995 AND 1996 AND FOR THE
SIX MONTHS ENDED DECEMBER 31, 1995 (UNAUDITED) AND 1996 (UNAUDITED)
NOTE 2--INVENTORIES
INVENTORIES CONSISTED OF THE FOLLOWING:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1996 1996
---------- ------------
<S> <C> <C>
(UNAUDITED)
Finished goods..................................................... $ 159,151 $ 212,166
Raw materials (components)......................................... 103,506 101,379
---------- ------------
................................................................... $ 262,657 $ 313,545
---------- ------------
---------- ------------
</TABLE>
NOTE 3--PROPERTY AND EQUIPMENT
PROPERTY AND EQUIPMENT CONSISTED OF THE FOLLOWING:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1996 1996
---------- ------------
<S> <C> <C>
(UNAUDITED)
Studio computers and equipment..................................... $ 246,107 $ 508,973
Office furniture and equipment..................................... 60,914 64,356
---------- ------------
................................................................... 307,021 573,329
Less accumulated depreciation...................................... (129,954) (174,407)
---------- ------------
................................................................... $ 177,067 $ 398,922
---------- ------------
---------- ------------
</TABLE>
As of June 30, 1996 and December 31, 1996 (unaudited), the Company had a
total cost of $86,723 of assets under capital leases (see Note 8).
NOTE 4--NOTES PAYABLE
1995 BRIDGE FINANCING
During June through August 1995, the Company offered up to $700,000 of Units
(the "1995 Bridge Financing"), each consisting of $9,975 in principal amount of
the Company's 10% Secured Promissory Notes (the "Bridge Notes") and warrants to
purchase 586 shares of the Company's common stock (the "Bridge Warrants").
Pursuant to this offering, the Company sold 32 Units for net proceeds to the
Company of $278,400, net of costs of $41,600. A total of 18,747 Bridge Warrants
were issued in connection therewith. The dealer/manager received 20,918 Bridge
Warrants for $50 as partial consideration for services in connection with this
offering. Upon completion of the IPO, the Bridge Warrants were automatically
converted into Redeemable Warrants (see Note 9).
The principal and accrued interest on the Bridge Notes was due and payable
in full on August 15, 1995. The Company did not repay the Bridge Notes upon
their maturity. During the pendency of such default, the Bridge Note holders
were entitled to receive a penalty of two percent per month in addition to
F-16
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED JUNE 30, 1995 AND 1996 AND FOR THE
SIX MONTHS ENDED DECEMBER 31, 1995 (UNAUDITED) AND 1996 (UNAUDITED)
NOTE 4--NOTES PAYABLE (CONTINUED)
the interest otherwise payable on the Bridge Notes. These notes, plus accrued
interest, were repaid in full during September 1995 in connection with the 1995
Private Placement, discussed below.
1995 PRIVATE PLACEMENT
In August 1995, the Company engaged two dealer/managers to assist in a
private placement (the "1995 Private Placement") to sell a minimum of $1,000,000
of Units to a maximum of $5,000,000 of Units, each consisting of $95,000 in
principal amount of the Company's 10% Secured Promissory Notes (the "Private
Notes") due on the earlier of September 1, 1996 or the completion by the Company
of an IPO, and 100,000 warrants (the "Private Warrants") to purchase one share
of the Company's common stock. A total of 5,250,000 Private Warrants were issued
in connection therewith (see below). As of June 30, 1996, the Company had sold
52.5 units for net proceeds of $4,256,400, of which $262,500 represents the
Private Warrants, net of costs of $993,600. Included in accrued interest on the
accompanying consolidated balance sheet as of June 30, 1996 is accrued interest
of $364,188 related to this private placement. In connection with this offering,
the Company issued 400,000 Private Warrants as partial consideration for
services provided by a dealer/manager (see below).
The obligations of the Company under the Private Notes were secured by a
security interest in all the assets of the Company, including a pledge of all of
the issued and outstanding capital stock of its Subsidiary. A portion of the net
proceeds of this private placement were utilized to retire all of the
outstanding indebtedness of the 1995 Bridge Financing, discussed above. The
Private Notes, plus accrued interest totaling $373,573, were repaid in full
during July 1996 in connection with the Company's IPO (see Note 9).
Upon completion of the IPO, the Private Warrants were converted into
Redeemable Warrants (see Note 9).
NOTE 5--RELATED PARTY TRANSACTIONS
PRIOR NOTES PAYABLE
During the year ended June 30, 1995, the Company repaid a note due to a
stockholder amounting to $19,587. The Company also repaid a $22,000 note in 1995
due to an affiliate of a stockholder through issuance of shares. During the year
ended June 30, 1996, the Company repaid $13,500 of short-term non-interest
bearing advances to certain officers of the Company.
NOTE PAYABLE TO RELATED PARTY
On May 30, 1996, ASSI, Inc., a shareholder, loaned the Company $500,000 (the
"ASSI Convertible Loan"). The ASSI Convertible Loan bore interest at 8% per
annum, and principal and accrued interest was due on the earlier of September 1,
1996 or the completion of the Company's IPO. Upon the closing of the Company's
IPO, ASSI, Inc. had the option to convert all or part of the ASSI Convertible
Loan plus accrued interest into warrants to purchase common stock at a
conversion price of $.25 per warrant (the "ASSI Loan Warrants").
F-17
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED JUNE 30, 1995 AND 1996 AND FOR THE
SIX MONTHS ENDED DECEMBER 31, 1995 (UNAUDITED) AND 1996 (UNAUDITED)
NOTE 5--RELATED PARTY TRANSACTIONS (CONTINUED)
On July 7, 1996, in connection with the Company's IPO, ASSI, Inc. exercised
the conversion option to convert this note, plus accrued interest totalling
$4,164, into 2,016,657 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 9).
ASSI WARRANTS
On April 30, 1996, in consideration of certain financial and personnel
consulting services 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 9), except that they became exercisable October 1, 1996, they are not
mandatorily redeemable by the Company and they are subject to separate
registration rights, including one demand registration right and unlimited
piggyback registration rights for as long as they are held by ASSI, Inc. or
one of its affiliates. Upon a transfer of the ASSI Warrants or ASSI Loan
Warrants to any nonaffiliate of ASSI, Inc., the terms of such transferred
ASSI Warrants and ASSI Loan Warrants will become identical to those of the
Redeemable Warrants. The demand registration rights will expire on August 31,
2001. Until and unless exercised, the holders of the ASSI Warrants and ASSI
Loan Warrants will have no voting, dividend or other rights as shareholders
of the Company.
NOTE 6--SHORT-TERM ADVANCE
In June 1995, the Company entered into a five-year sales and distribution
agreement (the "Agreement") with a subsidiary of Acclaim, a distributor of
entertainment software. Under the terms of the Agreement, Acclaim was
responsible for the distribution of the Company's products on a world-wide basis
to retail accounts. The Company retained the rights to certain direct
distribution, such as direct mail and infomercials.
In conjunction with the signing of the Agreement, the Company received a
non-interest bearing advance from Acclaim in the amount of $400,000. The advance
was due in twelve monthly installments of $33,333 each, commencing no later than
90 days subsequent to first billing by the Company. The installments were to be
deducted from amounts due the Company from Acclaim related to product sales.
Effective April 1, 1996, such Agreement was terminated. In connection
therewith, the advance was deducted from the final amounts due the Company, as
reported by Acclaim (see Note 14).
NOTE 7--DEFERRED REVENUE
In August 1994, the Company entered into a contract to develop computer
software for Fox Interactive, a division of Fox, Inc. In exchange, the Company
received nonrefundable advances based upon the attainment of certain milestones.
The Company recognizes these advances into revenues based upon the percentage of
completion method. As of June 30, 1996, the Company had received $24,000 of
advances in excess of earnings and has therefore recorded such amount as
deferred revenue in the accompanying
F-18
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED JUNE 30, 1995 AND 1996 AND FOR THE
SIX MONTHS ENDED DECEMBER 31, 1995 (UNAUDITED) AND 1996 (UNAUDITED)
NOTE 7--DEFERRED REVENUE (CONTINUED)
consolidated balance sheet. As of December 31, 1996, the Company had $12,000
(unaudited) of such amounts as deferred revenue in the accompanying consolidated
balance sheet.
The Company has entered into various agreements with computer manufacturers
to sell and distribute certain of the Company's products. In exchange, the
Company receives royalties and advances against expected royalties. As of June
30, 1996, the Company received $48,360 of advances in excess of royalties
earned. As of December 31, 1996, such advances were earned in full (unaudited).
As of June 30, 1996, the Company received $12,000 of advance royalties in
connection with the licensing of the music division (see Note 12). Accordingly,
the Company has recorded such amounts as deferred revenues on the accompanying
June 30, 1996, consolidated balance sheet. As of December 31, 1996, the Company
has recorded $4,655 (unaudited) of such amounts as deferred revenues on the
accompanying consolidated balance sheet.
NOTE 8--COMMITMENTS AND CONTINGENCIES
EMPLOYMENT CONTRACTS
The Company has entered into employment contracts with five of its
employees, including three officers, which expire on various dates through
September 1998 and provide for certain expense allowances.
In April 1996, effective March 31, 1996, the Company modified the employment
contracts of two officers. Such modifications reduced the annual base
compensation by a specified amount. Upon the Company achieving specified sales
levels, the annual base compensation is increased by the amount of the specified
reduction. The Company also modified the employment contract of a third officer
in March 1996 to change the number and vesting period of options previously
granted and to grant additional options (see Note 11).
Future minimum base salaries, by year and in the aggregate, after giving
effect to the modification of two of the contracts, consist of the following as
of June 30, 1996:
<TABLE>
<CAPTION>
YEARS ENDING
JUNE 30,
- ----------------------------------------------------------------------------------
<S> <C>
1997.............................................................................. $ 508,625
1998.............................................................................. 332,083
1999.............................................................................. 62,500
----------
$ 903,208
----------
----------
</TABLE>
Certain of the employment contracts provided for commissions based on net
revenues. Commissions under employment contracts for the years ended June 30,
1995 and 1996, related to continuing operations amounted to $132,078 and
$66,067, respectively, and are included in marketing and sales costs in the
accompanying consolidated statements of operations. As of June 30, 1996, all
such amounts have been paid. Effective November 1995, commissions are no longer
paid under any of the employment contracts.
Effective November 1, 1996, the employment contract with an officer, as
modified, was terminated through mutual agreement. The agreement specifies
monthly payments beginning December 1996 through September 1998. As of December
31, 1996, the Company has recorded $278,649 (unaudited) under the
F-19
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED JUNE 30, 1995 AND 1996 AND FOR THE
SIX MONTHS ENDED DECEMBER 31, 1995 (UNAUDITED) AND 1996 (UNAUDITED)
NOTE 8--COMMITMENTS AND CONTINGENCIES (CONTINUED)
terms of this agreement. Such amounts are included in accrued compensation and
related taxes in the accompanying consolidated balance sheet.
OPERATING LEASES
The Company leases its facilities and certain equipment under noncancelable
operating leases which expire at various dates through February 1997.
The facility lease expense is being recognized on a straight-line basis over
the term of the related lease. The excess of the expense recognized over the
cost paid is included in accounts payable and accrued expenses in the
accompanying consolidated balance sheet.
Future minimum lease payments as of June 30, 1996, due through June 30, 1997
under such leases total $56,273.
Rent expense under operating lease agreements totaled $94,006 and $89,192
for the years ended June 30, 1995 and 1996, respectively, and totaled $48,514
(unaudited) and $47,828 (unaudited) for the six months ended December 31, 1995
and 1996, respectively, and is included in other general and administrative
expenses on the accompanying consolidated statements of operations.
Subsequent to December 31, 1996, the Company entered into an operating lease
agreement for office space (see Note 15).
CAPITAL LEASES
The Company leases certain equipment and computers under capital lease
obligations with interest rates ranging from 14.19% to 35.08% per annum.
Aggregate monthly principal and interest payments total $3,306 as of June 30,
1996.
Future minimum lease payments, by year and in the aggregate, under capital
leases for equipment and computers with initial or remaining terms of one year
or more, consist of the following as of June 30, 1996:
<TABLE>
<CAPTION>
YEARS ENDING
JUNE 30,
- ------------------------------------------------------------------------------------
<S> <C>
1997................................................................................ $ 31,438
1998................................................................................ 14,068
1999................................................................................ 4,196
---------
49,702
Less amount representing interest................................................... (8,833)
---------
Present value of net minimum lease payments......................................... 40,869
Less current portion................................................................ (27,058)
---------
$ 13,811
---------
---------
</TABLE>
During the six months ended December 31, 1995, the Company acquired $34,150
of property and equipment under capital leases. Interest expense under capital
lease obligations amounted to $7,045 and $10,500 for the years ended June 30,
1995 and 1996, respectively, and was insignificant for the six months ended
December 31, 1995 (unaudited) and 1996 (unaudited).
F-20
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED JUNE 30, 1995 AND 1996 AND FOR THE
SIX MONTHS ENDED DECEMBER 31, 1995 (UNAUDITED) AND 1996 (UNAUDITED)
NOTE 8--COMMITMENTS AND CONTINGENCIES (CONTINUED)
CONSULTING AGREEMENT
On October 16, 1995, the Company entered into a one year binding letter of
intent with a consultant whereby for consulting services the Company would pay a
minimum $39,000 per year plus royalties up to 3%, as defined, on products as
specified. Through June 30, 1996, the Company paid a total of $73,340 under this
agreement. During the year ended June 30, 1996, $39,581 is included in marketing
and sales expense and $33,759 is included in cost of sales on the accompanying
consolidated statements of operations.
Insignificant amounts were paid under the terms of this agreement for the
six months ended December 31, 1995 (unaudited). For the six months ended
December 31, 1996, the Company paid $27,000 (unaudited) under this agreement.
During the six months ended December 31, 1996, such agreement was terminated and
the consultant became an employee of the Company.
DEVELOPMENT CONTRACTS
Periodically, the Company enters into certain agreements with software
developers whereby for specified development services, the Company will pay a
fixed fee and/or a percentage of sales of the product developed. As of June 30,
1996, the Company was party to two such contracts. No amounts were paid under
such agreements during the year ended June 30, 1995. For the year ended June 30,
1996, the Company paid a total of $146,416 under such agreements. Of such
amounts, $113,125 is included in research and development and $33,291 is
included in cost of sales in the accompanying consolidated statements of
operations.
For the six months ended December 31, 1995 (unaudited), the Company paid an
insignificant amount to outside developers. For the six months ended December
31, 1996, the Company paid $179,492 (unaudited) under such agreements. Such
amounts are included in research and development in the accompanying
consolidated statement of operations.
LICENSE AGREEMENT
In December 1996 (unaudited), the Company entered into an agreement for
license fees, as defined, whereby the counterparty has the exclusive right to
create localized language versions of certain of the Company's products for
distribution in certain specified territories. The agreement is for three years
beginning January 1, 1997, subject to termination, as defined.
LITIGATION
In July 1995, a stockholder of the Company filed a complaint in the United
States District Court for the District of Washington, naming, among others, the
Company and its subsidiary, and Bentley, Richards Investments (the "Placement
Agent") claiming federal and state securities violations, breach of contract,
and negligent misrepresentation related to the 1994 Private Placement (see Note
9). The complaint sought rescission of all monies paid to the Company and
unspecified amounts of punitive damages, attorney's fees and costs, prejudgment
and postjudgment interest and cost of suit.
In September 1995, the stockholder entered into a settlement agreement
whereby the stockholder dismissed all defendants, including the Company and its
subsidiary, upon delivery of certain shares of the
F-21
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED JUNE 30, 1995 AND 1996 AND FOR THE
SIX MONTHS ENDED DECEMBER 31, 1995 (UNAUDITED) AND 1996 (UNAUDITED)
NOTE 8--COMMITMENTS AND CONTINGENCIES (CONTINUED)
Company's common stock owned by the Placement Agent and its affiliates. A
portion of these shares have been distributed to the 1994 Private Placement
holders and the balance has been canceled (see Note 9). Pursuant to the
settlement, the Placement Agent's options also were canceled. The Company was
not required to pay any consideration as a part of the settlement. The Company
has been dismissed with prejudice from the complaint.
NOTE 9--COMMON STOCK
During the fiscal year 1994, the Company engaged an agent (the "Placement
Agent") to sell a private placement of up to 125,502 shares of its common stock
at $13.00 per share (the "1994 Private Placement"). Through June 30, 1994, the
Company issued 55,639 shares of its common stock for $665,000 in cash, net of
offering costs of $58,312.
During the fiscal year 1995, the Company issued an additional 59,238 shares
of its common stock in exchange for $706,107 in cash, net of costs of $61,759.
In accordance with the terms of the 1994 Private Placement, the Company
agreed to compensate the Placement Agent with up to 81,997 shares of its common
stock and an option to purchase up to 60,241 shares of its common stock at a
price equal to the closing bid price of the common stock on the first day of
trading following the stock-for-stock exchange (see Note 1). For the years ended
June 30, 1994 and 1995, the Placement Agent earned 39,770 and 42,227 shares
valued at $475,315 and $504,686, respectively.
During September 1995, the Placement Agent notified the Company that all
shares held by the Placement Agent or its affiliates, or held in escrow for the
benefit of the Placement Agent or its affiliates, representing and aggregate of
108,769 shares of the Company's common stock, will be distributed to the holders
of the 1994 Private Placement shares. In addition, 15,120 shares were returned
to the Company for retirement (see Note 8).
CANCELLATION OF SHARES
In fiscal 1996, it was determined by the Company that 36,238 shares of
common stock were improperly issued in 1992 due to the fact no consideration was
received. Accordingly, such common shares were canceled effective June 30, 1996.
STOCKHOLDER PRIVATE PLACEMENT
Concurrent with the 1995 Private Placement (see Note 4), the Company's major
stockholder conducted a private placement of up to 200,000 shares of common
stock, held by such stockholder, at a purchase price of $5.00 per share. Through
June 30, 1996, the stockholder had sold 107,500 shares of common stock. On July
1, 1996 in connection with the Company's IPO, such shares of common stock
purchased in this private placement were registered with the Securities and
Exchange Commission (see below).
INITIAL PUBLIC OFFERING ("IPO")
On July 1, 1996, the Company issued 2,400,000 shares of common stock at
$4.00 per share and 1,200,000 redeemable warrants (the "Redeemable Warrants") at
$.25 per warrant. Net proceeds totaled
F-22
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED JUNE 30, 1995 AND 1996 AND FOR THE
SIX MONTHS ENDED DECEMBER 31, 1995 (UNAUDITED) AND 1996 (UNAUDITED)
NOTE 9--COMMON STOCK (CONTINUED)
$7,691,623, net of offering costs of $2,208,625 (unaudited). 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.
Through June 30, 1996, in connection with the IPO, the Company has incurred
offering costs totalling $620,904. Such costs have been capitalized on the
accompanying consolidated balance sheet as of June 30, 1996 and have been offset
against the aforementioned proceeds as of December 31, 1996 in fiscal 1997.
Each Redeemable Warrant entitles the holder to purchase one share of Common
Stock at $4.40 per share, subject to adjustment as defined, expiring December
31, 2001. In the event that the Redeemable Warrants are called for redemption,
they will be exercisable for 30 days preceding the applicable redemption date.
Commencing one year after July 1, 1996, the Redeemable Warrants will be subject
to redemption at $.25 per Redeemable Warrant if the average closing bid price of
the common stock equals or exceeds $5.60 per share for any 20 trading days
within a period of 30 consecutive trading days ending on the fifth trading day
prior to the date of the notice of redemption.
In connection with the registration of the shares of common stock and
Redeemable Warrants discussed above, the Company registered 107,500 shares of
common stock registered for the account of certain selling stockholders.
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.
NOTE 10--SERIES A PREFERRED STOCK
In connection with the Company's reverse acquisition of BSA (see Note 1) on
May 16, 1994, the Company issued to its major stockholder 1,000,000 shares of
Series A preferred stock, par value of $.001. The Series A preferred stockholder
was entitled to vote as a single class with the holders of the Company's common
stock on all matters coming before the Company's stockholders for a vote. The
holder of the Series A preferred stock was entitled to ten votes per share
whereas the holders of common stock are entitled to only one vote per share. The
holder was entitled to a liquidation preference of $.001 per share, provided the
holder would not share any liquidating distribution except to the extent of such
preference. The Company did not ascribe any value to the preferred shares.
Prior to June 30, 1994, the 1,000,000 shares of Series A preferred stock
were converted into 83,669 shares of the Company's common stock with an ascribed
value of $645,000.
In fiscal 1996, the Company amended its articles of incorporation and
deleted the authorization to issue Series A preferred stock.
NOTE 11--STOCK OPTIONS
The 1992 Stock Option PlanThe 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.
F-23
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED JUNE 30, 1995 AND 1996 AND FOR THE
SIX MONTHS ENDED DECEMBER 31, 1995 (UNAUDITED) AND 1996 (UNAUDITED)
NOTE 11--STOCK OPTIONS (CONTINUED)
Any shares which are subject to an award but are not used because the terms
and conditions of the award are not met, or any shares which are used by
participants to pay all or part of the purchase price of any option may again be
used for awards under the Plan. However, shares with respect to which a stock
appreciation right (see below) has been exercised may not again be made subject
to an award.
At the discretion of a committee comprised of directors, officers and key
employees of the Company and its subsidiaries or employees of companies with
which the Company does business may become participants in the Plan upon
receiving grants in the form of stock options or restricted stock.
Stock options may be granted as non-qualified stock options or incentive
stock options, upon stockholder approval as defined, but incentive stock options
may not be granted at a price less than 100% of the fair market value of the
stock as of the date of grant (110% as to any 10% stockholder at the time of
grant); non-qualified stock options may not be granted at a price not less than
85% of fair market value of the stock as of the date of grant. Restricted stock
may not be granted under the Plan in connection with incentive stock options.
Stock options granted under the 1992 Plan may include the right to acquire
an Accelerated Ownership Non-Qualified Stock Option ("AO"). All options granted
to date have included the AO feature. If an option grant contains the AO feature
and if a participant pays all or part of the purchase price of the option with
shares of the Company's common stock, then upon exercise of the option the
participant is granted an AO to purchase, at the fair market value as of the
date of the AO grant, the number of shares of common stock of the Company equal
to the sum of the number of whole shares used by the participant in payment of
the purchase price and the number of whole shares, if any, withheld by the
Company as payment for withholding taxes. An AO may be exercised between the
date of grant and the date of expiration, which will be the same as the date of
expiration of the option to which the AO is related.
Stock appreciation rights and/or restricted stock may be granted in
conjunction with, or may be unrelated to stock options. A stock appreciation
right entitles a participant to receive a payment, in cash or common stock or a
combination thereof, in an amount equal to the excess of fair market value of
the stock at the time of exercise over the fair market value of the date of
grant. Stock appreciation rights may be exercised during a period of time fixed
by the Committee.
Restricted stock requires the recipient to continue in service as an
officer, director, employee or consultant for a fixed period of time for
ownership of the shares to vest. If restricted shares or stock appreciation
rights are issued in tandem with options, the restricted stock or stock
appreciation right is canceled upon exercise of the option and the option will
likewise terminate upon vesting of the restricted shares.
On April 6, 1994, the Company issued a non-qualified stock option outside of
the Plan to a prior officer of the Company (see Note 8) to purchase an aggregate
of 251,004 shares of the Company's common stock for $.06 per share and
subsequently in fiscal 1994 an option was granted to the prior officer to
purchase 41,834 shares of the Company's common stock for $.06 per share. All
stock options issued to the prior officer were immediately vested and are
exercisable for a period of up to four years after termination of employment
from the Company. During the year ended June 30, 1995 and during the six months
ended December 31, 1996 (unaudited), a portion of the difference between the
fair market value of the common stock underlying the options at the date of
grant and the exercise price was included in operating costs and
F-24
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED JUNE 30, 1995 AND 1996 AND FOR THE
SIX MONTHS ENDED DECEMBER 31, 1995 (UNAUDITED) AND 1996 (UNAUDITED)
NOTE 11--STOCK OPTIONS (CONTINUED)
expenses in the accompanying consolidated statement of operations. During the
six months ended December 31, 1996 (unaudited), the prior officer exercised
10,000 of such options.
On April 6, 1994, the Company issued options to purchase 199,130 shares of
the Company's common stock at $.06 per share to employees of the Company and to
certain consultants. During the year ended June 30, 1995 and during the six
months ended December 31, 1996 (unaudited), a portion of the difference between
the fair market value of the common stock underlying the options at the date of
grant and the exercise price was included in operating costs and expenses in the
accompanying consolidated statement of operations. These options had an original
vesting period of four years. In September 1995, the Company modified the
vesting period to 50% vested on the first year anniversary from the date of
grant, 25% on the third year anniversary and 25% on the fourth year anniversary
from the date of grant.
For the year ended June 30, 1995 and for the six months ended December 31,
1996, an aggregate of $733,165 and $178,607 (unaudited), respectively, was
charged to operating costs and expenses for the options vested during the year,
as discussed in the preceding two paragraphs. No amounts were charged to
operating costs for the year ended June 30, 1996 or the six months ended
December 31, 1995.
On September 5, 1995, in connection with the resignation of an officer of
the Company, 12,550 options were canceled in accordance with the 1992 Plan and
the officer's employment contract. In connection with the resignation of such
officer, 4,184 options were exercised effective June 30, 1995.
On October 9, 1995, the Company granted 100,000 options to an
employee/officer with an exercise price of $5.00, the fair market value of the
common stock as determined by the Company. The options vested immediately and
expire 10 years from the date of grant. On March 31, 1996, the employee/officer
agreed to the termination of his existing 100,000 share option in consideration
for the Company's agreement to grant to him a new 200,000 share option pursuant
to the 1992 Plan. Such option will be vested and exercisable upon the date of
its grant as to 100,000 shares at a purchase price of $3.40 per share, and will
become vested and exercisable as to 100,000 shares ratably between June 30, 1996
and September 30, 1997 at a purchase price of $4.00 per share. The
employee/officer's employment agreement further provides that following the
voluntary or involuntary termination of his employment by the Company, the
employee/officer is entitled to a single demand registration right with respect
to the common stock held by or issuable to him pursuant to his option agreement.
On September 22, 1995, the Board of Directors resolved that no additional
shares shall be issued under the 1992 Plan, with the exception of the options
discussed in the preceding paragraph.
THE 1995 STOCK OPTION PLAN
On October 9, 1995, the Company adopted the 1995 stock option plan (the
"1995 Plan") effective November 1, 1995. On May 15, 1996, the Company adopted
the Company's restated 1995 stock option plan whereby the Company can grant up
to 500,000 options for shares of the Company's common stock.
Options under the 1995 Plan may be granted in the form of incentive stock
options as provided in section 422 of the Internal Revenue Code, as amended, or
in the form of non-qualified stock options (the "Options"). The 1995 Plan
terminates October 31, 2005 and shall be administered by a committee appointed
by the Board of Directors of the Company.
F-25
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED JUNE 30, 1995 AND 1996 AND FOR THE
SIX MONTHS ENDED DECEMBER 31, 1995 (UNAUDITED) AND 1996 (UNAUDITED)
NOTE 11--STOCK OPTIONS (CONTINUED)
Incentive stock options shall be limited to persons who are employees of the
Company and may not be granted at a price less than 100% of the fair value of
the stock as of the date of grant (110% as to any 10% stockholder at the time of
grant).
The term of each Option shall not be more than 10 years from the date of
grant (5 years for any 10% stockholder). Vesting of the Options is determinable
by the Committee on a case-by-case basis and the Options are not exercisable
unless the holder is currently employed with the Company. Upon termination of an
employee, the holder has 30 days to exercise any Options held.
On July 2, 1996, the Company agreed to grant 13,610 options under the 1995
stock option plan to non-executive employees at an exercise price of $4.00 per
share. The options vested 50% upon the date of grant and will vest 25% on June
30, 1997 and 1998, respectively. The options expire 10 years from date of grant.
Subsequent to December 31, 1996, certain options issued to employees under
the 1992 Plan were exercised (see Note 15).
The following table summarizes option transactions during the years ended
June 30, 1995 and 1996 and for the six months ended December 31, 1996
(unaudited) under both of the aforementioned plans:
<TABLE>
<CAPTION>
NUMBER PRICE
OF SHARES PER SHARE
---------- -------------
<S> <C> <C>
Balances at July 1, 1994........................................... 491,968 $0.06
Granted............................................................ -- --
Exercised.......................................................... (4,184) $0.06
Canceled........................................................... (12,550) $0.06
---------- -------------
Balances at June 30, 1995.......................................... 475,234 $0.06
Granted............................................................ 300,000 $3.40-$5.00
Exercised.......................................................... -- --
Canceled........................................................... (100,000) $5.00
---------- -------------
Balances at June 30, 1996.......................................... 675,234 $0.06-$4.00
Granted............................................................ 13,610 $4.00
Exercised.......................................................... (10,000) $0.06
Canceled........................................................... (836) $0.06
---------- -------------
Balances at December 31, 1996 (unaudited).......................... 678,008 $0.06-$4.00
---------- -------------
---------- -------------
Vested as of December 31, 1996 (unaudited)......................... 551,418
---------- -------------
---------- -------------
</TABLE>
SFAS 123 PRO FORMA INFORMATION
Pro forma information regarding net income is required by SFAS 123, and has
been determined as if the Company had accounted for its employee stock options
under the fair value method pursuant to SFAS 123, rather than the method
pursuant to APB #25 discussed herein. The fair value for these options was
estimated at the date of grant using a Black-Scholes option pricing model with
the following assumptions: risk-free interest rates of 6.3%; dividend yields of
0.0%; volatility factors of the expected market price of the Company's common
stock of 100%; and expected terms of two to five years.
F-26
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED JUNE 30, 1995 AND 1996 AND FOR THE
SIX MONTHS ENDED DECEMBER 31, 1995 (UNAUDITED) AND 1996 (UNAUDITED)
NOTE 11--STOCK OPTIONS (CONTINUED)
The Black-Scholes valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
For purposes of pro forma disclosure, the estimated fair value of the
options is amortized to expense over the options' vesting period. The Company's
pro forma information is as follows:
<TABLE>
<CAPTION>
FOR THE SIX
YEAR ENDED MONTHS ENDED
JUNE 30, DECEMBER 31,
1996 1996
------------- -------------
<S> <C> <C>
(UNAUDITED)
Pro forma net loss:
Net loss, as reported.......................................... $ (4,474,976) $ (941,636)
Compensation expense under SFAS 123............................ (226,659) (88,513)
------------- -------------
Pro forma net loss............................................. $ (4,701,635) $(1,030,149)
------------- -------------
------------- -------------
Pro forma net loss per share................................... $ (2.56) $ (0.24)
------------- -------------
------------- -------------
</TABLE>
NOTE 12--DISCONTINUED OPERATIONS
In July 1995, the Company approved a formal plan to license certain
proprietary assets to Greytsounds Sound Development ("GSD") in exchange for
royalties, as defined. Effective November 1, 1995 (commencement of a license
agreement with GSD), $15,000 was paid to the Company representing advance
royalties. As of June 30, 1996 and December 31, 1996, $12,000 and $4,655
(unaudited), respectively, of such advance royalties are included in deferred
revenue on the accompanying consolidated balance sheet. GSD also is to guarantee
$50,000 of royalties over the license term of two years. The license agreement
is exclusive and worldwide. The proprietary assets licensed to GSD include the
Company's musical instrument sound library, all music related inventory and all
music related fixed assets owned and leased by the Company.
As of June 30, 1996 no assets or liabilities of the music division are
included in the accompanying consolidated balance sheet.
The following summarizes the results of operations for the discontinued
operations for the year ended June 30, 1995:
<TABLE>
<S> <C>
Revenues......................................................... $ 220,937
Costs and expenses............................................... (332,043)
---------
Loss from operations............................................. $(111,106)
---------
---------
</TABLE>
F-27
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED JUNE 30, 1995 AND 1996 AND FOR THE
SIX MONTHS ENDED DECEMBER 31, 1995 (UNAUDITED) AND 1996 (UNAUDITED)
NOTE 13--INCOME TAXES
The provision for income taxes from continuing operations for the years
ended June 30, 1995 and 1996 is comprised of minimum state taxes only.
A reconciliation of the provision for income taxes from continuing
operations with expected income tax benefit computed by applying the federal
statutory income tax rate to loss before provision for income taxes for the
years ended June 30, 1995 and 1996 is as follows:
<TABLE>
<CAPTION>
1995 1996
------------------------ -------------------------
<S> <C> <C> <C> <C>
Income tax benefit computed at Federal statutory tax rate.......... $ (513,486) (34.0%) $ (1,520,948) (34.0%)
State and local taxes.............................................. 1,600 -- 1,600 --
Expenses not deductible for income tax purposes.................... 252,173 15.9 3,774 --
Change in the beginning-of-the-period balance of the valuation
allowance for deferred tax assets allocated to income tax
benefit.......................................................... 261,313 18.1 1,517,174 34.0
------------- --------- ------------- ---------
$ 1,600 --% $ 1,600 --%
------------- --------- ------------- ---------
------------- --------- ------------- ---------
</TABLE>
The components of the net deferred tax asset recorded in the accompanying
balance sheet as of June 30, 1996 is as follows:
<TABLE>
<S> <C>
Reserves, principally due to allowances for sales returns and
obsolete inventory............................................. $ 363,213
Accrued liabilities, principally due to accrual for financial
reporting purposes............................................. 1,811,583
Net operating loss carryforwards................................. 2,129,913
Less valuation allowance......................................... (4,304,709)
-----------
................................................................. $ --
-----------
-----------
</TABLE>
The valuation allowance increased $1,456,540 during the year ended June 30,
1996.
At June 30, 1996, the Company had federal and state net operating loss
carryforwards of approximately $5,742,000 and $2,864,000, respectively,
available to offset future taxable federal and state income. The federal and
state carryforwards amounts expire in varying amounts through 2012 and 2001,
respectively.
Due to the change in ownership provisions of the Tax Reform Act of 1986, net
operating loss carryforwards for federal income tax reporting purposes are
subject to annual limitations. Should a change of ownership occur, net operating
loss carryforwards may be limited as to use in future years.
NOTE 14--DISTRIBUTION AGREEMENTS
ACCLAIM TERMINATION AGREEMENT
Effective April 1, 1996, the Company and Acclaim entered into an agreement
to terminate the distribution agreement (the "Termination Agreement"). On or
before June 30, 1996, Acclaim was to render a final accounting to the Company
together with payment of the balances of any amounts due to
F-28
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED JUNE 30, 1995 AND 1996 AND FOR THE
SIX MONTHS ENDED DECEMBER 31, 1995 (UNAUDITED) AND 1996 (UNAUDITED)
NOTE 14--DISTRIBUTION AGREEMENTS (CONTINUED)
the Company under the distribution agreement. The final accounting was not
received by June 30, 1996. Pursuant to the terms of the Termination Agreement,
Acclaim was obligated to notify its accounts that it will not accept returns of
any of the Company's software products after June 30, 1996.
In July 1996, Acclaim submitted certain information to the Company together
with payment of $256,067, and a promissory note with a principal amount of
$256,067, maturing August 26, 1996 and bearing interest at 10% per annum. Such
represented the balances of all amounts due to the Company under the
distribution agreement, as determined by Acclaim. Included in the information
provided by Acclaim it was noted that the Company is not obligated to repay the
short-term advance totaling $400,000 (see Note 6).
On August 28, 1996, the Company received $256,067 plus accrued interest of
$2,175 pursuant to the terms of the promissory note discussed above.
As of June 30, 1996, the Company recorded an additional $703,421 in accounts
receivable from Acclaim, which has been fully reserved for (see Note 1), due to
disputes and discrepancies in the information as reported by Acclaim.
SIMON & SCHUSTER DISTRIBUTION AGREEMENT
On June 1, 1996, the Company entered into a two year distribution services
agreement with Simon & Schuster Interactive Distribution Services ("SSIDS"),
which became effective July 1, 1996. SSIDS is the consumer software distribution
unit of Simon & Schuster, Inc., the publishing operations of Viacom, Inc.
Pursuant to this new distribution agreement, SSIDS will provide distribution,
warehousing and order fulfillment services for all of the Company's products
(subject to certain exceptions) throughout the United States and Canada. The
Company's relationship with SSIDS will be exclusive except as regards the rights
to distribute the Company's products in direct-to-the-customer programs
including direct mail, telemarketing and in-box coupon fulfillment, which will
be nonexclusive.
The Company will recognize revenue, net of distribution fees, for product
shipped to SSIDS on the date that SSIDS purchases such product and ships it
to SSIDS's customers. Pursuant to the agreement, SSIDS will make a monthly
payment to the Company in the amount equal to its gross revenues, as defined,
during such month from the Company's products, less a distribution fee and
reserve for returns equal to stated percentages of the gross revenues and
less certain other items, including out-of-pocket costs associated with
inventory maintenance and order fulfillment. The payments will be due not
later than 75 days after the calendar month in question. Under the agreement
with SSIDS, SSIDS will be responsible for collection of accounts receivable
and the Company will remain liable for product returns. The Company intends
to maintain a reserve of 15 percent of gross revenues for product returns.
NOTE 15--SUBSEQUENT EVENTS (UNAUDITED)
LEASES
Effective April 1, 1997, the Company entered into a five-year operating
lease for office space. Rent under this agreement totals $12,058 per month,
adjusted annually, as defined.
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<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED JUNE 30, 1995 AND 1996 AND FOR THE
SIX MONTHS ENDED DECEMBER 31, 1995 (UNAUDITED) AND 1996 (UNAUDITED)
NOTE 15--SUBSEQUENT EVENTS (UNAUDITED) (CONTINUED)
OPTIONS
In January and February 1997, certain employees exercised stock options to
purchase 31,275 shares of common stock for cash at $0.06 per share under the
terms of the 1992 Plan (see Note 11).
F-30
<PAGE>
No dealer, salesperson or any other person has been authorized to give any
information or to make representations other than those contained in this
Prospectus and, if given or made, such information or representations must not
be relied upon as having been authorized by the Company. This Prospectus does
not constitute an offer to sell or a solicitation of an offer to buy any
security other than the securities offered by the Prospectus. This Prospectus
does not constitute an offer to sell or a solicitation of an offer to buy any
security by any person in any jurisdiction in which such offer or solicitation
is not authorized or in which the person making such offer or solicitation is
not qualified to do so or to anyone to whom it is unlawful to make such offer or
solicitation. Neither the delivery of this Prospectus nor any sale made
hereunder shall, under any circumstances, create any implication that the
information in this Prospectus is correct as of any time subsequent to the date
of this Prospectus.
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TABLE OF CONTENTS
Page
Additional Information...................................................... 1
Prospectus Summary.......................................................... 2
Risk Factors................................................................ 8
Use of Proceeds............................................................. 20
Dividend Policy............................................................. 20
Market Price of Securities.................................................. 21
Dilution.................................................................... 22
Capitalization.............................................................. 24
Selected Financial Data..................................................... 25
Management's Discussion and Analysis of Financial
Condition and Results of Operations....................................... 26
Business.................................................................... 33
Management.................................................................. 45
Principal Stockholders...................................................... 57
Selling Security Holders.................................................... 59
Certain Transactions........................................................ 61
Description of Securities................................................... 66
Securities Eligible for Future Sale......................................... 69
Plan of Distribution........................................................ 71
Legal Matters............................................................... 71
Experts..................................................................... 71
Index to Consolidated Financial Statements.................................. F-1
-----------
11,318,097 Shares of Common Stock Issuable Upon Exercise of Warrants
690,338 Shares of Common Stock for Selling Security Holders
5,058,307 Redeemable Warrants for Selling Security Holders
-----------
PROSPECTUS
-----------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Capitalized terms used in this Part II without definitions are as defined in the
Prospectus.
Item 24. Indemnification of Directors and Officers.
Section 145 of the Delaware General Corporation Law, as amended (the
"Delaware GCL"), permits under certain circumstances, the indemnification of any
person with respect to any threatened, pending or completed action, suit or
proceeding, whether civil, criminal, administrative or investigative, to which
such person was or is a party or is threatened to be made a party by reason of
the fact that such person is or was a director, officer, employee or agent of
the corporation or was serving in a similar capacity for another enterprise at
the request of the corporation. To the extent that a director, officer,
employee, or agent of the corporation has been successful in defending any such
proceeding, the Delaware GCL provides that he shall be indemnified against
expenses (including attorneys' fees) actually and reasonably incurred by him in
connection therewith.
With respect to a proceeding by or in the right of the corporation, such
person may be indemnified against expenses (including attorneys' fees) if he
acted in good faith and in a manner he reasonably believed to be in or not
opposed to the best interests of the corporation. The statute provides, however,
that no indemnification is allowed in such a proceeding if such person is
adjudged liable to the corporation unless, and only to the extent that, the
court may, upon application, determine that he is entitled to indemnification
under the circumstances. With respect to proceedings other than those brought by
or in the right of the corporation, such person may be indemnified against
judgments, fines, and amounts paid in settlement, as well as expenses, if he
acted in good faith and in a manner he reasonably believed to be in or not
opposed to the best interests of the corporation and, with respect to any
criminal action, had no reasonable cause to believe his conduct was unlawful,
notwithstanding the outcome of the proceeding. Except with respect to mandatory
indemnification of expenses to successful defendants as described in the
preceding paragraph or pursuant to a court order, the indemnification described
in this paragraph may be made only upon a determination in each specific case by
majority vote of a quorum of directors not parties to the proceeding, by written
opinion of independent legal counsel, or by the stockholders, that the defendant
met the applicable standard of conduct described above.
The Delaware GCL permits a corporation to advance expenses incurred by a
proposed indemnitee in advance of final disposition of the proceeding provided
the indemnitee undertakes to repay such advanced expenses if it is ultimately
determined that he is not entitled to indemnification. A corporation may
purchase insurance on behalf of an indemnitee against any liability asserted
against him in his designated capacity, whether or not the corporation itself
would be empowered to indemnify him against such liability.
Delaware law also provides that the above rights shall not be deemed
exclusive of other rights of indemnification or advancement of expenses under
any bylaw, agreement, vote of stockholders or disinterested directors, or
otherwise. The Bylaws of Sound Source Interactive, Inc. a Delaware
corporation (the "Registrant"), generally require the Registrant to indemnify
and advance expenses to its directors and its officers, employees and other
agents to the fullest extent permitted by the Delaware GCL as the same exists
or may hereafter be amended. The Registrant has purchased a directors' and
officers' liability policy insuring its directors and officers. The
Registrant also has entered into indemnification agreements with each of its
directors whereby the Registrant will indemnify each such person against
II-1
<PAGE>
certain claims arising out of certain past, present or future acts, omissions or
breaches of duty committed by an indemnitee while serving as a director.
Such indemnification does not apply to acts or omissions which are knowingly
fraudulent, deliberately dishonest or arise from willful misconduct.
Indemnification will only be provided to the extent that the indemnitee has not
already received payments in respect of a claim from the Registrant or from an
insurance company. Under certain circumstances, such indemnification (including
reimbursement of expenses incurred) will be allowed for liability arising under
the Securities Act of 1933, as amended (the "Securities Act").
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers or persons controlling the Registrant
pursuant to the foregoing provisions, the Registrant has been informed that, in
the opinion of the Securities and Exchange Commission, (the "Commission"), such
indemnification is against public policy as expressed in the Securities Act and
is therefore unenforceable.
Section 102(b)(7) of the Delaware GCL permits Delaware corporations in
their certificates of incorporation to eliminate or limit the personal liability
of directors to the corporation or its stockholders for monetary damages for
breaches of certain duties. Under the Registrant's Certificate of Incorporation,
a director of the Registrant shall, to the maximum extent currently or hereafter
permitted by Section 102(b)(7) of the Delaware GCL (or any successor provision),
have no personal liability to the Registrant or its stockholders for monetary
damages for breach of fiduciary duty as a director. Section 102(b)(7) of the
Delaware GCL provides that Delaware corporations may not eliminate or limit the
liability of a director (i) for any breach of the director's duty of loyalty to
the Registrant or its stockholders, (ii) for acts or omissions not in good faith
or that involve intentional misconduct or a knowing violation of law, (iii) as
provided under Section 174 of the Delaware GCL (involving certain unlawful
dividends and stock purchases or redemptions), or (iv) for any transaction from
which the director derived an improper personal benefit.
The foregoing descriptions are general summaries only. Reference is made to
the full text of Registrant's Certificate of Incorporation and Bylaws filed as
part of this Registration Statement.
Item 25. Other Expenses of Issuance and Distribution.
The following tables sets forth the various expenses in connection with the
sale and distribution of the securities being registered, other than
underwriting discounts and commissions and non-accountable expense allowance.
All of the amounts shown are estimates except the Securities and Exchange
Commission registration and NASD filing fees.
Securities and Exchange Commission registration fee .............. $505
Accounting fees and expenses ..................................... $7,500*
Printing and engraving expenses .................................. $10,000*
Blue Sky fees and expenses (including counsel fees) .............. $2,000*
Other legal fees and legal expenses .............................. $23,000*
--------
Total ............................................................ $43,005*
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* Estimated.
II-2
<PAGE>
Item 26. Recent Sales of Unregistered Securities.
On May 16, 1994, the Registrant acquired all the issued and outstanding
capital stock of Sound Source Interactive, Inc. a California corporation (the "
"Subsidiary"), in exchange for newly issued stock of the Registrant (the "1994
Acquisition"). Pursuant to the 1994 Acquisition, the Registrant issued 1,278,515
shares of Common Stock and 1,000,000 shares of the Registrant's Series A
Preferred Stock to Vincent J. Bitetti, 73,394 shares of Common Stock to Martin
H. Meyer and 122,323 shares of Common Stock to Mark Lane. Each of such persons
was an "accredited investor" as defined in Securities Act Rule 501(a). The
issuance of Common Stock to such persons was exempt from the registration
requirements of the Securities Act pursuant to Sections 4(2) and 4(6) thereof.
On June 15, 1994, Mr. Bitetti exchanged his 1,000,000 shares of Series A
Preferred Stock for 83,333 shares of Common Stock issued by the Company. Such
issuance was exempt from the registration requirements of the Securities Act
pursuant to Sections 4(2) and 4(6) thereof.
During May through August 1994, the Registrant conducted a private offering
of its Common Stock (the "1994 Private Placement"). Pursuant to that offering, a
total of 113,036 shares of Common Stock were sold for total cash consideration
of approximately $1,492,000. An additional 1,841 shares were issued to the
brother of the Chief Executive Officer in payment of a $22,000 note payable. The
1994 Private Placement was made on a private basis only to persons who were
"accredited investors" as defined in Securities Act Rule 501(a). The issuance of
Common Stock to such persons was exempt from the registration requirements of
the Securities Act pursuant to Sections 4(2) and 4(6) thereof. In addition,
certain of the issuances pursuant to the 1994 Private Placement may have been
exempt from the registration requirements of the Securities Act pursuant to
Regulation S thereunder or may otherwise have been outside the jurisdictional
means required by Section 5 of the Securities Act.
As compensation for its services as the placement agent for the 1994
Private Placement, the Registrant paid Bentley, Richards Investments
("Bentley, Richards"), an affiliate of the Registrant's then controlling
stockholders, Jehu Hand and Eric Anderson, 81,997 shares of Common Stock, and
issued to Bentley, Richards an option to purchase up to 60,241 shares of
Common Stock, subject to the satisfaction of certain contingencies, at a
price to be determined in accordance with a formula. In July 1995, one of the
investors in the 1994 Private Placement filed a suit naming as defendants the
following: Jehu Hand and Eric Anderson (who together organized the Registrant
and managed it prior to the 1994 Acquisition), and their spouses Jacqueline
Hand and Marie Anderson; the Registrant and the Subsidiary; and Bentley,
Richards. No then current director or officer of the Registrant was named as
a defendant. Such litigation was settled in September 1995. In connection
with such settlement, Bentley, Richards distributed all 81,997 shares of
Common Stock issued to it for its services as placement agent for the 1994
Private Placement to the investors in the 1994 Private Placement. Bentley,
Richards also agreed to the cancellation of its option to purchase 60,241
shares of the Registrant's Common Stock. In addition, Jehu Hand distributed
an additional 26,772 shares of Common Stock held by him to the investors in
the 1994 Private Placement, and returned 15,120 shares of Common Stock to the
Registrant which were cancelled. The Registrant did not pay any consideration
to any party in connection with such settlement.
During May 1992 through October 1994, the Registrant, pursuant to its 1992
Stock Option Plan, issued options to purchase 190,763 shares of Common Stock to
its directors, employees and one unaffiliated party. The issuance of such
options to such persons was exempt from the registration requirements of the
Securities Act pursuant to Section 4(2) thereof. Of these, options to purchase a
total of 142,337 shares of Common Stock currently are issued pursuant to the
1992 Stock Option Plan. All of such options are non-qualified stock options with
an exercise price of $.06 per share, and are presently
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<PAGE>
exercisable. On June 30, 1995, David Weiss, then an executive officer and
director of the Registrant, exercised an option to purchase 4,184 shares of
Common Stock for an aggregate purchase price of $251, which option had been
granted pursuant to the Registrant's 1992 Stock Option Plan. The issuance of
Common Stock to Mr. Weiss upon such exercise was exempt from the registration
requirements of the Securities Act pursuant to Sections 4(2) and 4(6) thereof.
On September 3, 1996, the Registrant filed with the Commission a registration
statement on Form S-8, Registration No. 333-11483, pertaining to the 1992
Stock Option Plan.
In April 1994, the Registrant granted Eric H. Winston, then an executive
officer and director of the Registrant, an option to purchase 251,004 shares
of Common Stock. In June 1994, the Registrant granted Mr. Winston, then an
executive officer and director of the Registrant, an option to purchase
41,834 shares of Common Stock. The issuances of such options to Mr. Winston
were exempt from the registration requirements of the Securities Act pursuant
to Section 4(2) thereof. On December 3, 1996, Mr. Winston exercised an option
to purchase 10,000 shares of Common Stock for an aggregate purchase price of
$600. The issuance of stock to Mr. Winston pursuant to such exercise was
exempt from the registration requirements of the Securities Act pursuant to
Sections 4(2) and 4(6) thereof.
During June through August of 1995, the Registrant conducted a private
offering (the "1995 Bridge Financing") of Units consisting of notes and
warrants. Pursuant to that offering, a total of 32 Units were sold at a price of
$10,000 per Unit. Each Unit consisted of $9,975 principal amount of the
Registrant's 10% Secured Promissory Notes due August 15, 1995, and warrants to
purchase 586 shares of Common Stock (the "Bridge Warrants"). The gross offering
proceeds of the 1995 Bridge Financing were $320,000. The 1995 Bridge Financing
was made on a private basis only to persons who were "accredited investors" as
defined in Securities Act Rule 501(a). The issuance of the Units to such persons
was exempt from the registration requirements of the Securities Act pursuant to
Sections 4(2) and 4(6) thereof and Rule 506 of Regulation D thereunder. In
consideration for its services as dealer manager for the 1995 Bridge Offering,
the Registrant paid Financial West Group, Inc. aggregate commissions and fees of
$41,600. The Registrant also issued to Financial West Group, Inc. a Bridge
Warrant to purchase 20,918 shares of Common Stock for $50. Such Bridge Warrant
was on the same terms as the other Bridge Warrants, except that the Company
separately agreed that it may be exercised on a cashless basis.
During November 1995, the Registrant effectuated an exchange offer with the
holders of the Bridge Warrants, whereby all of the Bridge Warrants originally
issued in connection with the 1995 Bridge Financing were exchanged for new
Bridge Warrants having terms substantially identical to those of the Private
Warrants referred to below. Such exchange offer was made on a private basis only
to persons who were "accredited investors" as defined in Securities Act Rule
501(a). The exchange offer was exempt from the registration requirements of the
Securities Act pursuant to Sections 4(2) and 4(6) thereof and Rule 506 of
Regulation D thereunder.
As described under "Certain Transactions - 1995 Bridge Financing," upon the
initial effectiveness of this Registration Statement on July 1, 1996, all of the
Bridge Warrants (including the warrant issued to Financial West Group, Inc.)
were converted to Redeemable Warrants. In connection with the 1995 Bridge
Financing, the Registrant retained Financial West Group, Inc. as its warrant
agent for the Bridge Warrants. Subsequently, Financial West Group, Inc. assigned
to The Boston Group, L.P. and Joseph Stevens & Co., L.P. (the "Underwriters")
its right to serve as warrant agent for the Bridge Warrants. As compensation for
such services as warrant agent, the Underwriters will receive a solicitation fee
of five percent of the exercise price of the Bridge Warrants, payable upon
exercise of the Bridge Warrants.
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<PAGE>
In September and October 1995, the Registrant conducted a private offering
(the "1995 Private Placement"). Pursuant to that offering, a total of 52.5 Units
were sold at a price of $100,000 per Unit. Each Unit consisted of $95,000
principal amount of the Registrant's 10% Secured Promissory Notes due 1996 and
warrants to purchase 100,000 shares of Common Stock (the "Private Warrants").
The gross offering proceeds of the 1995 Private Placement were $5,250,000. The
1995 Private Placement was made on a private basis only to persons who were
"accredited investors" as defined in Securities Act Rule 501(a). The issuance of
the Units to such persons was exempt from the registration requirements of the
Securities Act pursuant to Sections 4(2) and 4(6) thereof and Rule 506 of
Regulation D thereunder. In consideration for its services as dealer manager for
the 1995 Private Placement, the Registrant paid Financial West Group, Inc.
aggregate commissions and fees of $199,500. Additionally, $483,000 was allocated
to The Boston Group, L.P. for its services as a selected broker. The Registrant
also issued to Financial West Group, Inc. a warrant to purchase 400,000 shares
of Common Stock. Such warrant was on the same terms as the Private Warrants,
except that the Company separately agreed that it may be exercised on a cashless
basis. As described under "Certain Transactions - 1995 Private Placement," upon
the initial effectiveness of this Registration Statement on July 1, 1996 all of
the Private Warrants (including the warrant issued to Financial West Group,
Inc.) were converted to Redeemable Warrants. In connection with the 1995 Private
Placement, the Registrant retained Financial West Group, Inc. as its warrant
agent for the Private Warrants. Subsequently, Financial West Group, Inc.
assigned to the Underwriters its right to serve as warrant agent for the Private
Warrants. As compensation for its services as warrant agent, the Underwriters
will receive a solicitation fee of five percent of the exercise price of the
Private Warrants, payable upon exercise of the Private Warrants.
On October 9, 1995, the Registrant granted to Ulrich E. Gottschling, who is
the President, Chief Operating Officer, Chief Financial Officer, Treasurer,
Secretary and a director of the Registrant, an option to purchase 100,000 shares
of Common Stock pursuant to the Registrant's 1992 Stock Option Plan. On April
30, 1996, Mr.Gottschling agreed to the termination of the existing 100,000 share
option in consideration for the Registrant's granting him a new 200,000 share
option pursuant to the Registrant's 1992 Stock Option Plan. Such transactions
were exempt from the registration requirements of the Securities Act pursuant to
Sections 4(2) and 4(6) thereof.
On April 30, 1996, the Registrant granted ASSI, Inc. warrants to purchase
2,000,000 shares of Common Stock. On May 30, 1996, the Company issued a $500,000
convertible promissory note to ASSI, Inc., which was convertible into warrants
to purchase Common Stock at a conversion price of $.25 per warrant. On July 7,
1996, the Registrant issued 2,016,657 warrants to ASSI, Inc. upon its conversion
of such promissory note. The terms of all the warrants issued to ASSI, Inc. are
identical to those of the Redeemable Warrants, except that (i) they became
exercisable October 1, 1996, (ii) they are not be mandatorily redeemable by the
Company and (iii) they are 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 transfer by
ASSI, Inc. of any of its ASSI Warrants or Redeemable 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 held by
persons other than ASSI, Inc. All such transactions with ASSI Inc. were was
exempt from the registration requirements of the Securities Act pursuant to
Section 4(2) and 4(6) thereof.
See "Certain Transactions" for additional information concerning the
Registrant's stock issuances for the past three years.
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<PAGE>
Item 27. Exhibits and Financial Statement Schedules.
(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 of Form SB-2
(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 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 Underwriter's Warrant Agreement between the Registrant and The
Boston Group, L.P. and Joseph Stevens and Company, L.P. and form of
Underwriters' Warrant. Filed as Exhibit 4.3 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, L.P. and Joseph Stevens
& Co., L.P., as underwriters. Filed as Exhibit 1 to the Registration
Statement No. 33-80827 and incorporated herein by reference.
5.1 Opinion of McDermott, Will & Emery. Filed herewith.
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.
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 herewith.
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<PAGE>
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. Amended and Restated 1995 Stock Option
Plan. Filed as Exhibit 10.5 to the Registrant's Annual Report on Form
10K-SB, as amended (the "Form 10K-SB") 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, pertaining to the Bridge Warrants (as
defined in the Prospectus). 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, pertaining to the Private Warrants (as
defined in the Prospectus). 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. Previously filed.
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 Form of Registration Procedures Agreement executed between the
Registrant and each of the Selling Security Holders. Filed as Exhibit
10.44 to Registration Statement No. 33-80827 and incorporated herein
by reference.
10.14 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.
10.15 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.
10.16 Distribution Services Agreement, dated as of 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.
10.17 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.
10.18 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.
II-7
<PAGE>
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. Previously filed.
10.24 Office Lease, dated as of March 4, 1997, between Arden Realty Limited
Partnership and the Subsidiary. Previously filed.
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 McDermott, Will & Emery (included in Exhibit 5.1).
24.1 Power of Attorney (incorporated by reference to page II-11 of the
Registration Statement on Form SB-2).
(b) Financial Statement Schedules
None required
Item 28. Undertakings.
The undersigned Registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being
made, a post-effective amendment to this Registration Statement: (i)To
include any Prospectus required by section 10(a)(3) of the Securities
Act; (ii)To reflect in the Prospectus any facts or events arising
after the effective date of the Registration Statement (or the most
recent post-effective amendment thereof) which, individually, or in
the aggregate, represent a fundamental change in the information set
forth in the Registration Statement; notwithstanding the foregoing,
any increase or decrease in volume of securities offered (if the total
dollar value of securities offered would not exceed that which was
registered) and any deviation from the low or high end of the
estimated maximum offering range may be reflected in the form of
prospectus filed with the Commission pursuant to Rule 424(b)
(ss.230.424(b) of this Chapter) if, in the aggregate, the changes in
volume and price represent no more than a 20 percent change in the
maximum aggregate offering price set forth in the "Calculation of
Registration Fee" table in the effective registration statement; and
(iii)To include any material information with respect to the plan of
distribution not previously disclosed in the Registration Statement or
any material change to such information in the Registration Statement.
(2) That, for the purpose of determining any liability under the
Securities Act, each such post-effective amendment shall be deemed to
be a new Registration Statement relating to the securities offered
therein, and the offering of such securities at that time shall be
deemed to be the initial bona fide offering thereof.
(3) To remove from registration by means of a post-effective amendment
any of the securities being registered which remain unsold at the
termination of the offering.
II-8
<PAGE>
Insofar as indemnification for liabilities arising from the Securities Act
may be permitted to directors, officers and controlling persons of the
Registrant, the Registrant has been advised that in the opinion of the
Securities and Exchange Commission such indemnification is against public policy
as expressed in the Securities Act and is, therefore, unenforceable. In the
event that a claim for indemnification against such liabilities (other than the
payment by the Registrant of expenses incurred or paid by a director, officer or
controlling person of the Registrant in the successful defense of any action,
suit or proceeding) is asserted by such director, officer or controlling person
in connection with the securities being registered, the Registrant will, unless
in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the
Securities Act and will be governed by the final adjudication of such issue.
For purposes of determining any liability under the Securities Act, the
information omitted from the form of Prospectus filed as part of this
Registration Statement in reliance upon Rule 430A and contained in a form of
Prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or Rule
497(h) under the Securities Act shall be deemed to be part of this Registration
Statement as of the time it was declared effective.
For the purpose of determining any liability under the Securities Act, each
post-effective amendment that contains a form of Prospectus shall be deemed to
be a new Registration Statement relating to the securities offered therein, and
the offering of such securities at that time shall be deemed to be the initial
bona fide offering thereof.
II-9
<PAGE>
SIGNATURES
In accordance with the requirements of the Securities Act of 1933, the
Registrant certifies that it has reasonable grounds to believe that it meets all
of the requirements for filing on Form SB-2 and authorized this Registration
Statement to be signed on its behalf by the undersigned, in the City of Los
Angeles, State of California, on May 9, 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 requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities and on the dates stated.
Signature Title Date
--------- ----- ----
/s/ Vincent J. Bitetti Chairman of the Board and May 9, 1997
- -------------------------- Chief Executive Officer
Vincent J. Bitetti (principal executive officer)
/s/ Ulrich E. Gottschling President, Chief Operating May 9, 1997
- -------------------------- Officer, Chief Financial
Ulrich E. Gottschling Officer, Treasurer and
Secretary (principal financial
and accounting officer)
* Director May 9, 1997
- --------------------------
Robert S. Burke
* Director May 9, 1997
- --------------------------
Ronald W. Hart
* Director May 9, 1997
- --------------------------
Mark A. James
* Director May 9, 1997
- --------------------------
Ernest T. Klinger
*By:/s/ Ulrich E. Gottschling May 9, 1997
-------------------------
Ulrich E. Gottschling,
Attorney-in-fact
II-10
<PAGE>
Exhibit 5.1
May 9, 1997
Sound Source Interactive, Inc.
2985 E. Hillcrest Drive
Suite A
Westlake Village, CA 91362
Re: Sound Source Interactive, Inc.
Gentlemen:
We are providing this opinion in connection with Registration Statement No.
33-80827 and the Registration Statement of which this is being filed as an
exhibit of Sound Source Interactive, Inc. (the "Company"), each on Form SB-2 and
as amended (the "Registration Statements"), filed under the Securities Act of
1933, as amended. Capitalized terms used herein without definition have the
meanings set forth in the Registration Statements.
The Registration Statements relate to the following:
(a) 307,500 outstanding shares of Common Stock registered for the
account of certain Selling Security Holders;
(b) 5,058,307 outstanding Redeemable Warrants registered for the account
of certain Selling Security Holders;
(c) 382,838 shares of Common Stock issuable by the Company upon
exercise of options held by Eric H. Winston, a Selling Security
Holder;
(d) 11,078,097 shares of Common Stock issuable by the Company upon
exercise of Redeemable Warrants; and
(e) 240,000 shares of Common Stock issuable by the Company upon
exercise of Underwriters' Warrants.
We have examined (i) the Company's Second Restated Certificate of
Incorporation and its Amended and Restated By-Laws; (ii) an officer's
certificate as to the corporate proceedings of the Company relating to the
issuance of the
<PAGE>
Sound Source Interactive, Inc.
May 9, 1997
Page 2
Shares and the Warrants and other factual matters; and (iii) such other
documents and records as we have deemed necessary in order to render this
opinion.
Based on the foregoing, it is our opinion that:
1. The shares of Common Stock referred to in clause (a) above have
been duly authorized and are validly issued, fully paid and
nonassessable by the Company. The shares of Common Stock referred
to in clauses (c), (d) and (e) above have been duly authorized and,
upon their issuance by the Company in accordance with the terms of
the Eric H. Winston stock options, the Redeemable Warrants and the
Underwriters' Warrants, respectively, will be validly issued, fully
paid and nonassessable.
2. The Redeemable Warrants referred to in clause (b) above have been duly
authorized and are validly issued and are enforceable against the
Company in accordance with their terms, except as enforcement may be
limited by bankruptcy, insolvency, reorganization or other laws of
general applicability relating to or affecting the enforcement of
creditor's rights and by general equity principles.
We consent (i) to the use of this opinion as an exhibit to the Registration
Statement and (ii) to the reference to our firm name under the caption "Legal
Matters" in the Prospectus.
Very truly yours,
/s/ McDermott, Will & Emery
McDERMOTT, WILL & EMERY
<PAGE>
Exhibit 10.3
AMENDED AND RESTATED
EMPLOYMENT AGREEMENT
This AMENDED AND RESTATED EMPLOYMENT AGREEMENT (this "Agreement"),
dated as of February 1, 1997, between Sound Source Interactive, Inc., a
Delaware corporation, and Sound Source Interactive, Inc., a California
corporation (collectively, "Employer"), and Ulrich E. Gottschling
("Executive").
W I T N E S S E T H:
WHEREAS, Executive has served as Chief Financial Officer and
Treasurer of Employer since October 9, 1997, and as Secretary of Employer
since November 1995;
WHEREAS, Employer and Executive entered into an Employment Agreement
dated as of October 9, 1995, as amended pursuant to an amendment dated as of
April 30, 1996 (the "Prior Agreement");
WHEREAS, Employer and Executive mutually desire to amend and restate
the Prior Agreement in its entirety as set forth herein;
WHEREAS, Executive continues to possess an intimate knowledge of the
business and affairs of Employer, its policies, methods, personnel,
opportunities and problems;
WHEREAS, Employer desires to assure itself of Executive's continued
employment by Employer and to compensate him for such efforts; and
WHEREAS, Executive is desirous of committing himself to serve
Employer on the terms herein provided;
NOW, THEREFORE, in consideration of the covenants herein contained,
the parties hereto hereby agree as follows:
1. Employment. Executive is hereby employed as the President,
Chief Operating Officer, Chief Financial Officer, Treasurer and Secretary of
Employer. Executive, shall report to the Chairman of the Board and shall have
such powers and duties as may be from time to time assigned to him by the
Chairman of the Board and Chief Executive Officer and/or the Board of
Directors of Employer (the "Board"), and Executive hereby accepts such
employment, all subject to the terms and conditions herein contained.
Executive hereby agrees that during the period of his employment hereunder he
shall devote substantially all of his business time, attention and skills to
the business and affairs of Employer and its subsidiaries.
2. Place of Performance. In connection with his employment by
Employer, Executive shall be based at Employer's principal executive offices.
3. Compensation.
(a) Base Salary. Employer shall pay to Executive, and
Executive shall accept, for all services which may be rendered by him
pursuant to this Agreement, an annual base salary
<PAGE>
("Base Salary") as hereinafter set forth. The Base Salary during the first
two months of the first year of the term of this Agreement shall be $130,000.
The Base Salary during the remainder of the term of this Agreement shall be
$150,000; provided, that at the end of the first full year of this Agreement,
the Base Salary shall be increased by an amount equal to the Base Salary then
in effect multiplied by a fraction, the numerator of which shall be the
difference between (a) the Consumer Price Index (as hereinafter defined) as
of the first anniversary of the Effective Date (as hereinafter defined) and
(b) the Consumer Price Index as of the Effective Date, and the denominator of
which shall be the Consumer Price Index as of the Effective Date; provided,
that the "fraction" set forth in this sentence shall never be zero or less.
Any increase in Base Salary or other compensation granted by
Employer, the Board or any committee thereof shall in no way limit or reduce
any other obligation of Employer hereunder and, once established at an
increased specified rate, Executive's Base Salary hereunder shall not
thereafter be reduced, other than as necessitated by Employer's adverse
financial condition. Executive's salary shall be payable in accordance with
Employer's payroll practices as from time to time in effect.
For purposes of this Agreement, the "Consumer Price Index" as
of any particular date means the Consumer Price Index for Urban Consumers for
All Items, as reported in the Monthly Labor Review (published by the Bureau
of Labor Statistics of the United States Department of Labor) in respect of
the month immediately preceding such particular date. In the event that the
Consumer Price index is not available, a successor or substitute index shall
be used for the computations herein set forth. In the event that the
Consumer Price Index or such successor or substitute index is not published,
a reliable governmental or other nonpartisan publication evaluating the
information theretofore used in determining the Consumer Price index shall be
used for the computations herein set forth.
(b) Additional Cash Compensation. Employer shall pay
Executive compensation in addition to Executive's Base Salary upon Employer's
attainment of one or more revenue or profitability levels. This additional
compensation shall be computed on an annual basis at the close of the
Employer's fiscal year and paid to Executive within ten days of completion of
the annual audit.
(i) Revenue Attainment. Employer shall pay Executive a
cash bonus if Employer realizes certain gross revenues. The cash bonus shall
be based upon the following schedule:
Cumulative
Revenue Attainment Cash Bonus
------------------ ----------
$12,000,000 $ 20,000
$16,000,000 $ 60,000
$24,000,000 $100,000
The foregoing schedule shall apply in respect of the fiscal year ending June
30, 1997. The revenue attainment levels set forth in the schedule shall be
increased annually by 60 percent per annum for each subsequent fiscal year
during the term of this Agreement.
-2-
<PAGE>
(ii) Employer Gross Profit. Employer shall pay Executive
a cash bonus if Employer achieves successful gross profit levels. For
purposes hereof, "gross profit" means total revenues less cost of sales as
determined by Employer's independent public accountants in accordance with
Generally Accepted Accounting Principles ("GAAP") consistently applied. The
cash bonus shall be calculated based upon the following performance schedule:
Cumulative
Gross Profit Cash Bonus
------------ ----------
$ 3,200,000 $ 40,000
$ 3,600,000 $ 60,000
$ 4,000,000 $ 80,000
The foregoing schedule shall apply in respect of the fiscal year ending June
30, 1997. The gross profit attainment levels set forth in the schedule shall
be increased annually by 60 percent per annum per annum for each subsequent
year during the term of this Agreement.
(iii)Pre-Tax Profitability. Employer shall pay Executive
a cash bonus upon Employer achieving certain levels of pre-tax profitability.
For purposes hereof, "pre-tax profitability" shall mean earnings before
interest, amortization, depreciation and income taxes divided by gross
revenues as determined by Employer's independent public accountants in
accordance with GAAP. For each fiscal year during the term of this Agreement,
the cash payment shall be based on the following pre-tax profitability
schedule:
Cumulative
Pre-Tax Profitability Cash Bonus
--------------------- ----------
10% $ 50,000
15% $100,000
(iv) Separate Bonus Categories. Each of the three bonus
categories set forth above shall be independent of each other and Executive
may obtain cash bonuses from one or more of the categories in the same fiscal
year.
(c) Automobile. In order to facilitate travel by Executive in
the performance of his duties hereunder, Employer shall furnish Executive, at
no expense to him, with an automobile owned or leased by Employer; provided,
that the total cost to the Company for lease/purchase payments shall not
exceed $500 per month. The manufacturer and type of such automobile shall be
chosen by Employer. Employer shall reimburse Employee for all expenses of
maintaining, insuring and operating such automobile upon the presentation of
appropriate vouchers and/or receipts (to the extent that Employer does not
pay such expenses directly). At the discretion of the Board, Employer may,
in lieu of furnishing Executive with an automobile owned or leased by
Employer and paying all maintenance, insurance and operation expenses in
connection therewith, reimburse Executive for all expenses he incurs
-3-
<PAGE>
in maintaining, insuring and operating one automobile owned or leased by
Executive upon the presentation of appropriate vouchers and/or receipts (to
the extent that Employer does not pay such expenses directly).
(d) Expenses. During the term of his employment hereunder,
Executive shall be entitled to receive prompt reimbursement for all
reasonable expenses incurred by him in performing services hereunder,
provided that Executive properly accounts therefor in accordance with
Employer's policy relating thereto. Without limiting the generality of the
foregoing, the parties agree that any travel Executive undertakes in
connection with the performance of his duties hereunder shall be in business
class or better, and Employer shall reimburse Executive for such expenses.
(e) Benefit Plans. Executive shall be entitled to participate
in or receive benefits under any employee benefit plan or arrangement
currently available, or made available by Employer in the future, to its
executives and key management employees, subject to and on a basis consistent
with the terms, conditions and overall administration of such plan or
arrangement. If Executive elects not to participate in any of the health
plans sponsored by Employer, then Employer shall reimburse Executive in an
amount not to exceed $1,000 per month for costs incurred by Executive in
obtaining alternative health care coverage for Executive and his family.
Employer shall not make any changes in any employee benefit plans or
arrangements in effect on the date hereof or during the term of this
Agreement in which Executive participates (including, without limitation, any
pension and retirement plan, supplemental pension and retirement plan,
savings and profit sharing plan, stock ownership plan, stock purchase plan,
stock option plan, life insurance plan, medical insurance plan, disability
plan, dental plan, health-and-accident plan or arrangement) which would
adversely affect Executive's rights or benefits thereunder, unless such
change occurs pursuant to a program applicable to all executives of Employer
and does not result in a proportionately greater reduction in the rights of
or benefits to Executive as compared with any other executive of Employer.
Any payments or benefits payable to Executive hereunder in respect of any
calendar year during which Executive is employed by Employer for less than
the entire such year shall, unless otherwise provided in the applicable plan
or arrangement, be prorated in accordance with the number of calendar days in
such calendar year during which he is so employed.
(f) Vacations, Holidays and Sick Leave. Executive shall be
entitled to the number of paid holidays, personal days off, vacation days and
sick leave days in each calendar year as are determined by Employer from time
to time for its senior executive officers, but not less than four weeks in
any calendar year (prorated, in any calendar year during which Executive is
employed under this Agreement for leans than the entire such year, in
accordance with the number of calendar days in such calendar year during
which he is so employed). Vacation may be taken in Executive's discretion, so
long as it is not inconsistent with the reasonable business needs of
Employer. Executive shall be entitled to accrue from year to year all
vacation days not taken by him.
(g) Perquisites. Executive shall be entitled to continue to
receive the perquisites and fringe benefits appertaining to the office of the
President and Chief Operating Officer of Employer in accordance with present
practice and appropriate to the industry.
(h) Key Man Life Insurance. Executive shall cooperate with
Employer to secure, for Employer, a key man life insurance policy on the life
of Executive in the amount of $500,000,
-4-
<PAGE>
to be paid to Employer upon Executive's death.
(i) Base Salary Not Effected by Other Benefits. None of the
benefits to which Executive is entitled under any of the provisions of
Sections 3(b) - 3(f) hereof shall in any manner reduce or be deemed to be in
lieu of the Base Salary payable to Executive pursuant to Section 3(a) hereof.
4. Term of Employment. The employment by Employer of Executive
pursuant hereto shall commence as of the date hereof (the "Effective Date")
and, subject to the provisions of Section 5 hereof, shall terminate two years
after the Effective Date (the "Termination Date"). This Agreement shall
automatically be extended for one additional year beyond the Termination Date
(the "Extended Termination Date") unless at least 30 calendar days prior to
the Termination Date, Executive or Employer shall have given notice that he
or it does not wish to extend this Agreement.
5. Premature Termination. Anything in this Agreement contained to
the contrary notwithstanding:
(a) Death. Executive's employment hereunder shall terminate
forthwith upon the death of Executive.
(b) Disability. Executive's employment hereunder shall
terminate, at the option of Employer, in the event that the Board makes a
good faith determination that Executive suffers from Disability (as
hereinafter defined) so as to be unable to substantially perform his duties
hereunder for an aggregate of 180 calendar days during any period of 12
consecutive months. As used in this Agreement, the term "Disability" shall
mean the material inability, in the opinion of three-fourths of the entire
membership of the Board set forth in a resolution giving the particulars
thereof, of Executive to render his agreed-upon services to Employer due to
physical and/or mental infirmity, which opinion is concurred in by a
physician or psychiatrist selected by Executive or his duly appointed
representative or guardian and reasonably acceptable Employer.
(c) Termination for Cause. Employer may terminate Executive's
employment hereunder for Cause. For purposes of this Agreement, Employer
shall have "Cause" to terminate Executive's employment hereunder upon (i) the
willful and continued failure by Executive to substantially perform his
duties hereunder (other than any such failure resulting from Executive's
incapacity due to physical or mental illness) after demand for substantial
performance is delivered by Employer specifically identifying the manner in
which Employer believes Executive has not substantially performed his duties,
or (ii) the willful engaging by Executive in misconduct which is materially
injurious to Employer, monetarily or otherwise, or (iii) the willful
violation by Executive of the provisions of Section 8 hereof provided that
such violation results in material injury to Employer. No act, or failure to
act, on Executive's part shall be considered "willful" unless done, or
omitted to be done, by him not in good faith and without reasonable belief
that his action or omission was in the best interest of Employer.
Notwithstanding the foregoing, Executive shall not be deemed to have been
terminated for Cause unless and until there shall have been delivered to
Executive a copy of a resolution, duly adopted by the affirmative vote of not
less than a majority of the entire membership of the Board at a meeting of
the Board called and held for such purpose (after reasonable notice to
Executive and an opportunity for him, together with his counsel, to be heard
before the Board), finding that, in the good faith opinion of the
-5-
<PAGE>
Board, Executive conducted, or failed to conduct, himself in a manner set
forth above in clause (i), (ii), or (iii) of this Section 5(c), and
specifying the particulars thereof in detail. Any dispute as to whether
Cause to dismiss Executive exists, shall be resolved by arbitration conducted
in Los Angeles, California in accordance with the rules of the American
Arbitration Association and by a single arbitrator reasonably acceptable to
Executive and Employer.
(d) Termination by Executive. Executive may terminate his
employment hereunder (i) for Good Reason (as hereinafter defined) or (ii) if
his physical or mental health becomes impaired to an extent that makes the
continued performance of his duties hereunder hazardous to his physical or
mental health or his life, provided that Executive shall have furnished
Employer with a written statement from a doctor or psychiatrist to such
effect, and provided further, that, at Employer's request and expense,
Executive shall submit to an examination by a physician or psychiatrist
selected by Employer and such physician or psychiatrist shall have concurred
in the conclusion of Executive's physician or psychiatrist. Until Executive
terminates his employment pursuant to clause (ii) of this Section 5(d), he
shall continue to receive his full Base Salary, payable at the time such
payments are due.
(e) "Good Reason" Defined. For purposes of this Agreement,
"Good Reason" shall mean (i) any removal of Executive as, or any failure to
re-elect Executive as, President of Employer except in connection with
termination of Executive's employment for Disability; provided, however, that
any removal of Executive as, or any failure to re-elect Executive as,
President of Employer (except in connection with termination of Executive's
employment for Disability) shall not diminish or reduce the obligations of
Employer to Executive under this Agreement, or (ii) a reduction of ten
percent (10%) or more in Executive's then current Base Salary, other than a
reduction necessitated by Employer's adverse financial condition, or any
failure by Employer to comply with any of the provisions of Sections 1, 2, 3
or 4 hereof, or (iii) the failure of Employer to obtain the assumption of the
agreement to perform this Agreement by any successor to Employer, as provided
for in Section 8 hereof.
(f) Notice of Termination. Any termination of Executive's
employment by Employer or by Executive (other than termination pursuant to
Section 5(a) hereof) shall be communicated by written Notice of Termination
to the other party hereto. For purposes of this Agreement, a "Notice Of
Termination" shall mean a notice which shall indicate the specific
termination provision in this Agreement relied upon and shall set forth in
reasonable detail the facts and circumstances claimed to provide a basis for
termination of Executive's employment under the provision so indicated.
(g) Date of Termination. For purposes of this Agreement,
"Date of Termination" shall mean (i) if Executive's employment is terminated
by his death, the date of his death, (ii) if Executive's employment is
terminated pursuant to Section 5(b) hereof, 30 calendar days after Notice of
Termination is given (provided that Executive shall not have returned to the
performance of his duties on a full-time basis during such 30-day period),
and (iii) if Executive's employment is terminated for any other reason, the
date on which a Notice of Termination is given.
6. Payments and Benefits Upon Early Termination.
(a) Early Termination for Death or Disability. Upon the
termination of this Agreement prior to the Termination Date (or, if this
Agreement shall have been extended to the Extended
-6-
<PAGE>
Termination Date, as provided in Section 4 hereof, prior to the Extended
Termination Date) (X) by Employer as a result of death or Disability or (Y)
by Executive for any of the reasons set forth in clause (ii) of Section 5(d)
hereof, Employer shall pay Executive:
(i) his Base Salary through the Date of Termination at the
rate in effect at the time of Notice of Termination is given or, in
the case of the death of Executive, the Date of Termination, payable
at the time such payments are due; and
(ii) all other amounts to which Executive is entitled,
including, without limitation, expense reimbursement amounts or
amounts due under any benefit plan of Employer accrued to the Date
of Termination, at the time such payments are due.
(b) Early Termination Other than for Death or Disability.
Upon the termination of this Agreement prior to the Termination Date (or, if
this Agreement shall have been extended to the Extended Termination Date, as
provided in Section 4 hereof, prior to the Extended Termination Date) (X) by
Employer other than for death or Disability or Cause or (Y) by Executive for
Good Reason or as a result of a breach of this Agreement by Employer,
Employer shall pay to Executive:
(i) his Base Salary through the Termination Date at the rate
in effect at the time Notice of Termination is given, payable at the
time such payments are due (or, if this Agreement shall have been
extended to the Extended Termination Date, as provided in Section 4
hereof, his Base Salary through the Extended Termination Date at the
rate in effect at the time Notice of Termination is given, payable
at the time such payments are due); and
(ii) all other amounts to which Executive is entitled,
including, without limitation, expense reimbursement amounts or
amounts due under any benefit plan of Employer accrued to the Date
of Termination, at the time such payments are due.
In addition, for the 36-month period after termination for
any of the reasons specified in this Section 6(b), Employer shall arrange to
provide Executive with life and health insurance benefits substantially
similar to those which Executive was receiving immediately prior to the
Notice of Termination.
(c) Payment of Damages. Upon the early termination of this
Agreement, Employer shall pay all other damages to which Executive may be
entitled as a result of Employer's termination of his employment under this
Agreement, including damages for any and all loss of benefits to Executive
under Employer's employee benefit plans which he would have received if
Employer had not breached this Agreement and had his employment continued for
the full term provided in Section 4 hereof, and including all legal fees and
expenses incurred by him in contesting or disputing any such termination of
in seeking to obtain or enforce any right or benefit provided by this
Agreement.
(d) Mitigation Not Required. Executive shall not be required
to mitigate the amount of any payment provided for in this Section 6 by
seeking other employment or otherwise. However, the amount of any payment
provided for in this Section 6 shall be reduced by any
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<PAGE>
compensation earned by Executive as the result of employment by another
employer engaged in the business of interactive educational computer software
after the Date of Termination, or otherwise.
7. Nondisclosure; Noncompete.
(a) Confidential Information. Executive shall not, to the
detriment of Employer, knowingly use for his own benefit or disclose or
reveal to any unauthorized person, any trade secret or other confidential
information received by Executive in the course of his employment or
engagement in any capacity by employer which relates to Employer or to any of
the businesses operated by it, including, but not limited to, any customer
lists, customer needs, price and performance information, specifications,
hardware, software, devices, supply sources and characteristics, business
opportunities, marketing, promotional, pricing and financing techniques, or
other information relating to the business of Employer, and Executive
confirms that such information constitutes the exclusive property of
Employer. However, said restriction on confidential information shall not
apply to information which is: (i) generally available in the industry in
which Employer operates, (ii) disclosed in published literature or (iii)
obtained by Executive from a third party without binder or secrecy.
Executive agrees that, except as otherwise expressly agreed to by Employer,
he will return to Employer, promptly upon the request of the Board or any
executive officer designated by the Board, any physical embodiment of such
confidential information.
(b) Noncompetition. During the term of his employment by
Employer, Executive shall not engage, directly or indirectly (which includes,
but is not limited to, owning, managing, operating, controlling, being
employed by, giving financial assistance to, participating in or being
connected in any material way with any business or person so engaged),
anywhere in the continental United States, in the business of interactive
educational computer software based on licensed products from major motion
pictures and television shows; provided, however, that Executive's ownership
as a passive investor of less than five percent of the issued and outstanding
stock of any publicly held corporation or partnership so engaged shall not by
itself be deemed to constitute such engagement by Executive; and provided
further that, subject to obtaining (as and when required) prior written
consent, which consent will not be unreasonably withheld, nothing herein
shall be construed to prevent Executive from engaging, directly or
indirectly, in any capacity in any business in the computer software or movie
industries not specified above. During such period, Executive shall not act
to induce any of Employer's or its subsidiaries, customers or employees to
take action which might be disadvantageous to Employer.
(c) Remedies. Executive recognizes that the possible
restrictions on his activities which may occur as a result of his performance
of his obligations under this Section 8 are required for the reasonable
protection of Employer and its investments, and Executive expressly
acknowledges that damages alone will be an inadequate remedy for any breach
or violation of this Section 8, and that Employer, in addition to all other
remedies at law or in equity, shall be entitled, as a matter of right, to
injunctive relief, including specific performance, with respect to any such
breach or violation, in any court of competent jurisdiction. If any of the
provisions of this Section 8 are held to be in any respect an unreasonable
restriction upon Executive, then they shall be deemed to extend only over the
maximum period of time, geographic area, and/or range of activities as to
which they may be enforceable.
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<PAGE>
(d) Nonexclusivity. The undertakings of Executive contained
in Sections 8(a), 8(b) and 8(c) hereof shall be in addition to, and not in
lieu of, any obligations which he may have with respect to the subject matter
hereof, whether by contract, as a matter of law or otherwise.
8. Successors; Benefits.
(a) Successors. Employer shall require any successor (whether
direct or indirect, by purchase, merger, consolidation or otherwise) to all
or substantially all of the business and/or assets of Employer, by agreement
in form and substance satisfactory to Executive, to expressly assume and
agree to perform this Agreement in the same manner and to the same extent
that Employer would be required to perform it if no such succession had taken
place. Failure of Employer to obtain such agreement prior to the
effectiveness of any such succession shall be a breach of this Agreement and
shall entitle Executive to compensation from Employer in the same amount and
on the same terms as he would be entitled to hereunder if he terminated his
employment for Good Reason, except that for purposes of implementing the
foregoing, the date on which any such succession becomes effective shall be
deemed the Date of Termination. As used in this Agreement, "Employer" shall
mean Employer as hereinbefore defined and any successor to its business
and/or assets as aforesaid which executes and delivers the agreement provided
for in this Section 9 or which otherwise becomes bound by all the terms and
provisions of this Agreement by operation of law.
(b) Benefits. This Agreement and all rights of Executive
hereunder shall inure to the benefit of and be enforceable by Executive's
personal or legal representatives, executors, administrators, successors,
heirs, distributees, devisees and legatees. If Executive should die while
any amounts would still be payable to him hereunder if he had continued to
live, all such amounts, unless otherwise provided herein, shall be paid in
accordance with the terms of this Agreement to Executive's devisee, legatee,
or other designee or, if there be no such designee, to Executive's estate.
9. Miscellaneous Provisions.
(a) Execution in Counterparts. This Agreement may be executed
in one or more counterparts, and by the different parties hereto in separate
counterparts, each of which shall be deemed to be an original but all of
which taken together shall constitute one and the same agreement.
(b) Notices. All notices, requests, demands and other
communications hereunder shall be in writing and shall be deemed to have been
duly given or made as of the date delivered, if delivered personally, or
three calendar days after having been mailed, if mailed by registered or
certified mail, postage prepaid, return receipt requested, as follows:
If to Employer, to: Sound Source Interactive,Inc.
2985 East Hillcrest Drive
Suite A
Westlake Village, CA 91362
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If to Executive, to: Ulrich E. Gottschling
6437 East Joshua Tree
Orange, CA 92867
or to such other address as either party hereto shall have designated by like
notice to the other party hereto (except that a notice of change of address
shall only be effective upon receipt).
(c) Amendment. This Agreement may only be amended by a
written instrument executed by each of the parties hereto.
(d) Entire Agreement. This Agreement constitutes the entire
agreement of the parties hereto with respect to the subject matter hereof,
and supersedes all prior agreements and understandings of the parties hereto,
oral and written.
(e) Applicable Law. This Agreement shall be governed by the
laws of the State of California applicable to contracts made and to be wholly
performed therein.
(f) Headings. The headings contained herein are for the sole
purpose of convenience of reference and shall not in any way limit or affect
the meaning or interpretation of any of the terms or provisions of this
Agreement.
(g) Waiver, etc. The failure of either of the parties hereto
to at any time enforce any of the provisions of this Agreement shall not be
deemed or construed to be a waiver of any such provision, nor to in any way
affect the validity of this Agreement or any provision hereof or the right of
either of the parties hereto to thereafter enforce each and every provision
of this Agreement. No waiver of any breach of any of the provisions of this
Agreement shall be effective unless set forth in a written instrument
executed by the party against whom or which enforcement of such waiver is
sought; and no waiver of any such breach shall be construed or deemed to be a
waiver of any other or subsequent breach.
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IN WITNESS WHEREOF, this Agreement has been executed and delivered
by the parties hereto as of the date first above written.
EMPLOYER:
SOUND SOURCE INTERACTIVE, INC.
By:/s/ Vincent J.Bitetti
-------------------------------------------
Vincent J. Bitetti
Chief Executive Officer
SOUND SOURCE INTERACTIVE, INC.
By:/s/ Vincent J. Bitetti
-------------------------------------------
Vincent J. Bitetti
Chief Executive Officer
EXECUTIVE:
/s/ Ulrich E. Gottschling
----------------------------------------------
Ulrich E. Gottschling
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Exhibit 23.1
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
Sound Source Interactive, Inc.
We hereby consent to the use in this Registration Statement of our report
dated September 16, 1996 relating to the consolidated financial statements as
of and for the two-year period ended June 30, 1996 appearing in the
Prospectus, which is part of the Registration Statement of Sound Source
Interactive, Inc. and to the reference to us under the heading
"Experts" in the Prospectus.
/s/ Corbin & Wertz
CORBIN & WERTZ
Irvine, California
May 9, 1997
