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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
----- EXCHANGE ACT OF 1934
For the fiscal year ended June 30, 2000
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
----- EXCHANGE ACT OF 1934
For the transition period from __________ to
Commission File No. 0-28604
SOUND SOURCE INTERACTIVE, INC.
(Name of Small Business Issuer in its Charter)
Delaware 95-4264046
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
26115 Mureau Road, Suite B
Calabasas, California 91302
(Address of principal executive offices) (Zip Code)
(818) 878-0505
(Issuer's telephone number
including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Common Stock, par value $.001
Redeemable Warrants
Check whether the Issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the issuer was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days.
Yes [X] No [_]
Check if there is no disclosure of delinquent filers pursuant to Item 405
of Regulation S-B contained herein, and such disclosure will not be contained,
to the best of the Issuer's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [X]
State Issuer's revenues for its most recent fiscal year: $2,623,520
The aggregate market value of the common stock of the Issuer (the "Common
Stock") held by nonaffiliates, based on the market price at September 30,2000,
was approximately $2,044,804. As of September 30, 2000, there were 10,661,796
shares of the Common Stock outstanding and 6,253,824 redeemable warrants.
Transitional Small Business Disclosure Format: Yes [_] No [X]
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DOCUMENTS INCORPORATED BY REFERENCE
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Portions of the Issuer's Proxy Statement to be filed with the Securities
and Exchange Commission within 120 days of the close of its fiscal year ended
June 30, 2000 are incorporated by reference into Part lll of this Form 10-KSB.
INDEX
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PART I
Page No.
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ITEM 1. DESCRIPTION OF BUSINESS.......................................... 3
ITEM 2. PROPERTIES....................................................... 12
ITEM 3. LEGAL PROCEEDINGS................................................ 12
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.............. 12
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND
RELATED SHAREHOLDER MATTERS.................................... 13
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS...................................... 15
ITEM 7. FINANCIAL STATEMENTS............................................. 20
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE............................ 20
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS..... 21
ITEM 10. EXECUTIVE COMPENSATION........................................... 24
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT... 28
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................... 30
PART IV
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K................................. 30
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SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS
This Annual Report on Form 10-KSB contains statements that are based upon
certain estimates, projections and other forward-looking statements within the
meaning of the Securities Litigation Reform Act of 1995 with respect to Sound
Source Interactive, Inc. (the "Company"). Forward-looking statements give the
Company's expectations of forecast of future events. These statements can be
identified by the fact that they do not relate strictly to historical or current
facts. They use words such as "estimate," "expect," "project," "plan,"
"believe," "anticipate" "intend," and other words and terms of similar meanings
in connection with disclosures of future operating or financial performance. In
particular, these statements relate to future actions, prospective performance
or results of current and anticipated products, sales, efforts, expenses, the
outcome of contingencies such as legal proceedings, and financial results.
All of the forward-looking statements contained in this Annual Report on
Form 10-KSB or in other Company publications may turn out to be wrong. They can
be affected by inaccurate assumptions or by known or unknown risks and
uncertainties. Many such factors will be important in determining actual or
future results. Consequently, no forward-looking statement can be guaranteed.
The Company's actual results may vary materially and there are no guarantees
about the performance of the Company's publicly traded securities.
The Company undertakes no obligation to correct or update any forward-
looking statements, whether as a result of new information, future events or
otherwise. Future disclosures on related subjects in the Company's reports to
the Securities and Exchange Commission (the "SEC") may update some of the
Company's `s disclosures (including Forms 10-QSB and 8-K filed in the future)
contained herein.
Some of the facts that could cause uncertainties are:
- New competitors and intensification of price competition from other
manufacturers of consumer software products and/or toy companies and the
studio licensors themselves;
- New products that make the Company's products and services obsolete;
- Inability to obtain additional capital as needed;
- Loss of customers;
- Technical problems with the Company's products and services;
- Departure of key employees, and inability to attract new employees;
- Litigation and administrative proceedings;
- Departure or retirement of key executives; and
- Contracts tied to key executives and / or change in control.
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PART I
ITEM 1. DESCRIPTION OF BUSINESS.
The Company
Sound Source Interactive, Inc. and Subsidiaries (the "Company"), which was
incorporated in Delaware on March 8, 1990, is engaged primarily in developing,
publishing and marketing of interactive computer software and video games
primarily based on well recognized intellectual content. The Company produces
educational software and entertainment software for the PC CD ROM format and
includes the development, marketing and publishing of video games for electronic
entertainment platforms other than the PC. PC CD ROM Educational software
consists principally of children's educational and entertainment type products
including Interactive MovieBooks(TM), Activity Centers and Learning
Adventures(TM) (including Math, Kindergarten, Preschool, etc) for children ages
two to twelve. The Company expects to ship its first products for platforms
other than the PC in the first fiscal quarter of 2001.
The Company's objective is to be a leading publisher of high quality,
competitively priced, Consumer oriented children's and casual gaming software on
both the PC and dedicated game console formats such as Sony PlayStation and
Nintendo Game Boy. 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 programming, home video
franchises, children's literary works and other intellectual characters or
brands, 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 trade name recognition, (v)
leverage its licensed content to develop products intended for the dedicated
game console market, and (vi) pursue strategic alliances, joint ventures and
acquisitions.
Many of the Company's products are based on the licensed content of major
motion picture studios including Twentieth Century Fox Licensing, New Line
Cinema, Harvey Entertainment, Warner Bros. Consumer Products, Universal Studios
and others. The Company's license agreements for existing products include The
Land Before Time(TM), Casper(TM), Lost In Space(TM), An American Tail(TM), The
Berenstain Bears(TM), The King and I(TM) and Maisy(TM). The Company is
continuing the discussion and negotiation of additional licenses to develop new,
high quality software products using content from such intellectual properties.
The licensing contracts with the licensors/studios are generally three to
five years in duration. The licenses are usually exclusive, worldwide and
typically allow for multiple titles to be produced in all applicable localized
languages to suit market needs by territory. The Company seeks licenses that
have strong brand awareness worldwide and franchises that receive studio
support.
In addition to CD-ROM, many of the licenses allow for digital videodisk
("DVD") and dedicated game console formats such as the Sony(TM) PlayStation(TM).
Universal's The Land Before Time(TM) franchise will be among the first titles
shipped by the Company on the Sony PlayStation format in time for the holiday
selling season of calendar 2000. On July 22nd, 1998 the Company signed a four
year Publishing license agreement with Sony Entertainment Corporation of America
to publish Sony PlayStation titles and on September 30th, 1998 signed an
additional agreement to become an authorized developer for the PlayStation
dedicated game console system. Subsequently, the Company has also been licensed
for the Sony PlayStation2 Computer Entertainment System. The Company is also
an authorized
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developer and Publisher for the Nintendo Game Boy Color handheld gaming system
and is exploring other dedicated game console opportunities such as Microsoft's
X-Box, Nintendo's Game Cube and Game Boy Advance systems as well as new wireless
technologies such as cellular phone consumer-based entertainment.
The Company believes that as of August 31, 2000, its products were in
distribution to approximately 6,000 retail outlets. Retailers currently selling
one or more of the Company's products include Toys R Us, Office Depot, Office
Max, Staples, CompUSA, Best Buy, BJ's, Electronics Boutique, Babbages, Etc.,
Kmart, Costco, Learningsmith, Wal-Mart, Zainy Brainy, Virgin Megastores, Fry's
Electronics and others including numerous e-commerce internet stores such as
eToys and Beyond.com.
The Company is located at 26115 Mureau Road, Suite B, Calabasas,
California, 91302. Its telephone number is (818) 878-0505, and its facsimile
number is (818) 878-0007.
Industry Background
In recent years, the installed base of multimedia personal computers
("Multimedia PCs") in households has grown as prices have declined and as
improvements in computing power and capability have been achieved. There are a
number of factors driving the increased demand and use of Multimedia PCs in U.S.
and foreign households beyond the general impact of falling prices and increased
performance. Enabling technologies and standards, such as graphical user
interfaces and the Internet 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 have
allowed software developers to produce more engaging software with advanced
three-dimensional graphics, realistic sound and full-motion video suitable for
both educational and entertainment - oriented content.
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
CDs and motion picture videos. With the increasing consumerization of the
software market, prices for consumer software products are now at impulse price
levels ranging from $4.99 on CD ROM to $49.99 on dedicated game platforms such
as Sony PlayStation and Nintendo Game Boy. The Company believes that the
distribution channels for consumer software will continue to expand to include
book and music stores, toy stores, department stores, electronic stores,
appliance stores, video outlets, supermarkets, catalogs and internet e-commerce
stores. In addition, technology will soon allow for broadband distribution of
certain software products into households with `'fast internet access'' on a pay
per view basis similar to the cable television industry. See Part I, Item 1,
"Description of Business - Risk Factors - Forward-Looking Statements."
The home video game Software market consists both of cartridge-based and
CD-ROM-based Software for use solely on dedicated hardware systems manufactured
by the Manufacturers, and to a significantly lesser extent, other vendors. Until
1996, most Software for dedicated Platforms was sold in cartridge form. However,
CD-ROMs have become increasingly popular because they have substantially greater
data storage capacity and lower manufacturing costs than cartridges. The first
modern Platform was introduced by Nintendo in 1985 using "8-bit" technology. "8-
bit" means that the central processing unit, or "chip," on which the Software
operates is capable of processing data in 8-bit units. Subsequent advances in
technology have resulted in continuous increases in the processing power of the
chips that power the Platforms. As the technology of the hardware has advanced,
the Software designed for the Platforms has similarly advanced, with faster and
more complex images, more lifelike animation and sound effects and more
intricate scenarios. The larger data storage capacity of CD-ROMs enable them to
provide richer content and longer play. Portable Platforms manufactured by the
Manufacturers are less sophisticated technologically and do not require
television monitors. Currently, the non-portable
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Platforms being marketed are based primarily on 32-bit and 64-bit technology. In
addition, so-called `'next generation'' systems are on the way with Sony's
PlayStation2 hitting store shelves in time for the holiday 2000 selling season.
The Company also expects to see DVD ROM and possibly other `'optical disk''
formats replace the CD-ROM over the next few years as their capacity is far
greater than current CD-ROM media formats which will allow for more information,
such as multiple languages and higher quality graphics to be formatted and
stored on a single disk. Handheld video games systems such as manufactured by
Nintendo utilize an IC chip-based storage medium encased in a durable plastic
cartridge which is manufactured in Japan. The IC chip storage capacity varies
per game as dictated by sophistication and design demands of the software.
As consumer software has become a mass-market product, the Company believes
it is increasingly important for consumer software companies to have direct
relationships with retailers to effectively market their products to consumers.
The Company believes that in order to be successful, consumer software companies
must have international distribution (with products produced/translated to local
languages), a consumer-driven focus, a broad offering of category-leading
products, close relationships with distributors and retailers, a recognized
brand name and a cost-efficient business model. In an effort to incrementally
increase the Company's revenues, as well as create new revenue sources, the
Company is active in searching for new ways to market the Company's products.
Included in these non-traditional methods is e-commerce, internet marketing and
web links, email campaigns direct to consumers, the placement of coupons in
videos, coupons in complimentary products, "un-lockable" discs, and enhanced up-
sell programs.
Core Competence
To achieve its objectives, the Company believes that a high quality product
with solid playability is critical to consumer acceptance and repeat purchases.
The Company's products are produced in sustainable categories by product
development teams that have achieved or acquired a core competence in those
categories. The products are produced in the Company's Calabasas, California
offices and/or by qualified outside developers that are managed by Company
personnel. The Company has outsourced a majority of its product development to
gain greater expertise across a wider spectrum of product types and to better
control overhead and other related expenses. As of July 2000, PC Data, Inc., a
qualified industry source, ranked the Company as the eleventh largest
educational software publisher in the United States. The Company will not
release its first video game until fall 2000 and therefore is not currently
included in available video game sales tracking data.
Products
Children's Software
The Company has divided its children's software products into the following
categories:
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Curriculum Series PC CD ROM
This product line contains both subject specific and multi-subject
children's learning products based on accepted curriculum standards and
practices. Titles include: The Land Before Time(TM) Math Adventure, The Land
Before Time(TM) Kindergarten Adventure, The Casper(TM) Early Reader, The
Babe(TM) Preschool Adventure and others. Currently, the products are sold at
suggested retail prices of up to $20 each. To date, the Company has released 9
subject specific or multi-subject educational products and has under development
one additional product that is scheduled for release prior to December 2000.
According to PC Data, Inc., curriculum-based products currently account for
approximately 36 percent of the consumer educational software market. It is
anticipated that as the Company transitions to the video game console
entertainment market, the Curriculum Series titles will be phased out of the
product line.
Play and Learn Series PC CD ROM
This product line contains titles that have learning and/or fun activities
that may not be curriculum specific, intended to teach young children logic,
language skills, arithmetic and reading comprehension, along with developmental
challenges such as multiple choice questions, rhyme and motor basics while
entertaining and captivating the players. Titles include: The Land BeforeTime
Interactive MovieBook(TM), The American Tail Interactive MovieBook(TM), The Babe
Interactive MovieBook(TM), The Land Before Time(TM) Activity Center, The
Casper(TM) Activity Center, The King and I Thinking Adventure(TM), The Lost in
Space(TM) Learning Adventure and others. Currently, the products are sold at
suggested retail prices of up to $20 each. To date the Company has released 16
Edutainment titles. According to PC Data, products in the edutainment categories
account for approximately twenty five percent of the consumer educational
software market. It is anticipated that as the Company transitions to the video
game console entertainment market, the Play and Learn Series titles will be
phased out of the product line.
Life Skills Series PC CD ROM
Designed specifically for children ages 2 to 6, the product line contains
titles that emphasize early learning activities intended teach young children
independence, confidence and other socially responsible traits such as getting
along, cleaning up, and recycling. Familiar themes such as logic, matching
skills, and color recognition round out the game play while entertaining and
captivating the players. Currently, the products are sold at suggested retail
prices of up to $20 each. To date the Company has released 5 Life Skills Series
titles and has under development one additional product that is scheduled for
release prior to December 2000. There is currently no relevant tracking data
available from PC Data or other source for this new software category. It is
anticipated that as the Company transitions to the video game console
entertainment market, the Life Skills Series titles will be phased out of the
product line.
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Video Game Software
The Company intends to ship three entertainment-based video games for the
holiday 2000 selling season based on currently licensed content. The first
titles released during the transition from PC only formats to the video game
formats will be based on The Land Before Time, Casper and the Berenstain Bears.
These titles will be available for the Sony PlayStation (Land Before Time:
Return to the Great Valley and Casper: Friends Around The World) and the
Nintendo Color Game Boy (Extreme Sports with the Berenstain Bears). The first
titles shipped in the transition will be for children 5 to 8. Subsequent titles
will not only embrace this age group, but also 8+ (8 years old to the casual
gamer/family entertainment). The first wave of products will carry a suggested
retail price of $19.99 at most retailers.
Product Distribution
North American Sales
On March 14, 2000, the Company entered into a national sales representation
agreement with Strategic Marketing Partners, a leading manufacturers product
representation firm. Simultaneously, the Company's exclusive distribution
agreement with Macmillan Digital Publishing was terminated and a 90 day
transition (as contemplated in the agreement) took place. Macmillan's
capabilities (sales and distribution) do not include the ability to sell or
distribute video game software as contemplated by the Company. The Company will
manage the Strategic Marketing Partners sales force via a VP of National Sales
and sign up retailers and independent (non-exclusive) distributors as necessary.
The Company maintains reserves for bad debts and product returns based upon its
prior experience, industry standards, and as market conditions dictate, against
which credits for actual bad debts and returns are applied.
International Sales
Although the Company utilizes several international distributors to
actively promote and sell the Company's English language products throughout
most of the English speaking countries, the majority of international business
is conducted via a Republishing and Distribution agreement with TDK Recording
Media Europe S.A. to distribute its software titles throughout Europe and other
territories. The Company signed an expanded worldwide agreement with TDK Europe
on February 28, 2000. Under the terms of the TDK agreement, the Company is paid
a republishing fee on each product sold. All costs of localization of the
product, product boxes and collateral materials, as well as all costs or
replication, marketing, warehousing and fulfillment, are borne by TDK. The
success of the localization is dependent upon the international appeal of
certain of the Company's products, growth of the interactive software market
internationally, the ability of the republishing partners to successfully
localize and market the products and the ability of the Company to continue to
obtain licenses with worldwide appeal.
Sales and Marketing
By offering a portfolio of products, the Company believes that it 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, children's television, literary works and direct
to video titles. These promotional programs may include discount coupons for
products in videocassettes, movie trailers in the Company's software products,
and promotional contests with various motion picture studios. The Company is
actively seeking additional cross-promotion opportunities. The Company believes
that additional revenues could be generated
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through the Company's involvement in cross-promotional efforts with studio
partners, other licensees and direct sale programs, although there can be no
assurance that such will occur.
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
emphasizing high-impact design and concise, non technical product information,
lead to higher visibility and impulse purchases of its products in retail
stores.
The Company provides product and technical support to its customers by
telephone and on-line via its web site (soundsourceinteractive.com). The
Company has also 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 and
producers for development of product enhancements and upgrades.
Development
The Company seeks to develop a broad line of products in sustainable market
categories in which a reasonable market share can be obtained. The Company
believes that its development model is consistent with industry standards,
including high product quality, reliable delivery schedules, cost containment
and controlled capital investment risk.
The Company's product managers (producers) 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 licensor based upon upcoming theatrical and/or video and book releases,
television programming, 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 producers then execute the development project with a team that
includes programmers, sound engineers, artists, animators, designers, writers
and testers. The Company's 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 sometimes partially paid by
royalties based on net sales, which lowers the Company's investment risk. The
Company's agreements with its external developers grant the Company an exclusive
worldwide license to use the developers' source code. The agreements typically
have three-year terms, with renewal provisions upon mutual agreement of the
parties. The Company expects to outsource the majority of product development to
qualified outside sources for the foreseeable future.
Products under development are extensively tested by the quality assurance
department, and must be approved by the licensor(s) 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. Producers are also responsible for reviewing customer
feedback,
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competitive products, product performance and market positioning in order to
introduce features that keep abreast of consumer tastes and trends. Products
designed for dedicated video game consoles are tested and evaluated in a similar
fashion.
The Company currently is the licensee under technology licenses with
Microsoft Corp., Apple Computer, Inc., Macromedia, EchoMedia, Sony Entertainment
Corporation of America and Nintendo of America. The Company utilizes technology
provided by these licensors to develop and operate several of its products.
Operations
The Company controls all purchasing, inventory, scheduling, order
processing and accounting functions related to its operations, with all
production and warehousing performed by independent contractors in accordance
with the Company's specifications. The Company intends to continue to invest in
additional management information systems and other capital equipment, which it
believes to be necessary to achieve operational efficiencies and support
increasing sales volumes.
The Company and/or its designated outside contractors (developers) prepare
master software disks, user manuals and packaging designs. 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 and or technology licensor specifications. The
Company has multiple sources for most components, with assembly and shipping
currently performed by several independent fulfillment houses. To date, the
Company has not experienced any material difficulties or delays in the
production and assembly of its products. It is anticipated that the Company will
continue with this process in regards to CD ROM and DVD titles. Dedicated game
console products are manufactured and packaged by the respective licensors (such
as Sony and Nintendo) and then forwarded to company designated fulfillment
centers for physical distribution to retail stores and non-exclusive
distributors.
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 have broadened their product lines to compete with the
Company's licensed products, and new competitors, including computer hardware
and software manufacturers, diversified media companies and toy companies have
entered the consumer software market, resulting in greater competition for the
Company.
Only a small percentage of products introduced in the consumer software
market achieve any degree of, or have sustained, market acceptance. Principal
competitive factors in marketing consumer software include product features,
quality, reliability, trade name and licensed title recognition, ease-of-use,
merchandising, access to distribution channels and retail shelf space,
marketing, price and the availability and quality of support services. The
Company believes that it continues to compete effectively in these areas,
particularly in the areas of quality, brand recognition, ease-of-use,
merchandising, access to distribution channels and retail shelf space and price.
The Company considers Sony, Nintendo, THQ, Activision, Eidos, Infogrames,
Hasbro, Havas, Disney, and New Kid Co. to be its chief competitors.
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Proprietary Rights and Licenses
The Company regards its software as proprietary and relies primarily on a
combination of trademark, copyright and trade secret laws, employee and third
party nondisclosure agreements and other methods to protect its proprietary
rights. During the fiscal years ended June 30, 2000, 1999 and 1998, the Company
was unaware of any significant amount of unauthorized copying of its products.
The Company's products are based primarily upon the licensed content of
major motion picture studios under exclusive license agreements. All of such
license agreements to which the Company currently is a party are for fixed
terms, which will expire over the next five years. Additionally, the Company
attempts to obtain in all of its agreements automatic renewals based on
achievement of certain milestones, and/or the right of first refusal and last
negotiation for additional products utilizing the same characters. The Company
anticipates that in most cases the licensor under each agreement will extend its
terms, although no licensor is required to extend any license. Provided that
the Company is in compliance with all requirements of each license, including
most significantly that the Company has satisfied the applicable minimum royalty
guarantees, the licenser can not prematurely cancel a license.
Employees
As of September 30, 2000, the Company had 24 full-time employees, including
3 employees in sales and marketing, 10 employees in development and customer
support, 9 employees in administration and finance and 2 employees in licensing.
None of the Company's employees are represented by a labor union or are subject
to a collective bargaining agreement. From time to time the Company will engage
consultants and independent contractors.
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Recent Developments
On September 8, 2000, the Company and TDK USA Corporation, a New York
corporation ("TDK"), entered into a Purchase Agreement (the "Purchase
Agreement"), pursuant to which TDK agreed to purchase, and the Company agreed to
sell, a total of 16,667,000 shares of common stock, par value $.0001 per share
of the Company (the "Common Stock"), for the purchase price $.30 per share and
an aggregate purchase price of $5,000,100. The Purchase Agreement contains
representations, warranties, covenants, and conditions customary for a
transaction of this size and nature.
Upon the execution of the Purchase Agreement, TDK acquired 4,750,000 shares
of Common Stock for an aggregate purchase price of $1,425,000 (the "Initial
Closing"). Pursuant to the Purchase Agreement, TDK has agreed to purchase an
additional 11,917,000 shares of Common Stock for an aggregate purchase price of
$3,575,000 (the "Subsequent Closing"). The Subsequent Closing is subject to the
satisfaction of certain conditions, including (i) the filing of amendments to
the Company's Certificate of Incorporation (the "Charter Amendment") to (a)
change the name of the Company to "TDK Mediactive, Inc." and (b) increase the
number of shares of Common Stock the Company is authorized to issue from
20,000,000 to 50,000,000 and (ii) (a) the resignation of each of Richard
Azevedo, Mark A. James and Samuel L. Poole as directors of the Company and (b)
the resulting vacancies having been filled by the remaining directors
appointment of nominees designated by TDK. In the event that the directors
described above shall not have resigned as of the Subsequent Closing, TDK may
waive such condition and execute a Written Consent of Stockholders of the
Company for the purpose of removing from office those directors and electing in
their place the TDK nominees. There can be no assurance that all of the
conditions will be satisfied and that the Subsequent Closing will occur on the
terms set forth herein or at all.
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Following the consummation of the Initial Closing, TDK became the Company's
largest stockholder owning approximately 45% of the outstanding Common Stock.
Upon the consummation of the Subsequent Closing and based upon the number of
shares of Common Stock currently outstanding, TDK will own approximately 74% of
the outstanding Common Stock.
Simultaneous with the Initial Closing, the Company and TDK entered into a
registration rights agreement (the "Registration Rights Agreement") pursuant to
which the Company granted to TDK certain registration rights with respect to the
Common Stock purchased and owned by TDK pursuant to the Purchase Agreement.
Furthermore, simultaneous with the Initial Closing, the Company, TDK and
Mr. Vincent J. Bitetti entered into a lock-up agreement (the "Lock-Up
Agreement"), whereby Mr. Bitetti agreed to certain limitations on his rights to
sell or otherwise transfer any Common Stock that he now owns or may acquire from
the Company pursuant to options that he now holds.
ITEM 2. DESCRIPTION OF PROPERTY.
The Company leases approximately 8,613 square feet of office and
warehousing space in Calabasas, Los Angeles County, California, under a lease
which expires on May 31, 2002. The Company currently expects that these
facilities will be sufficient for its needs at least through the term of the
lease. The Company may lease additional space as its needs require, which it
believes will be available on acceptable terms.
ITEM 3. LEGAL PROCEEDINGS.
The Company and its officers and directors in the past have been, and in
the future the Company and/or its officers and directors may be, involved in
suits and actions incidental to the Company's business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of security holders in the fourth
fiscal quarter of 2000.
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PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's Common Stock and Redeemable Warrants were traded on the
NASDAQ Small Cap Market under the symbols "SSIIBB" and "SSIIWBB," respectively,
for the period from July 2, 1996 to September 3, 1999. On September 3, 1999, the
Company's securities were delisted from the NASDAQ Small Cap Market, and on that
date the Common Stock commenced trading on the OTC Bulletin Board. The
Redeemable Warrants, however, do not presently trade on any market other than
the "pink sheets". 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.
<TABLE>
<CAPTION>
Common Stock High Low
---- ----
<S> <C> <C>
1998
Fourth Calendar Quarter 1.25 0.59
1999
First Calendar Quarter 2.25 0.56
Second Calendar Quarter 1.25 0.31
Third Calendar Quarter 0.69 0.25
Fourth Calendar Quarter 0.59 0.25
2000
First Calendar Quarter 0.52 0.28
Second Calendar Quarter 0.69 0.22
Third Calendar Quarter 1.02 0.27
Redeemable Warrants High Low
---- ----
<S> <C> <C>
1998
Fourth Calendar Quarter 0.16 0.03
1999
First Calendar Quarter 0.22 0.03
Second Calendar Quarter 0.13 0.03
Third Calendar Quarter 0.09 0.01
Fourth Calendar Quarter 0.02 0.01
2000
First Calendar Quarter 0.05 0.01
Second Calendar Quarter 0.06 0.01
Third Calendar Quarter 0.06 0.01
</TABLE>
As of September 30, 2000, there were approximately 154 holders of record of
the Common Stock and 57 holders of record of the Redeemable Warrants. Most such
securities are held in street name by nominees who hold stock certificates for
an unknown number of beneficial owners.
13
<PAGE>
During fiscal 2000, the Company did not sell any equity securities that
were not registered under the Securities Act of 1933.
The Company has never paid cash dividends on its Common Stock. The Company
currently intends to retain any earnings for use in its operations and does not
anticipate payment of cash dividends in the foreseeable future.
14
<PAGE>
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
Overview
The following is a discussion of the consolidated financial condition and
results of operations of the Company for the fiscal years ended June 30, 2000,
1999 and 1998, and certain factors that are expected to affect the Company's
prospective financial condition. See "Special Note Regarding Forward-Looking
Statements."
The Company derives substantially all of its revenues from sales of its
retail consumer software. The Company designs, develops, markets and supports a
broad line of consumer software products. The Company focuses primarily on
family-oriented products with educational and entertainment value, which are
easy to use and install, using popular licensed intellectual content.
On March 14, 2000, the Company entered into a national sales representation
agreement with Strategic Marketing Partners, a leading manufacturers product
representation firm. Simultaneously, the Company's exclusive distribution
agreement with Macmillan Digital Publishing was terminated and a transition from
an exclusive distribution partner to a direct sales and non-exclusive
distribution model was adopted. Macmillan's capabilities do not include the
ability to sell or distribute video game software as contemplated by the
Company. The Company will manage the Strategic Marketing Partners sales force
via its VP of National Sales and sign up retailers and independent (non-
exclusive) distributors as necessary. The Company maintains reserves for bad
debts and product returns based upon its prior experience, industry standards,
and as market conditions dictate, against which credits for actual bad debts and
returns are applied.
Net sales consist of gross sales net of allowances for returns, credit
losses and other adjustments. The Company adjusts its allowance for returns as
it deems appropriate. The Company could be forced to accept substantial product
returns or other concessions to maintain its relationships with retailers and
distributors and its access to distributor channels. The Company is also
exposed to the risk of returns of defective, shelf-worn and damaged products
from retailers and distributors.
Costs of sales consist primarily of product cost, freight charges,
royalties to outside developers, programmers and content providers, and an
inventory provision for damaged and obsolete products. Product costs consist of
the costs to purchase the underlying materials and print boxes and manuals,
media costs and fulfillment.
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<PAGE>
Results of Operations
Fiscal Year Ended June 30, 1999 Compared to Fiscal Year Ended June 30, 2000
Net Revenues. Net revenues decreased by 43.3 percent from $4,624,540 for
the year ended June 30, 1999 to $2,623,520 for the year ended June 30, 2000.
Product sales of the Company's software products decreased by 46.3 percent from
$4,556,442 in 1999 to $2,446,412 in 2000. The decrease in sales is attributed to
the Company's inability to sufficiently fund operations through CD ROM sales
revenues in the absence of additional financing and significant CD ROM returns
during the fiscal year. In addition, the Company began to transition to the
video game business which was being funded in part via a series of advances from
TDK Recording Media Europe. Net sales for the 12 months ended June 30, 2000 also
included revenue of $437,500 from TDK Recording Media Europe ("TDK", as
previously defined), representing a non-refundable contract guarantee against
the Company's international republishing and distribution agreement. The Company
has recognized revenue only when certain milestones and passage of time have
occurred. The Company has approximately $4,800,000 in deferred revenue at June
30, 2000 related to these agreements. The agreement with TDK extends through
February 28, 2005. The Company has established a reserve for product 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. Cost of Sales decreased by 20.1 percent from $3,175,637
during 1999 to $2,535,776 during 2000, and increased as a percentage of net
sales from 68.7 percent to 96.7 percent during the same periods. This decrease
in cost of sales is attributable to the above noted 43.3 percent decrease in net
sales. The increase in cost of sales as a percentage of revenues is primarily
due to the transition of distribution services from MDP to direct distribution
in 2000 and also attributable to the writeoff of obsolete inventory product and
prepaid royalties determined not to be recoverable in future periods in the
amounts of $131,032 and $608,818, respectively.
General and Administrative. General and administrative costs decreased by
15.2 percent from $1,828,381 during 1999 to $1,549,877 during 2000 and increased
as a percentage of net sales from 39.5 percent to 59.1 percent, respectively.
The decrease of $278,504 is primarily attributable to (i) the reducing payroll
and related costs and (ii) stabilizing overhead and administrative costs during
the transition period. The increase in general and administrative costs as a
percentage of net sales is primarily attributable to the 43.3 percent decrease
in net sales as noted above. The Company anticipates that for the foreseeable
future, general and administrative expenses may increase as a percentage of net
sales as the Company self distributes products for North America.
Research and Development. Research and development expenses decreased by
29.5 percent from $1,356,867 during 1999 to $957,216 during 2000, and increased
as a percentage of net sales from 29.3 percent to 36.5 percent, respectively.
The decrease in costs of $399,651 is primarily related the limited new product
releases during 2000 as it began to develop new titles and platforms for
introduction during the new fiscal year of 2001. The increase in research and
development expenses as a percentage of net sales is primarily attributable to a
43.3 percent decrease in net sales. The Company believes that development costs
will increase as the Company develops additional children's products and as the
Company develops increasingly more complex products that contain additional
features. The Company is currently developing products for the Sony
Playstation2 and Nintendo Color Game Boy which require more expensive
development processes.
Sales and Marketing. Marketing and sales expenses decreased by 63.7
percent from $2,177,248 during 1999 to $789,281 during 2000, and also decreased
as a percentage of net sales from 47.1 percent to 30.1 percent, respectively.
This decrease in expenses was primarily due to decreased costs associated with
the cutback of internal sales and marketing as the Company transitioned its
business from CD Rom's to video game platforms and from the termination of the
distribution agreement with MDP distribution. The Company anticipates that for
the foreseeable future, marketing and sales expenses may increase as a
percentage of net sales as the Company self distributes products for North
America.
Other Income/Expense. Other expense increased by 3.5% form $62.437 in 1999
to $64,861 in 2000. The increase is due primarily to increase in miscellaneous
expense offset by decrease in interest expense.
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<PAGE>
Tax Provision. The current period tax provision is comprised of minimum
State of California Franchise Taxes of $2,400. The Company's effective tax rate
differs from the statutory Federal income tax principally as a result of Federal
and State net operating losses for which no deferred benefit is recognized due
to a full valuation allowance provided on the resulting deferred tax asset.
The net loss for the year ended June 30, 2000 was $3,275,890 as compared
with $3,977,630 for the prior fiscal year. The net loss for the year was
largely attributable to fewer CD ROM releases during the current year and
significant returns of existing CD ROM product. Despite the decrease in the
total operating expenses from $3,175,637 during 1999 to $2,535,776 during the
fiscal year ended 2000, the cost of sales increased as a percentage of net sales
from 68.7 percent in fiscal 1999 to 96.7 percent during fiscal 2000,
contributing to the net loss for the year. The increase in cost of sales as a
percentage of revenues is primarily due to the transition of distribution
services from MDP to direct distribution in 2000 and also attributable to the
writeoff of obsolete inventory product and prepaid royalties determined not to
be recoverable in future periods in the amounts of $131,032 and $608,818,
respectively.
17
<PAGE>
Fiscal Year Ended June 30, 1998 Compared to Fiscal Year Ended June 30, 1999
Net Sales. Net sales decreased by 47.9 percent from $8,867,490 for the
year ended June 30, 1998 to $4,624,540 for the year ended June 30, 1999. Total
sales of the Company's software products decreased by 48.3 percent from
$8,819,529 in 1998 to $4,556,442 in 1999. The decrease in sales is attributed
(i) the failure of our existing children's software, games and entertainment
utilities to substantively perform at retail during the period, (ii) the
postponement and eventual cancellation of a new strategy game title due to lack
of performance by the outside developer and (iii) the failure at retail of
certain of the Company's products that were linked to theatrical release
expectations. The lack of consumer acceptance for the Babe: Pig in the City
(TM) and The King & I theatrical releases translated into lower than expected
children's software revenue. Net sales for the 12 months ended June 30, 1999
also included revenue of $760,000 from TDK Recording Media Europe ("TDK", as
previously defined), representing a non-refundable contract guarantee against
the Company's international republishing and distribution agreement. The
agreement with TDK extends through October 31, 2001 and the Company expects TDK
to begin shipping titles by October 1999. The Company has established a reserve
for product 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. Cost of Sales decreased by 11.2 percent from $3,574,168
during 1998 to $3,175,637 during 1999, and increased as a percentage of net
sales from 40.3 percent to 68.7 percent during the same periods. This decrease
in cost of sales is attributable to the above noted 47.9 percent decrease in net
sales. The increase in cost of sales as a percentage of revenues is primarily
due to the transition of distribution services from SSIDS to MDP and to changes
in product mix to lower priced items. The increase in cost of sales is also
attributable to the writeoff of obsolete inventory product and prepaid royalties
determined not to be recoverable in future periods in the amounts of $120,968
and $372,476, respectively.
Marketing and Sales. Marketing and sales expenses increased by 6.4 percent
from $2,045,312 during 1998 to $2,177,248 during 1999, and increased as a
percentage of net sales from 23.1 percent to 47.1 percent, respectively. The
increase in expenses was primarily due to increased costs associated with
channel marketing, new product packaging design and branding, as well as
increased personnel costs associated with the development of an internal sales
and marketing team that was continued in the beginning months of the fiscal
year. The increase in marketing and sales expenses as a percentage of net sales
is primarily attributable to a 47.9 percent decrease in net sales. Internal
sales efforts were cut back with the signing of the master distribution
agreement with MDP. The Company anticipates that for the foreseeable future,
marketing and sales expenses may decrease as a percentage of net sales as the
Company distributes products for North America through master distributors such
as MDP.
General and Administrative. General and administrative costs decreased by
0.6 percent from $1,839,386 during 1998 to $1,828,381 during 1999 and increased
as a percentage of net sales from 20.7 percent to 39.5 percent, respectively.
This decrease of $11,005 is primarily attributable to an decrease of $155,193
relating to legal and SEC-related consulting expenses of $312,884 in the fiscal
year ended June 30, 1998 to $157,691 in the year ended June 30, 1999, which were
offset by increased expenses within the areas of asset depreciation and
salaries.
Compensation In Connection With Common Stock and Common Stock Options
Issued for Services Rendered. In 1998, the Company incurred non-cash charges
to earnings of $323,351 in connection with the vesting of stock options granted
to employees in prior fiscal years. No such charges were incurred in 1999. The
amount of the charge for 1998 was determined as the difference between the fair
market value of the stock at the date of grant and the exercise price.
Research and Development. Research and development expenses decreased by
14.1 percent from $1,580,413 during 1998 to $1,356,867 during 1999, and
increased as a percentage of net sales from 17.8 percent to 29.3 percent,
respectively. The decrease in costs is primarily related to the Company's
decision to exit the teen and above (non-family oriented software) game
marketplace and
18
<PAGE>
to decrease the number of products under development by the Company. The
increase in research and development expenses as a percentage of net sales is
primarily attributable to a 47.9 percent decrease in net sales. The Company
believes that development costs will increase as the Company develops additional
children's products and as the Company develops increasingly more complex
products that contain additional features. The Company is currently developing
products for the Sony Playstation, which require a more expensive development
process.
Tax Provision. The current period 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 1999 and sufficient net
operating loss carryforwards from 1997 to offset its 1998 taxable income.
Compensation In Connection With Common Stock and Common Stock Options
Issued for Services Rendered. A total of $323,351 and $333,029 of expenses for
1998 and 1997, respectively, relate to noncash charges to earnings in connection
with the vesting of stock options granted to employees in prior fiscal years,
determined as the difference between the fair market value of the stock at the
date of grant and the exercise price.
Research and Development. Research and development expenses increased by
29.6 percent from $1,219,456 during 1997 to $1,580,413 during 1998, and
decreased as a percentage of net sales from 26.5 percent to 17.8 percent,
respectively. The increase in costs is primarily related to increases in the
number of products under development by the Company and increased personnel
costs that resulted from the acquisition of BWT Labs, Inc., partially offset by
lower development costs for certain product types and the establishment of
royalty based agreements with certain developers. The Company believes that
development costs will continue to increase as the Company develops increasing
numbers of products and as the Company develops increasingly more complex
products that contain additional features. The Company is also evaluating other
platforms for product development.
Other Income. Other income is principally comprised of a recovery of a bad
debt from Acclaim Entertainment, Inc., the Company's former exclusive
distributor that had been previously reserved, and other income associated with
the settlement of the lawsuit filed by the Company against Acclaim.
Tax Provision. The current period 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 1997, and has sufficient net
operating loss carry-forwards to offset its 1998 taxable income.
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 the licenses upon which they are based and those of its
competitors, development and promotional expenses relating to the introduction
of new products or new versions of existing products, product returns, changes
in pricing policies by the Company and its competitors, the accuracy of
retailers' forecasts of consumer demand, the timing of the receipt of orders
from major customers, and account cancellations or delays in shipment. The
Company's expense levels are based, in part, on its expectations as to future
sales and, as a result, operating results could be disproportionately affected
by a reduction in sales or a failure to meet the Company's sales expectations.
Seasonality
The consumer software business traditionally has been seasonal. Typically,
net sales are the highest during the fourth calendar quarter and decline
sequentially in the first and second calendar quarters. The seasonal pattern is
due primarily to the increased demand for consumer software during
19
<PAGE>
the year-end holiday buying season. The Company expects its net sales and
operating results to continue to reflect seasonality.
Liquidity and Capital Resources
The Company's previous independent accountants' report dated September 10,
1999, relating to the Company's financial statements for the year ended June 30,
1999 and 1998, contained a paragraph expressing substantial doubt about the
Company's ability to continue as a going concern.
The Company incurred net losses of $3,275,890 and $3,977,630 for the fiscal
years ended June 30, 2000 and 1999, respectively while the Company realized a
net profit of $501,200 for the year ended June 30, 1998. The Company has not
historically generated sufficient cash flows to fund operations, and has had to
rely on debt and equity financings to fund operations. The Company had negative
working capital of $1,363,022 and $823,364 at June 30, 2000 and 1999.
The Company experienced a continual significant decrease in growth during
the last fiscal year as compared to the prior fiscal year. The Company
continues to search for new opportunities to obtain licenses and develop and
sell products. Additionally, the Company is expanding from the Personal Computer
Platform to embrace Dedicated Game Console Platforms such as Sony PlayStation
and is seeking new distributors and innovative ways to deliver its products to
consumers, most of which will require large up-front cash resources. If the
Company enters into agreements relating to such business opportunities in the
future, the Company will require additional financing to fund its growth.
Management has strengthened their distribution channels and product
offerings to include Sony Playstation and Nintendo Game Boy to enable the
Company to compete in the video game market place and raise the level of sales
to sufficiently fund operations. During the fiscal year 2000, cash flow
activity from operations show that the Company had invested more than $1.1
million in prepaid software development costs on newly released and upcoming
titles. In 1999, the Company signed an agreement with TDK Recording Media
("TDK"), a global electronic components manufacturer with a distribution
division of children's edutainment software. TDK provided $3.95 million in the
current fiscal year in accordance with this agreement and a new contract was
signed in February 2000 for expanded future TDK development and distribution.
On September 8, 2000, Sound Source Interactive, Inc. (the "Company") and
TDK USA Corporation, a New York corporation ("TDK"), entered into a common stock
purchase agreement (the "Purchase Agreement"), pursuant to which TDK agreed to
purchase, and the Company agreed to sell, a total of 16,667,000 shares of common
stock, par value $.0001 per share of the Company (the "Common Stock"), for the
purchase price $.30 per share and an aggregate purchase price of Five Million
One Hundred Dollars ($5,000,100). The Purchase Agreement contains
representations, warranties, covenants, and conditions customary for a
transaction of this size and nature.
Upon the execution of the Purchase Agreement, TDK acquired 4,750,000 shares
of Common Stock for an aggregate purchase price of $1,425,000 (the "Initial
Closing"). Pursuant to the Purchase Agreement, TDK has agreed to purchase an
additional 11,917,000 shares of Common Stock for an aggregate purchase price of
$3,575,000 (the "Subsequent Closing"). The Subsequent Closing is subject to the
satisfaction of certain conditions, including (i) the filing of amendments to
the Company's Certificate of Incorporation (the "Charter Amendment") to (a)
change the name of the Company to "TDK Mediactive, Inc." and (b) increase the
number of shares of Common Stock the Company is authorized to issue from
20,000,000 to 50,000,000 and (ii) (a) the resignation of each of Richard
Azevedo, Mark A. James and Samuel L. Poole as directors of the Company and (b)
the resulting vacancies having been filled by the remaining directors
appointment of nominees designated by TDK. In the event that the directors
described above shall not have resigned as of the Subsequent Closing, TDK may
waive such condition and execute a Written Consent of Stockholders of the
Company for the purpose of removing from office those directors and electing in
their place the TDK nominees. There can be no assurance that all of the
conditions will be satisfied and that the Subsequent Closing will occur on the
terms set forth herein or at all.
Following the consummation of the Initial Closing, TDK became the Company's
largest stockholder owning approximately 45% of the outstanding Common Stock.
Upon the consummation of the Subsequent Closing and based upon the number of
shares of Common Stock currently outstanding, TDK will own approximately 74% of
the outstanding Common Stock.
Simultaneous with the Initial Closing, the Company and TDK entered into a
registration rights agreement (the "Registration Rights Agreement") pursuant to
which the Company granted to TDK certain registration rights with respect to the
Common Stock purchased and owned by TDK pursuant to the Purchase Agreement.
Furthermore, simultaneous with the Initial Closing, the Company, TDK and
Mr. Vincent J. Bitetti entered into a lock-up agreement (the "Lock-Up
Agreement"), whereby Mr. Bitetti agreed to certain limitations on his rights to
sell or otherwise transfer any Common Stock that he now owns or may acquire from
the Company pursuant to options that he now holds.
The Company relied substantially on TDK advances within the current year in
order to meet their cash obligations. TDK has agreed to fund all cash
shortfalls during the next year.
During September 1997, the Company entered into a factoring agreement with
Silicon Valley Financial Services, a division of Silicon Valley Bank. The
factoring agreement provides the Company with borrowing availability of up to
85% of the Company's qualified gross domestic accounts receivable, not to exceed
$1,500,000 in the aggregate, at a rate of 1.75% per month of the average gross
daily factoring account balance. The credit agreement is renewed annually and is
secured by all the assets of the Company. As of June 30, 2000, the Company had
no outstanding borrowings under the agreement and is in the process of obtaining
renewal through September 30, 2001.
New Accounting Prouncements
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities" (SFAS No. 133). SFAS No. 133 requires companies to recognize all
derivatives contracts as either assets or liabilities in the balance sheet and
to measure them at fair value. If certain conditions are met, a derivative may
be specifically designated as a hedge, the objective of which is to match the
timing of gain or loss recognition on the hedging derivative with the
recognition of (i) the changes in the fair value of the hedged asset or
liability that are attributable to the hedged risk or (ii) the earnings effect
of the hedged forecasted transaction. For a derivative not designated as a
hedging instrument, the gain or loss is recognized in income in the period of
change. SFAS No. 133 is effective for all fiscal quarters of fiscal years
beginning after June 15, 2000. Historically, the Company has not entered into
derivatives contracts either to hedge existing risks or for speculative
purposes. Accordingly, the Company does not expect adoption of the new standard
on January 1, 2001 to affect its financial statements.
In December 1999, the SEC staff released Staff Accounting Bulletin No. 101,
"Revenue Recognition in Financial Statements" ("SAB 101"). SAB 101 provides
interpretive guidance on the recognition, presentation and disclosure of revenue
in the financial statements. SAB 101 must be applied to the financial statements
no later than the quarter ending September 30, 2000. The Company does not
believe that the adoption of SAB 101 will have a material affect on the
Company's financial results.
In March 2000, the Financial Accounting Standards Board issued
Interpretation No. 44 ("FIN 44") Accounting for Certain Transactions Involving
Stock Compensation, an Interpretation of APB Opinion No. 25. FIN 44 clarifies
the application of APB No. 25 for (a) the definition of employee for purposes of
applying APB No. 25, (b) the criteria for determining whether a plan qualifies
as a non-compensatory plan, (c) the accounting consequences of various
modifications to the terms of a previously fixed stock option or award, and (d)
the accounting for an exchange of stock compensation awards in a business
combination. FIN 44 is effective July 2, 2000, but certain conclusions cover
specific events that occur after either December 15, 1998, or January 12, 2000.
The Company has adopted FIN 44 in accounting for the stock options granted
during the year ended June 30, 2000.
ITEM 7. FINANCIAL STATEMENTS.
The information required by Item 7 is filed herewith under the Consolidated
Financial Statements of Sound Source Interactive, Inc. and Subsidiaries together
with the report of BDO Seidman dated September 20, 2000 in the financial
information section, included as Appendix A of this report.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
On November 29, 2000, Deloitte & Touche LLP resigned as principal
accountants and BDO Seidman LLP was appointed the Company's new independent
auditors on May 5, 2000.
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PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS
Board of Directors
The name, age, business experience and offices held by each director of the
Company as of September 30, 2000 are as follows:
Richard Azevedo, age 67, is President of Azevedo and Associates, Inc.,
which was formed in June 1995 as a consulting firm to the nursing industry, and
which owns 40 percent of Unified Health Services, LLC, an operator of nursing
homes, which Mr. Azevedo also founded and of which he serves as President. Mr.
Azevedo also is President of Star Nursing Home Enterprises, Inc., which he
founded in 1997 and which operates two nursing homes in northern California.
From 1991 to 1995, Mr. Azevedo was President of Jesse Lee Group, Inc., which he
also founded and which operated skilled nursing home facilities. From 1986 to
1990, Mr. Azevedo was President of Medicrest of California, a corporation
comprised of 18 skilled nursing home facilities. Prior to that Mr. Azevedo was
a real estate developer with Ron-Mar Constriction Company, Inc. Mr. Azevedo has
been a director of the Company since April 1998.
Vincent J. Bitetti, age 45, founded Sound Source Interactive, Inc., a
California corporation (the "Subsidiary"), in 1989 and served as the President
of the Subsidiary from its formation. For the period from the acquisition by
the Company of the Subsidiary in 1994 until November 12, 1999, Mr. Bitetti
served as the Chairman of the Board and Chief Executive Officer and as a
director of both the Company and the Subsidiary. Effective November 12, 1999,
Mr. Bitetti resigned as Chairman of the Board of the Company. Mr. Bitetti has
been a director of the Company since 1994.
Mark A. James, age 41, is a founding member of the law firm of James,
Driggs, Walch, Santoro & Thompson in Las Vegas, Nevada, where he has been a
partner since April 1996. From 1991 until the founding of James, Driggs, Walch,
Santoro & Thompson, he was a partner in the Las Vegas firm of Jolley, Urga,
Wirth & Woodbury. Mr. James also has been a member of the Nevada State Senate
since 1992, where he serves as Chairman of the Senate Committee on Judiciary,
and on the Natural Resources and Legislative Affairs and Operations committee.
Mr. James is a director of ASSI, Inc., a principal stockholder of the Company.
Mr. James has been a director of the Company since July 1996.
Samuel L. Poole, age 52, is the founder and CEO of Poole Investment
Ventures, a consulting and equity investment firm, located in Escondido, CA.
From January 1998 to October 1999, Mr. Poole was the President and Chief
Executive Officer of Arista Knowledge Systems, Inc., a privately held enterprise
software publisher creating delivery and management software for e-learning
environments, that was recently acquired by Digital Think. Prior to joining
Arista Knowledge Systems, from August 1992 until July 1997 Mr. Poole was
employed by Maxis, Inc., a publicly held entertainment software publisher, where
he ultimately served as President and Chief Executive Officer and as a director.
His prior employers include Walt Disney Software, Inc., a publisher of
entertainment and education software, where he was Director of Sales from
January 1991 to August 1992;Cinemaware Corporation, a software publisher, where
he was Vice President of Marketing and Sales from January 1989 to January 1991;
and IntelliCreations, Inc., an interactive entertainment software publisher of
which he founded and served as President from 1984 to 1989. He holds a B.A.
from Thiel College and an MBA from Kent State University. Mr. Poole currently
serves on the Board of Trustees of Thiel College, and is a director for Oasys
Network Solutions and Legacy Interactive, Inc. Mr. Poole has been a director of
the Company since April 1998.
21
<PAGE>
John T. Wholihan, age 62, has been Dean of the College of Business
Administration at Loyola Marymount University since 1984. Previously, he served
for five years as an Associate Dean at Bradley University, where he also served
as Director of the MBA Program and as Director of the Small Business Institute.
During this period, he also taught in the areas of strategic management and
international business. He was a Fulbright Scholar in Brazil in 1977. Mr.
Wholihan holds a B.S. from the University of Notre Dame, an MBA from Indiana
University and a Ph.D. from The American University. He has published numerous
articles and other scholarly works. He is a member of several academic
associations and honor societies, including the Academy of Management, the Small
Business Institute Directors Association, Beta Gamma Sigma and Alpha Sigma Nu.
He currently is President of the Western Association of Collegiate Schools of
Business. He is past President of the Association of Jesuit Colleges and
Universities - Business Deans. He was the founding President of the
International Association of Jesuit Business Schools. He is a member of the
Rotary Club of Los Angeles, the Financial Executives Institute and the Jonathan
Club. He has served on the board of directors of several small companies and
currently is a member of the Board of Trustees of the TIP Funds, a family of
publicly traded mutual funds. He is the immediate past Chairman of the Board of
Notre Dame Academy in Los Angeles. Mr. Wholihan has been a director of the
Company since April 1998.
Contemporaneously with the Subsequent Closing under the Purchase Agreement
with TDK, it is anticipated that Richard Azevedo, Mark A. James and Samuel L.
Poole will resign as directors of the Company, and that the resulting vacancies
will be filled by three new nominees of TDK. See Item 1, "Description of
Business - Recent Developments."
Board Committees
The Board of Directors currently has appointed three standing committees:
the Audit Committee, the Compensation Committee and the Strategic Planning
Committee.
The Audit Committee consists of Richard Azevedo, Mark A. James and Samuel
L. Poole. Its purpose is to recommend the appointment of an independent auditor
for the Company, review the scope of the audit, examine the auditor's reports,
make appropriate recommendations to the Board of Directors as a result of such
review and examination and make inquiries into the effectiveness of the
financial and accounting functions and controls of the Company.
The Compensation Committee consists of Richard Azevedo, Samuel L. Poole and
John T. Wholihan. It is responsible for reviewing and setting the compensation
of executive officers of the Company and for administering the Company's stock
option plans.
The Strategic Planning Committee consists of Vincent J. Bitetti, Mark A.
James and Samuel L. Poole. The Strategic Planning Committee is responsible for
overseeing the development of the Company's strategic planning process.
Board and Committee Meetings
In fiscal 2000, the Board of Directors held 4 meetings. Board committees
met as follows during fiscal 2000: the Compensation Committee did not meet, the
Audit Committee met one time and the Strategic Planning Committee met one time.
The total combined attendance for all Board and Committee meetings was 92%. All
directors attended at least 92% of the meetings of the Board and of the
committees on which they served.
22
<PAGE>
Relationships With Outside Firms
None
Executive Officers
The executive officers of the Company, their ages and their positions with
the Company as of September 30, 2000 are as described below. Additional
information concerning Mr. Bitetti is set forth above.
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
Vincent J. Bitetti 45 Chairman, Interim Chief Executive
Officer and Director
Jeffrey Court 48 Vice President of Finance and acting
Chief Financial Officer
Eugene Code 54 Vice President of International Business
Affairs and Corporate Secretary
</TABLE>
Vincent J. Bitetti founded Sound Source Interactive, Inc., a California
corporation (the "Subsidiary"), in 1988 and served as the President of the
Subsidiary from its formation. Since the Company acquired the Subsidiary in
1994, Mr. Bitetti has served as the Chairman of the Board and Chief Executive
Officer and as a director of the Company and the Subsidiary. Prior to founding
the Subsidiary, from 1986 to 1988 Mr. Bitetti was President of Fantastic Planet
Consultants, a sound and musical instrument design consulting company. Mr.
Bitetti is a published music composer. From 1986 to 1993, Mr. Bitetti was a
consultant to manufacturers of keyboard synthesizers and other digitally
controlled musical instruments in the musical instrument industry. Mr. Bitetti
is primarily responsible for developing the concepts for the Company's products
and acts in the capacity of Executive Producer on all titles. He also is
responsible for initiating and maintaining the Company's licensor relationships
and negotiating its distribution, and republishing agreements. Mr. Bitetti has
been a director of the Company since 1994. Pursuant to a Separation Agreement
dated November 12. 1999, Mr. Bitetti is currently employed as the Company's
Interim Chief Executive Officer until December 31, 2002.
Jeffrey Court was recruited to Sound Source in August 1998 to manage the
accounting and management control systems and to support the production of
financial statements. On January 8, 1999, Mr. Court was appointed Vice
President of Finance and acting Chief Financial Officer. He came with over 18
years of experience as a senior accountant, corporate controller and chief
financial officer. Since May 1988, Mr. Court has held finance management
positions in related industries, including serving as controller of Metropolis,
a Southern California-based publisher of video game magazines, from July 1997 to
July 1998, serving as corporate controller of Klasky Csupo, Inc., a Southern
California-based animation production company, from May 1995 to June 1997; and
serving as chief financial officer of Full Moon Entertainment, a Southern
California-based motion picture production and distribution company, from May
1988 to April 1995.
Eugene Code was appointed Vice President of International Affairs and
Corporate Secretary on January 8, 1999 after having served in various capacities
within the Company since 1994. While at the Company, Mr. Code has managed
contract administration and the international product republishing program. He
successfully negotiated the Company's entry into the world market by
coordinating development of over 30 localized products. He has recently
concluded agreements with TDK for localization, republishing and distribution.
He manages the Company's efforts in support of TDK's product localization
initiative to bring the Company's products to market in as many as 20 languages
for distribution in over 60 countries. His mandate is to explore new market
areas for product adaptation and development. Mr. Code joined the Company in
1994 with over 20 years of international contract management and administration
experience. Prior to joining Sound Source Interactive, Mr. Code served in
management positions in the defense industry where he managed development of
projects associated with advanced weapons systems. Earlier positions also
included liaison with the Navy and industry for fleet weapons retrofitting and
repair.
Filings Under Section 16(a)
Based solely upon a review of the copies of the forms furnished to the
Company and written representations of the Company's directors and executive
officers, the Company believes that all filing requirements applicable to its
officers, directors and ten-percent beneficial owners were complied with during
fiscal 2000.
Pursuant to Section 16(a) of the Exchange Act, the Company is required to
identify any person who, at any time during fiscal year 2000, was a director of
the Company, an executive officer of
23
<PAGE>
the Company, or its subsidiaries or beneficial owner of more than 10% of the
Company's Common Stock or any other person who was subject to Section 16(a) of
the Exchange Act with respect to the Company that during fiscal 1999 failed to
file on a timely basis with the SEC any report required by Section 16(a) of the
Exchange Act, which are on Form 3 (an initial report of beneficial ownership of
common stock) and on form 4 and Form 5 (relating to changes in beneficial
ownership of common stock). Based solely on a review of such Forms 3, 4 and 5,
and amendments thereto, furnished to the Company by the reporting persons known
to it, as required by Exchange Act Rule 16a-3(e), no reporting person that was
required during fiscal 2000 to comply with Section 16(a) of the Exchange Act
failed to comply with such requirements.
ITEM 10. EXECUTIVE COMPENSATION
Compensation of Directors
Each director who is not an employee of the Company is entitled to receive
a director's fee of $15,000 per year, and to be reimbursed for out-of-pocket
expenses incurred in connection with his attendance at meetings. However, no
such fees have been paid since June 1998. Instead, each director of the Company
agreed to accept shares of the Company's Common Stock in lieu of cash in payment
of the accrued fees and all fees that became payable through June 30, 2000
pursuant to the Company's 1999 Director Stock Plan (the "1999 Director Stock
Plan"). The Company paid all of the director fees accrued through June 30,
2000, which totaled $120,000 in the aggregate, in 333,888 shares of its Common
Stock. The purchase price for the Common Stock issuable in payment of such
director fees was .3594 per share, which was the fair market value of the Common
Stock on December 29, 1999, the date on which the 1999 Director Stock Plan was
approved by the Company's stockholders.
In addition, pursuant to the 1999 Director Stock Plan, each non-employee
director receives nonqualified stock options to acquire 10,000 shares of Common
Stock upon appointment as a director, and receives nonqualified stock options to
acquire an additional 10,000 shares of Common Stock for each additional year
that the non-employee director continues to serve on the Board of Directors.
Such options previously were granted pursuant to the Company's 1995 Amended and
Restated Stock Option Plan (the "1995 Stock Option Plan"). Each option granted
to a non-employee director vests and becomes 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 expires on the earlier of ten years from the date the option was
granted, the expiration of the 1995 Stock Option Plan or the 1999 Director Plan,
as applicable, or three weeks after the optionee ceases to be a director of the
Company. The exercise price of such options is 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 is subject to the other provisions of the 1995
Stock Option Plan or the 1999 Director Plan, as applicable.
24
<PAGE>
Executive Compensation
Summary Compensation
The following table sets forth information concerning compensation of the
Company's Chief Executive Officer and each of the Company's other executive
officers and/or other most highly compensated employees who received salary and
bonus compensation from the Company in excess of $100,000 for the fiscal year
ended June 30, 2000 (the "Named Executives").
Summary Compensation Table
<TABLE>
<CAPTION>
Long-Term
Compensation
--------------------------
Annual Compensation Stock All Other
Fiscal ------------------------ Options Compen-
Name and Principal Position Year Salary Bonus (1) (Shares) sation (2)
----------------------------------- ------ ------ --------- -------- ----------
<S> <C> <C> <C> <C> <C>
Vincent J. Bitetti................. 2000 320,104 0 0 0
Chief Executive Officer 1999 240,000 132,500 0 23,288
1998 210,466 79,000 50,000 22,543
Tanya Baker........................ 2000 100,436 0 10,000 11,858
Vice President of Sales(3) 1999 61,167 0 15,000 4,682
</TABLE>
(1) The bonus paid in fiscal 1999 were earned in fiscal 1998. $60,000 of Mr.
Bitetti's 1999 bonus was accrued in fiscal 1998.
(2) The amounts in this column consist of the following: (1) personal use of
Company car: Mr. Bitetti - $12,000 (2000), $12,000 (1999), $12,000 (1998);
Ms. Baker - $3,200 (2000), $1,400 (1999); (b) life insurance premiums: Mr.
Bitetti - $7,333 (2000), $6,358 (1999), $6,143 (1998); (c) medical
insurance premiums: Mr. Bitetti - $5,279 (2000), $4,930 (1999), $4,400
(1998); Ms. Baker - $8,658 (2000), $3,282 (1999).
(3) Ms. Baker became an employee of the Company during October 1998.
25
<PAGE>
Option Grants
The following table sets forth information regarding grants of options to
and exercises of options by the Named Executives during the fiscal year ended
June 30, 2000.
Option Grant Table
<TABLE>
<CAPTION>
Number of Percentage of
Securities Total Options
Underlying Granted to
Options Employees in Exercised Base
Name Granted Fiscal Year Price Expiration Date
---- ------- ----------- ----- ---------------
<S> <C> <C> <C> <C>
Vincent J. Bitetti............. 0 --- --- ---
Tanya Baker.................... 10,000 11% $.315 3/1/10
</TABLE>
Option Exercises and Holdings
The following table sets forth information concerning each exercise of a
stock option during the fiscal year ended June 30, 2000 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, 2000.
Aggregate Options Exercised in Last Fiscal Year and Fiscal Year-End Option
Values
<TABLE>
<CAPTION>
Number of
Shares Value of
Underlying Unexercised
Unexercised in-the-Money
Options at Options at
Number of 6/30/00 6/30/00
Shares Value Exercisable/ Exercisable/Un-
Name Acquired Realized(1) Unexercisable exercisable(2)
---- -------- ----------- ------------- --------------
<S> <C> <C> <C> <C>
Vincent J. Bitetti.... 0 $0 50,000/0 $0/$0
Tanya Baker........... 0 0 21,250/3,750 $0/$0
</TABLE>
_______________
(1) Market value on the date of exercise of shares covered by options
exercised, less option exercise price.
(2) Market value of the shares covered by in-the-money options on June 30,
2000, less the option exercise price.
26
<PAGE>
Employment Agreement
The Company has entered into a Succession Agreement with Vincent J. Bitetti
dated as of November 12, 1999, which was amended pursuant to an amendment dated
as of April 15, 2000. Pursuant to the Separation Agreement, as amended, Mr.
Bitetti serves as the Company's Chief Executive Officer, but has agreed to
resign from this position on the earlier of (i) December 31, 2002 and (ii) the
date of the appointment of a new Chief-Executive Officer. The Succession
Agreement further provides that upon his resignation as Chief Executive Officer
prior to December 31, 2002, Mr. Bitetti will be appointed to serve as Chairman
of the Company until December 31, 2002.
The Succession Agreement terminated Mr. Bitetti's Third Amended and
Restated Employment Agreement, dated as of April 24, 1998 (the "Bitetti
Employment Agreement"). The Succession Agreement, however, provides that Mr.
Bitetti will remain entitled to receive substantially the same compensation and
benefits to which he would have been entitled under the Bitetti Employment
Agreement until December 31, 2002. A description of the compensation and
benefits that Mr. Bitetti is entitled to receive pursuant to the Bitetti
Employment Agreement, and which he remains entitled to receive by virtue of the
Succession Agreement, is set forth below.
The Bitetti Employment Agreement entitled Mr. Bitetti to receive annual
base salary of $240,000 effective April 27, 1998, subject to annual increases in
accordance with the Consumer Price Index (the "CPI") commencing on April 27,
1999. Currently, Mr. Bitetti is entitled to receive annual base salary of
$252,836.
Pursuant to the Bitetti Employment Agreement, Mr. Bitetti was entitled to
receive a bonus in the following amounts if the Company attained the specified
gross revenues for fiscal 2000:
Cumulative
Gross Revenues Cash Bonus
-------------- ----------
$19,200,000............................... $ 25,000
25,600,000............................... 75,000
38,400,000............................... 125,000
The gross revenue attainment levels required to receive each bonus level
for each subsequent fiscal year were to increase by 60% annually.
Pursuant to the Bitetti Employment Agreement, Mr. Bitetti was entitled to
receive a bonus in the following amounts if the Company attained the specified
gross profits for fiscal 1999:
27
<PAGE>
Cumulative
Gross Profits Cash Bonus
------------- ----------
$5,120,000............................... $ 50,000
5,760,000............................... 75,000
6,400,000............................... 100,000
The gross profit levels required to receive each bonus level for each
subsequent fiscal year were to increase by 60% annually.
The Bitetti Employment Agreement entitled Mr. Bitetti to receive a bonus in
the following amounts if the Company attained the specified levels of pre-tax
profitability (defined as annual earnings before interest, taxes, depreciation
and amortization divided by gross revenues) for any fiscal year during the term
of Mr. Bitetti's employment agreement:
Cumulative
Profitability Cash Bonus
------------- ----------
10%...................................... $ 50,000
15%...................................... 100,000
For the fiscal year ended June 30, 2000, Mr. Bitetti did not qualify to
receive a bonus under any of the three standards described above.
Mr. Bitetti was entitled to receive certain fringe benefits under the
Bitetti Employment Agreement, including use of a Company automobile or
automobile allowance, $5,000,000 in life insurance coverage (provided that in no
event could 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. The Bitetti Employment Agreement further provided that
following the voluntary or involuntary termination of his employment by the
Company, Mr. Bitetti was entitled to two demand registration rights with respect
to the Common Stock held by or issuable to him. These registration rights could
only become effective upon the voluntary or involuntary termination of Mr.
Bitetti's employment with the Company. The Bitetti Employment Agreement further
provided that if the Company employs a new Chief Executive Officer, Mr.
Bitetti's salary could not be less than that of such new Chief Executive
Officer, up to a maximum of $300,000.
In addition, pursuant to the April 15, 2000 amendment to the Succession
Agreement, the Company agreed to pay Mr. Bitetti (i) additional compensation of
$100,000 during the remainder of calendar year 2000, and (ii) a bonus of $35,000
for each calendar quarter during which the Company during which the Company
realizes a profit. No such bonus was earned for the quarter ended June 30,
2000, the first quarter for which Mr. Bitetti was eligible to receive this
bonus.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Security Ownership of Certain Beneficial Owners and Management
The following table sets forth certain information regarding the ownership
of the Common Stock of the Company as of September 30, 2000 by (i) each of the
Company's current directors and the Named Executives, (ii) all directors and
Named Executives and other executive officers as a group and (iii) each person
who is known to the Company to own, of record or beneficially, more than five
percent of the Common Stock. Where the persons listed have the right to acquire
additional shares of Common Stock through the exercise of options or warrants
within 60 days, such additional shares are deemed to be outstanding for the
purpose of computing the percentage of outstanding shares owned by such persons,
28
<PAGE>
but are not deemed to be outstanding for the purpose of computing the percentage
ownership interests of any other person. Unless otherwise indicated, each of the
stockholders shown in the table below has sole voting and investment power with
respect to the shares beneficially owned.
<TABLE>
<CAPTION>
Shares Beneficially Shares Beneficially
Owned Prior to Owned Assuming
Consummation of Consummation of
Subsequent Closing(12) Subsequent Closing(12)
---------------------- ----------------------
Name and Address of Beneficial Owner(1) Shares Percent Shares Percent
--------------------------------------- ------ ------- ------ -------
<S> <C> <C> <C> <C>
Current Directors
Vincent Bitetti (2).............................. 1,284,634(2) 11.99% 1,284,634(2) 5.67%
Richard Azevedo.................................. 15,000(3) * 113,472(5) *
Mark A. James.................................... 35,000(4) * 133,472(6) *
Samuel L. Poole.................................. 15,000(3) * 113,472(5) *
John T. Wholihan................................. 17,000(3) * 17,000(3) *
Other Named Executives
Tanya Baker...................................... 21,250(7) * 21,250(7) *
All directors and Named Executives and other
executive officers as a group (8)(9)............ 1,404,682 12.97% 1,700,098(10) 7.38%
Other Beneficial Owners
Louis A. Habash (11)............................. 1,140,000 10.69% 1,140,000 5.05%
TDK USA Corporation.............................. 4,750,000 44.55% 16,667,000 73.82%
</TABLE>
______________
* Less than 1%
(1) The address of the current directors and the other Named Executive is 26115
Mureau Road, Suite B, Calabasas, California 91302. The address of Louis
Habash is 5075 Spyglass Hill Drive, Las Vegas, Nevada 89122. The address of
TDK USA Corporation is 12 Harbor Park Drive, Port Washington, N.Y. 11050.
(2) Includes 50,000 shares of Common Stock issuable to Mr. Bitetti under
presently exercisable options. Also includes 100,000 shares of Common Stock
which Eric H. Winston is entitled to acquire from Mr. Bitetti pursuant to a
presently exercisable option. Excludes 1,140,000 shares of Common Stock
held by ASSI, Inc. as to which Mr. Bitetti has shared voting rights.
(3) Includes 15,000 shares of Common Stock issuable upon exercise of presently
exercisable options. Excludes 83,472 shares vested to such director's
account under the 1999 Director Stock Plan, as to which such director
disclaims beneficial ownership.
(4) Includes 35,000 shares of Common Stock issuable upon exercise of presently
exercisable options.
(5) Includes options to purchase 15,000 shares of Common Stock issuable upon
exercise of presently exercisable options, options to purchase 15,000
shares of Common Stock that will vest upon such director's removal from
Board at Subsequent Closing and 83,472 shares of Common Stock that will
vest upon such director's removal from Board at Subsequent Closing pursuant
to the 1999 Director Stock Plan.
29
<PAGE>
(6) Includes 35,000 shares of Common Stock issuable upon exercise of presently
exercisable options, 15,000 shares of Common Stock that will vest upon
removal from Board at Subsequent Closing and 83,472 Shares of Common Stock
that will vest upon removal from Board at Subsequent Closing pursuant to
the 1999 Director Stock Plan.
(7) Includes 21,250 shares of Common Stock issuable upon exercise of presently
exercisable options.
(8) Includes 11,250 shares of Common Stock issuable to Jeff Court upon exercise
of presently exercisable options and 5,548 shares of Common Stock issuable
to Eugene Code upon exercise of presently exercisable options.
(9) Includes 8 persons.
(10) Upon consummation of subsequent closing, Mr. Azeuedo, Mr. James and Mr.
Poole will no longer be members of the Board of Directors of the company.
(11) Based on information set forth in the Schedule 13(D) filed by ASSI, Inc.
with the Securities and Exchange Commission on April 11, 1998, all such
Common Stock is owned of record by ASSI, Inc., of which Mr. Habash is the
sole beneficial owner. Excludes 1,284,634 shares of Common Stock held by
Vincent J. Bitetti as to which ASSI, Inc. has shared voting rights.
(12) On September 8, 2000, the Company and TDK USA Corporation ("TUC") had
entered into a common stock purchase agreement pursuant to which TUC has
agreed to purchase a total of 16,667,000 shares of Common Stock, for the
purchase price of $.30 per share and an aggregate purchase price of
$5,000,100. On September 11, 2000, TUC acquired 4,750,000 shares of Common
Stock of the Company for an aggregate purchase price of $1,425,000. TUC has
agreed to purchase an additional 11,917,000 of Common Stock (Subsequent
Closing) for an aggregate purchase price of $3,575,100 immediately upon the
filing of an amendment by the Company to increase the number of shares of
Common Stock the Company is authorized to issue from 20,000,000 to
50,000,000.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Settlement Agreement
On April 27, 1998 the Company entered into a Settlement Agreement (the
"Settlement Agreement") dated as of April 24, 1998 with ASSI, Inc., NCD, Inc.,
The Boston Group, L.P., Vincent J. Bitetti, Ulrich E. Gottschling, Mark A. James
and Robert G. Kalik. Pursuant to the Settlement Agreement the Company settled
with prejudice two legal proceedings which were pending against it, its former
Chairman and Chief Executive Officer Vincent J. Bitetti, and its former
President and Chief Operating Officer Ulrich E. Gottschling, in Los Angeles
Superior Court and which related to an attempted expansion of the Company's
Board of Directors and the election of four persons to fill the expansion seats.
In connection with the Settlement Agreement, the Company (i) exchanged 1,100,000
shares of its Common Stock for 4,816,657 common stock purchase warrants held by
ASSI, Inc.; (ii) amended its Bylaws to provide for a seven-member Board of
Directors and to permit resigning directors to vote on the appointment of their
successors; (iii) appointed Richard Azevedo, Samuel L. Poole, Wayne M. Rogers
and John T. Wholihan to fill vacancies on the Board of Directors; and (iv)
entered into certain related agreements described below.
Pursuant to the Settlement Agreement, ASSI, Inc., NCD, Inc., Louis Habash
and the Company entered into a Lock-Up Agreement. Such agreement provided that
during the year ending May 30, 1999, ASSI, Inc., NCD, Inc. and Louis Habash (who
is the beneficial owner of all of the voting securities of ASSI, Inc. and NCD,
Inc.) could not sell shares of the Common Stock beneficially owned by them in an
aggregate amount in excess of an amount determined by a formula, which equates
to the product of approximately 94,620 shares times the number of full months,
commencing with the month of May 1998, elapsed since the settlement.
Pursuant to the Settlement Agreement, the Company entered into a Third
Amended and Restated Employment Agreement (the "Bitetti Employment Agreement,"
as previously defined) with Vincent J. Bitetti, which amended and restated Mr.
Bitetti's prior employment agreement.
Voting Agreements
Pursuant to the Underwriting Agreement (the "Underwriting Agreement") dated
July 1, 1996 pertaining to the Company's initial public offering, the Company
granted the underwriters for such offering, The Boston Group, L.P. and Joseph
Stevens & Co., L.P., each the right to nominate from time to time one director
of the Company or to have an individual designated thereby attend all Board
meetings as a nonvoting advisor. In addition, Vincent J. Bitetti and Eric H.
Winston agreed to vote all of their Common Stock in favor of the two director
nominees selected by the underwriters. The voting agreement with the
underwriters will terminate on July 8, 2001. Effective November 20, 1997, Joseph
Stevens & Co., L.P. assigned to The Boston Group, L.P. its director nomination
rights under the foregoing agreement.
Pursuant to a Stockholder Voting Agreement (the "Stockholder Voting
Agreement") dated as of April 30, 1996 among Vincent J. Bitetti, Eric H. Winston
and ASSI, Inc., Messrs. Bitetti and Winston agreed to vote all of their Common
Stock in favor of one director nominee selected by ASSI, Inc. and in favor of an
amendment to the Company's Bylaws providing that the number of directors would
be five, which provision could not be amended except with the consent of ASSI,
Inc. In addition, ASSI, Inc. agreed to vote all of its shares of Common Stock
for two directors nominated by Mr. Bitetti as long as he held at least 20
percent of the outstanding Common Stock, and for one director nominated by Mr.
Bitetti for as long as he held at least ten percent but less than 20 percent of
the outstanding Common Stock. The Stockholder Voting Agreement will terminate on
the earlier of July 1, 2001 or the date when Messrs. Bitetti and Winston
together cease to own at least ten percent of the Outstanding Common Stock. This
condition will be satisfied as of the Subsequent Closing, whereupon the
Stockholder Voting Agreement will terminate.
Pursuant to the Settlement Agreement, the Company received the consent (the
"Consent") of ASSI, Inc. to certain matters relating to the Stockholder Voting
Agreement. Among other things, the Consent provides that as between the Company,
ASSI, Inc., The Boston Group, L.P. and Vincent J. Bitetti, the nominees for the
seven-person Board of Directors will be determined as follows: two persons may
be nominated by Bitetti as long as he holds 750,000 or more shares of the Common
Stock (but only one person, if Bitetti holds more than 500,000 and less than
750,000 shares, and no person if Bitetti holds 500,000 or fewer shares); one
person may be nominated by ASSI, Inc. as long as it holds 500,000 or more shares
of the Common Stock (but no person if ASSI, Inc. holds fewer than 500,000
shares); up to two persons may be nominated by The Boston Group, L.P. (including
as assignee of the rights of Joseph Stevens & Co., L.P.) pursuant to the
Underwriting Agreement so long as it may be in effect in pertinent part; one
person (an "Expansion Member") may be nominated by Mr. Bitetti (subject to
approval of such person by ASSI, Inc. (unless a renomination of a presently
serving nominee)); and one person (another "Expansion Member") may be nominated
by ASSI, Inc. (subject to approval of such person by Mr. Bitetti (unless a
nomination of a presently serving nominee)). Each Expansion Member must be
independent of the Company and the person nominating such Expansion Member, and
must meet certain other requirements set forth in the Consent.
The Consent is terminable at the option of ASSI, Inc. in the event of a
breach of the Stockholder Voting Agreement, the Settlement Agreement or the
Consent by the Company, Vincent J. Bitetti or Ulrich E. Gottschling prior to the
termination of the Stockholder Voting Agreement. In the event of such
termination, the authorized number of directors will be automatically reduced
from seven to five at the next annual meeting of stockholders, and nominations
and elections for the resulting five-member Board will be governed by the
Stockholder Voting Agreement and the Underwriting Agreement, without regard to
the Consent. The Consent terminates automatically upon the termination of the
Stockholder Voting Agreement, which will occur as of the Subsequent Closing.
Mr. Bitetti determined that it was in the Company's interests to limit the
size of the Board, and therefore at the Company's most recent annual meeting of
stockholders did not exercise his right to nominate one of the two persons he
was then entitled to nominate pursuant to the Stockholder Voting Agreement and
the Consent, and the Expansion Member he was then entitled to nominate as
provided in the Consent. Accordingly, pursuant to the foregoing arrangements,
the directors elected at the Company's most recent annual meeting of
stockholders were nominated as follows:
Vincent J. Bitetti as the nominee of Vincent J. Bitetti pursuant to the
Stockholder Voting Agreement and the Consent
Richard Azevedo and Samuel L. Poole as the two nominees of The Boston
Group, L.P. pursuant to the Underwriting Agreement
Mark A. James as the nominee of ASSI, Inc. pursuant to the Stockholder
Voting Agreement and the Consent
John T. Wholihan as the Expansion Member nominated by ASSI, Inc. as
provided in the Consent
PART IV
ITEM 13. EXHIBITS LIST AND REPORTS ON FORM 8-K.
(a) Exhibits.
Exh.
No. Description of Exhibits
---- -----------------------
3.1 Second Restated Certificate of Incorporation of the Registrant.
[Filed as Exhibit 3.1 to the Registrant's Registration Statement on
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
3.1 to the Registrant's Form 8-K Report dated May 6, 1998 (the "May
1998 Form 8-K") and incorporated herein by reference.]
4.1 Specimen Common Stock Certificate. [Filed as Exhibit 4.1 to
Registration Statement No. 33-80827 and incorporated herein by
reference.]
4.2 Form of Warrant Agreement between the Registrant and Corporate
Stock Transfer, Inc., as warrant agent, and form of Redeemable
Warrant. [Filed as Exhibit 4.2 to Registration Statement No. 33-
80827 and incorporated herein by reference.]
4.3 Form of Warrant Agreement between the Registrant and The Boston
Group, LP and Joseph Stevens and Company, LP and form of
Underwriters' Warrant. [Filed as Exhibit 4.3 to Registration
Statement No. 33-80827 and incorporated herein by reference.]
4.4 Warrant dated April 30, 1996 issued to ASSI, Inc. [Filed as Exhibit
4.4 to Registration Statement No. 33-80827 and incorporated herein
by reference.]
4.5 Form of Underwriting Agreement among the Registrant, Vincent J.
Bitetti, Eric H. Winston and The Boston Group, LP and Joseph
Stevens & Co., LP, as underwriters. [Filed as Exhibit 1 to
Registration Statement No. 33-80827 and incorporated herein by
reference.]
9.1 Stockholder Voting Agreement dated as of April 30, 1996, among
ASSI, Inc., Vincent J. Bitetti and Eric H. Winston. [Filed as
Exhibit 9.1 to Registration Statement No. 33-80827 and incorporated
herein by reference.]
30
<PAGE>
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.]
9.7 Consent of ASSI, Inc., dated as of April 20, 1998, pursuant to the
Voting Agreement, dated as of April 30, 1996, among ASSI, Inc.,
Vincent J. Bitetti and Eric H. Winston. [Filed as Exhibit 9.1 to the
May 1998 Form 8-K Report 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 Amended and Restated Employment Agreement of Ulrich E. Gottschling
dated as of February 1, 1997. [Filed as Exhibit 10.3 to the
Registrant's Registration Statement on Form SB-2 (No. 333-24271,
("Registration Statement No. 333-24271") and incorporated herein by
reference.]
10.3 Sound Source Interactive, Inc. 1992 Stock Option Plan. [Filed as
Exhibit 10.4 to Registration Statement No. 33-80827and incorporated
herein by reference.]
10.4 Sound Source Interactive, Inc. and 1995 Stock Option Plan, as
amended. [Filed as Exhibit A to the Registrant's Proxy Statement on
Schedule 14A dated June 8, 1998 and incorporated herein by
reference.]
10.5 Warrant Agreement, dated as of September 26, 1995, among the
Registrant, Sound Source Interactive, Inc., a California corporation
(the "Subsidiary") and Financial West Group, Inc., corporation
("FWG"), as warrant agent. [Filed as Exhibit 10.6 to Registration
Statement No. 33-80827 and incorporated herein by reference.]
10.6 Warrant Agreement, dated as of June 30, 1995, between the Registrant
and FWG, as warrant agent. [Filed as Exhibit 10.7 to Registration
Statement No. 33-80827 and incorporated herein by reference.]
10.7 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.]
10.8 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.]
10.9 Indemnification Agreement, dated as of October 1, 1996, between the
Registrant and Mark A. James. [Filed as Exhibit 10.44 to Amendment
No. 1 to the Registrant's Annual Report on Form 10-KSB for the year
ended June 30, 1996 (the "1996 Form 10-KSB") and incorporated herein
by reference.]
10.10 Office Lease, dated as of March 4, 1997, between Arden Realty
Limited Partnership and the Registrant. [Filed as Exhibit 10.24 to
Registration Statement No. 333-24271 and incorporated herein by
reference.]
10.11 Factoring Agreement, dated as of September 19, 1997, between the
Registrant and Silicon Valley Financial Service, a division of
Silicon Valley Bank. [Filed as Exhibit 10.25 to the Registrant's
Annual Report on Form 10-KSB for the year ended June 30, 1997 (the
"1997 Form 10-KSB") and incorporated herein by reference.].
31
<PAGE>
10.12 Collateral Assignment, Patent Mortgage and Security Agreement, dated
as of September 19, 1997, between the Registrant and Silicon Valley
Financial Service, a division of Silicon Valley Bank. [Filed as
Exhibit 10.26 to the 1997 Form 10-KSB and incorporated herein by
reference.]
10.13 Settlement Agreement, dated as of April 27, 1998, among the
Registrant, ASSI, Inc., NCD, Inc., The Boston Group, LP, Vincent J.
Bitetti, Ulrich E. Gottschling, Mark A. James and Robert G. Kalik
[Filed as Exhibit 10.1 to the May 1998 Form 8-K and incorporated
herein by reference.]
10.14 Lock-Up Agreement, dated as of April 27, 1998, among the Registrant,
ASSI, Inc., NCD, Inc. and Louis Habash [Filed as Exhibit 10.2 to the
May 1998 Form 8-K and incorporated herein by reference.]
10.15 Third Amended and Restated Employment Agreement of Vincent J.
Bitetti dated as of April 27, 1998 [Filed as Exhibit 10.3 to the May
1998 Form 8-K and incorporated herein by reference.]
10.16 Employment Memorandum of Ulrich E. Gottschling dated as of April 27,
1998 [Filed as Exhibit 10.4 to the May 1998 Form 8-K and
incorporated herein by reference.]
10.17 Indemnification Agreement, dated as of April 27, 1998, between the
Registrant and Richard Azevedo. [Filed as Exhibit 10.29 to the
Registrant's Annual Report on Form 10-KSB for the year ended June
30, 1998 (the "1998 Form 10-KSB") and incorporated herein by
reference.]
10.18 Indemnification Agreement, dated as of April 27, 1998, between the
Registrant and Samuel L. Poole. [Filed as Exhibit 10.30 to the 1998
Form 10-KSB and incorporated herein by reference.
10.19 Indemnification Agreement, dated as of April 27, 1998, between the
Registrant and John Wholihan. [Filed as Exhibit 10.32 to the 1998
Form 10-KSB and incorporated herein by reference.]
10.20 Distribution and Republishing Agreement, dated as of June 8, 1998,
between the Registrant and Iona Software Ltd. [Filed as Exhibit
10.20 to the Registrant's Annual Report on Form 10-KSB for the year
ended June 30, 2000 (the "1999 Form 10-KSB") and incorporated herein
by reference.]
10.21 Distribution and Republishing Agreement, dated as of November 1,
1998, between the Registrant and TDK Recording Media Europe. [Filed
as Exhibit 10.21 to the 1999 Form 10-KSB and incorporated herein by
reference.]
10.22 Addendum to Distribution and Republishing Agreement, dated as of
March 1, 1999, between the Registrant and TDK Recording Media
Europe. [Filed as Exhibit 10.22 to the 1999 Form 10-KSB and
incorporated herein by reference.]
10.23 Electronic Software Distribution Agreement, dated as of July 1,
1998, between the Registrant and Digital River, Inc. [Filed as
Exhibit 10.23 to the 1999 Form 10-KSB and incorporated herein by
reference.]
10.24 Joint Venture Agreement, dated as of July 31, 1998, between the
Registrant and Morgan Creek Productions. [Filed as Exhibit 10.24 to
the 1999 Form 10-KSB and incorporated herein by reference.]
10.25 Distribution and Fulfillment Services Agreement, dated as of
February 5, 1999, between the Registrant and Macmillan Digital
Publishing. [Filed as Exhibit 10.25 to the 1999 Form 10-KSB and
incorporated herein by reference.]
10.26 Succession Agreement, dated November 12, 1999, between Vincent J.
Bitetti and the Registrant. [Filed as Exhibit 10.1 to the to the
Registrant's Quarterly Report on Form 10-QSB for the quarter ended
September 30, 1999 and incorporated herein by reference.]
10.27 1999 Director Stock Plan of the Registrant. [Filed as Exhibit 10.2
to the Registrant's Quarterly Report on Form 10-QSB for the quarter
ended December 31, 1999 and incorporated herein by reference.]
10.28 Amendment No. 1 to Succession Agreement, dated November 12, 1999,
between Vincent J. Bitetti and the Registrant. [Filed as Exhibit
10.1 to the to the Registrant's Quarterly Report on Form 10-QSB for
the quarter ended March 31, 2000 and incorporated herein by
reference.]
10.29 Exclusive Distribution Agreement, dated February 28, 2000, between
TDK Recording Media S.A. and the Registrant. [Filed as Exhibit 10.2
to the Registrant's Quarterly Report on Form 10-QSB for the quarter
ended March 31, 2000 and incorporated herein by reference.]
10.30 Purchase Agreement, dated September 8, 2000, between TDK USA
Corporation and the Registrant. [Filed as Exhibit 10.1 to the
Registrant's Form 8-K Report dated September 8, 2000 (the "September
2000 Form 8-K") and incorporated herein by reference.]
10.31 Registration Rights Agreement, dated as of September 8, 2000,
between TDK USA Corporation and the Registrant. [Filed as Exhibit
10.3 to the September 2000 Form 8-K and incorporated herein by
reference.]
10.32 Lock-Up Agreement, dated September 8, 2000, between Vincent J.
Bitetti and the Registrant. [Filed as Exhibit 10.2 to the September
2000 Form 8-K and incorporated herein by reference.]
21.1 Subsidiaries of the Registrant. [Filed herewith.]
23.1 Consent of Deloitte & Touche, LLP. [Filed herewith.]
23.2 Consent of BDO Seidman, LLP. [Filed herewith.]
27.1 Financial Data Schedule. [Filed herewith.]
(b) Reports on Form 8-K
The Registrant filed a report on Form 8-K dated September 15, 2000 under
Item 5 describing a stock sale by the Company to TDK USA Corporation.
32
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of
1934, as amended (the "Exchange Act"), the issuer has caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
Date: October 11, 2000 SOUND SOURCE INTERACTIVE, INC.
By /s/ Vincent J. Bitetti
----------------------------------------
Vincent J. Bitetti, Chairman and interim
Chief Executive Officer
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the issuer in the capacities and on the dates
indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ Vincent J. Bitetti Chairman and interim Chief Executive October 11, 2000
-------------------------------------- Officer (principal executive officer)
Vincent J. Bitetti
/s/ Jeffrey Court Vice President of Finance and, October 11, 2000
-------------------------------------- Acting Chief Financial Officer
Jeffrey Court
/s/ Richard Azevedo Director October 11, 2000
--------------------------------------
Richard Azevedo
/s/ Mark A. James Director October 11, 2000
--------------------------------------
Mark A. James
/s/ Samuel L. Poole Director October 11, 2000
--------------------------------------
Samuel L. Poole
/s/ John Wholihan Director October 11, 2000
--------------------------------------
John Wholihan
</TABLE>
No annual report or proxy materials have been sent to security holders. An
annual report for the Company's fiscal year ended June 30, 2000 will be
forwarded to stockholders.
33
<PAGE>
SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
--------------------------------------------------------------------------------
Page
Reports of Independent Certified Public Accountants 1-2
CONSOLIDATED FINANCIAL STATEMENTS AS OF JUNE 30, 2000 AND 1999 AND
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 2000:
Balance Sheets 3
Statements of Operations 4
Statements of Stockholders' Deficit 5
Statements of Cash Flows 6-7
Notes to Consolidated Financial Statements 8-19
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of
Sound Source Interactive, Inc.
Los Angeles, California
We have audited the accompanying consolidated balance sheets of Sound Source
Interactive, Inc. and Subsidiaries as of June 30, 2000, and the related
consolidated statements of operations, stockholders' deficit and cash flows
for the year then ended. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statements presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements present fairly, in all
material respects, the financial position of the Company at June 30, 2000, and
the results of their operations and their cash flows for the years then ended,
in conformity with generally accepted accounting principles.
BDO SEIDMAN, LLP
Los Angeles, California
September 20, 2000
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Sound Source Interactive, Inc.:
We have audited the accompanying consolidated balance sheet of Sound Source
Interactive, Inc. and subsidiaries (the "Company") as of June 30, 1999 and the
related consolidated statements of operations, stockholders' (deficit) equity,
and cash flows for the years ended June 30, 1998 and 1999. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. 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, such consolidated financial statements present fairly, in all
material respects, the financial position of the Company as of June 30, 1999 and
the results of its operations and its cash flows for the years ended June 30,
1998 and 1999 in conformity with accounting principles generally accepted in the
United States of America.
The accompanying financial statements for the year ended June 30, 1999 have been
prepared assuming that the Company will continue as a going concern. As
described in Note 1 to the consolidated financial statements, the Company's
recurring losses from operations, negative working capital, and stockholders'
deficit raise substantial doubt about its ability to continue as a going
concern. Management's plans concerning these matters are also described in Note
1. The financial statements do not include any adjustments that might result
from the outcome of this uncertainty.
/s/ Deloitte & Touche, LLP
September 10, 1999
<PAGE>
SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JUNE 30, 2000 AND 1999
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------
ASSETS (Note 9) 2000 1999
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 165,227 $ 857,143
Accounts receivable, net of allowance for doubtful accounts of $1,271
and $15,872 as of June 30, 2000 and 1999 275,248 575,521
Inventories, net of reserve of $164,127 and $117,626 as of June 30,
2000 and 1999 (Note 2) 209,716 329,368
Prepaid royalties 611,275 1,243,889
Prepaid expenses and other 80,869 35,803
Software development cost (Note 1) 1,316,802 226,484
------------ ------------
Total current assets 2,659,137 3,268,208
PROPERTY AND EQUIPMENT (Note 3) 144,520 245,274
OTHER ASSETS 13,733 16,762
------------ ------------
TOTAL $ 2,817,390 $ 3,530,244
============ ============
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES:
Accounts payable and accrued expenses $ 1,785,296 $ 1,998,512
Accrued royalties 1,295,715 1,750,601
Deferred revenue 937,123 11,416
Short-term borrowings (Note 9) - 331,043
Current portion of capital lease obligations (Note 4) 4,025 -
------------ ------------
Total current liabilities 4,022,159 4,091,572
DEFERRED REVENUE, LONG TERM 3,917,500 1,302,500
CAPITAL LEASE OBLIGATIONS (Notes 4) 4,024 -
------------ ------------
Total liabilities 7,943,683 5,394,072
============ ============
COMMITMENTS AND CONTINGENCIES (Note 4)
STOCKHOLDERS' DEFICIT (Notes 5 and 6):
Common stock, $.001 par value; 20,000,000 shares authorized;
5,911,796 and 5,869,402 shares issued and outstanding as of
June 30, 2000 and 1999, respectively 5,912 5,869
Warrants 559,928 559,928
Additional paid-in capital 14,316,259 14,302,877
Accumulated deficit (20,008,392) (16,732,502)
------------ ------------
Total stockholders' deficit (5,126,293) (1,863,828)
------------ ------------
TOTAL $ 2,817,390 $ 3,530,244
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
-3-
<PAGE>
SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED JUNE 30, 2000, 1999 AND 1998
<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------
2000 1999 1998
<S> <C> <C> <C>
REVENUES:
Product sales $ 2,446,412 $ 4,556,442 $8,819,529
Development fees and other 177,108 68,098 47,961
----------- ----------- ----------
Net revenues 2,623,520 4,624,540 8,867,490
COST OF SALES 2,535,776 3,175,637 3,574,168
----------- ----------- ----------
GROSS PROFIT 87,744 1,448,903 5,293,322
----------- ----------- ----------
OPERATING EXPENSES:
General and administrative (Note 8) 1,549,877 1,828,381 1,839,386
Research and development 957,215 1,356,867 1,580,413
Sales and marketing 789,281 2,177,248 2,045,312
Compensation in connection with stock options issued for
services rendered (Note 6) - - 323,351
----------- ----------- ----------
Total operating expenses 3,296,373 5,362,496 5,788,462
----------- ----------- ----------
OPERATING LOSS (3,208,629) (3,913,593) (495,140)
----------- ----------- ----------
OTHER INCOME (EXPENSE):
Interest income 2,903 6,107 23,261
Interest expense (59,944) (70,194) (24,521)
Other income 0 3,250 1,000,000
Other expense (7,820) (1,600) (800)
----------- ----------- ----------
Total other income (expense) (64,861) (62,437) 997,940
----------- ----------- ----------
INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES (3,273,490) (3,976,030) 502,800
PROVISION FOR INCOME TAXES (Note 7) 2,400 1,600 1,600
----------- ----------- ----------
NET INCOME (LOSS) $(3,275,890) $(3,977,630) $ 501,200
=========== =========== ==========
BASIC NET INCOME (LOSS) PER SHARE (Note 1) $ (0.55) $ (0.68) $ 0.11
========== =========== ==========
DILUTED NET INCOME (LOSS) PER SHARE (Note 1) $ (0.55) $ (0.68) $ 0.10
========== =========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
-4-
<PAGE>
SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
YEARS ENDED JUNE 30, 2000, 1999, 1998 AND 1997
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------------
Common Stock Additional
--------------------- Paid-in Accumulated
Shares Amount Warrants Capital Deficit
<S> <C> <C> <C> <C> <C> <C>
BALANCE, JULY 1, 1997 4,409,099 4,409 1,104,925 13,424,622 (13,256,072) 1,277,884
Issuance of common stock in connection with
exercise of employee stock options (Note 6) 140,875 141 6,002 6,143
Issuance of common stock in exchange for
warrants (Note 5) 1,100,000 1,100 (544,997) 543,897
Issuance of stock options for services 323,351 323,351
Net income - - - - 501,200 501,200
--------- ------ ---------- ----------- ------------ -----------
BALANCE, JUNE 30, 1998 5,649,974 5,650 559,928 14,297,872 (12,754,872) 2,108,578
Issuance of common stock in connection with
exercise of employee stock options (Note 6) 219,428 219 5,005 5,224
Net loss - - - - (3,977,630) (3,977,630)
--------- ------ ---------- ----------- ------------ -----------
BALANCE, JUNE 30, 1999 5,869,402 5,869 559,928 14,302,877 (16,732,502) (1,863,828)
Issuance of common stock in connection with
exercise of employee stock options (Note 6) 42,394 43 13,382 13,425
Net loss - - - - (3,275,890) (3,275,890)
--------- ------ ---------- ----------- ------------ -----------
BALANCE, JUNE 30, 2000 5,911,796 $5,912 $ 559,928 $14,316,259 $(20,008,392) $(5,126,293)
========= ====== ========== =========== ============ ===========
</TABLE>
See accompanying notes to consolidated financial statements.
-5-
<PAGE>
SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED JUNE 30, 2000, 1999 AND 1998
<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------
2000 1999 1998
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $(3,275,890) $(3,977,630) $ 501,200
Adjustments to reconcile net income (loss) to net cash
(used in) provided by operating activities:
Depreciation and amortization 125,547 182,446 144,014
Gain on sale of property and equipment - (3,250) -
Stock options issued for services rendered - - 323,351
Changes in operating assets and liabilities:
Accounts receivable 300,273 1,807,611 (1,022,014)
Inventories 119,652 87,847 (188,538)
Prepaid royalties 632,614 622,155 (310,781)
Prepaid expenses and other (1,135,384) (72,439) (111,975)
Accounts payable and accrued expenses (213,216) (204,647) 874,898
Accrued royalties (454,886) 135,439 4,721
Deferred revenue 3,540,707 1,268,916 33,000
----------- ----------- -----------
Net cash provided by (used in) operations (360,583) (153,552) 247,876
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (16,744) (20,341) (138,688)
Proceeds from sale of property and equipment - 5,000 -
Other assets 3,029 (1,059) (1,150)
----------- ----------- -----------
Net cash used in investing activities (13,715) (16,400) (139,838)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of common stock 13,425 5,224 6,143
Payments on capital lease obligations - (2,913) (10,899)
Proceeds from (Payment on) Short-term borrowing (331,043) 331,043 -
----------- ----------- -----------
Net cash provided by (used in) investing activities (317,618) 333,354 (4,756)
----------- ----------- -----------
NET CHANGE IN CASH AND CASH EQUIVALENTS (691,916) 163,402 103,282
CASH AND CASH EQUIVALENTS,
BEGINNING OF YEAR 857,143 693,741 590,459
----------- ----------- -----------
CASH AND CASH EQUIVALENTS,
END OF YEAR $ 165,227 $ 857,143 $ 693,741
=========== =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
-6-
<PAGE>
SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED JUNE 30, 2000, 1999 AND 1998
<TABLE>
<CAPTION>
---------------------------------------------------------------------------------
2000 1999 1998
<S> <C> <C> <C>
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION -
Cash paid during the year for:
Interest $74,982 $61,650 $24,521
======= ======= =======
Income taxes $ 2,400 $ 1,600 $ 1,600
======= ======= =======
</TABLE>
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
During the year end June 30, 2000, the Company entered into a capital lease
obligation of $8,050 for equipment.
During 1998, the Company issued 1,100,000 shares of common stock in exchange
for 4,816,657 common stock purchase warrants held by ASSI, Inc.(see Note 5).
See accompanying notes to consolidated financial statements.
(Concluded)
-7-
<PAGE>
SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 2000, 1999 AND 1998
--------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation - Sound Source Interactive, Inc. (a Delaware
Corporation incorporated on March 8, 1990), through its wholly owned
subsidiaries, Sound Source Interactive Inc. (a California Corporation) and
Biological Weapon Testing Laboratories, Inc. (BWTL), an inactive entity,
(collectively, the "Company"), creates, develops, produces, publishes and
distributes worldwide, interactive educational and entertainment software
properties for personal computers and video game systems. Significant
intracompany transactions and balances have been eliminated.
Liquidity--The Company's previous independent accountants' report dated
September 10, 1999, relating to the Company's financial statements for the
year ended June 30, 1999 and 1998, contained a paragraph expressing
substantial doubt about the Company's ability to continue as a going
concern.
The Company incurred net losses of $3,275,890 and $3,977,630 for the fiscal
years ended June 30, 2000 and 1999, respectively while the Company realized
a net profit of $501,200 for the year ended June 30, 1998. The Company has
not historically generated sufficient cash flows to fund operations, and
has had to rely on debt and equity financings to fund operations. The
Company had negative working capital of $1,363,022 and $823,364 at June 30,
2000 and 1999.
The Company experienced a continual significant decrease in growth during
the last fiscal year as compared to the prior fiscal year. The Company
continues to search for new opportunities to obtain licenses and develop
and sell products. Additionally, the Company is expanding from the Personal
Computer Platform to embrace Dedicated Game Console Platforms such as Sony
PlayStation and is seeking new distributors and innovative ways to deliver
its products to consumers, most of which will require large up-front cash
resources. If the Company enters into agreements relating to such business
opportunities in the future, the Company will require additional financing
to fund its growth.
Management has strengthened their distribution channels and product
offerings to include Sony Playstation and Nintendo Game Boy to enable the
Company to compete in the video game market place and raise the level of
sales to sufficiently fund operations. During the fiscal year 2000, cash
flow activity from operations show that the Company had invested more than
$1.1 million in prepaid software development costs on newly released and
upcoming titles. In 1999, the Company signed an agreement with TDK
Recording Media ("TDK"), a global electronic components manufacturer with a
distribution division of children's edutainment software. TDK had provided
$3.95 million in the current fiscal year in accordance with this agreement
and a new contract was signed in February 2000 for expanded future TDK
development and distribution.
On September 8, 2000, the Company entered into a common stock purchase
agreement with TDK whereby the Company agrees to sell a total of 16,667,000
shares of common stock for a purchase price of $5,000,100. See Note 10.
The Company relied substantially on TDK advances within the current year in
order to meet their cash obligations. TDK has agreed to fund all cash
shortfalls during the next year.
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 differ from
those estimates.
Concentration of Credit Risk - The Company at times maintains cash balances
at certain financial institutions in excess of federally insured deposits.
The Company performs periodic credit evaluations of its customers and
maintains an allowance for potential credit losses. The Company estimates
credit losses based on management's evaluation of historical experience and
current industry trends. Although the Company expects to collect amounts
due, actual collections may differ from the estimated amounts.
The Company's major customer for the year ended June 30, 1998 was Simon &
Schuster Interactive Distribution Services ("SSIDS"), accounting for 64% of
consolidated revenues for the year ended June 30, 1998. In 1999 SSIDS
transferred the Company's business to the Macmillan Distribution ("MD")
division. MD accounted for 52% and 40% of the consolidated revenues for the
years ended June 30, 1999 and 2000, respectively. TDK also accounted for
17% of consolidated revenues for the year ended June 30, 2000. Universal
Home Video accounted for 22% of consolidated revenues for the year ended
June 30, 1998, but did not account for more than 10% of consolidated
revenues for the years ended June 30, 1999 or 2000.
The Company's accounts receivable at June 30, 2000 of $275,248 are
primarily due from Scholastic Inc., Navarre Corp., and TJ Maxx, owing 29%,
26% and 17%, respectively.
JVC Disc America, Co. ("JVC") accounted for approximately 65% and 60% of
consolidated purchases for the year ended June 30, 2000 and 1999,
respectively. Wynalda Litho, Inc. also accounted for approximately 16% and
22% of consolidated purchases for the year ended June 30, 2000 and 1999,
respectively. Way Forwarding Technologies accounted for 21% of consolidated
accounts payable and accrued expenses as of June 30, 2000, while JVC
accounted for 33% of consolidated accounts payable and accrued expenses for
the year ended June 30, 1999.
-8-
<PAGE>
Risk and Uncertainties
Technological Obsolescence
The entertainment software industry is characterized by rapid technological
advancement and change. Should demand for the Company's products prove to
be significantly less than anticipated, the ultimate realizable value of
such products could be substantially less than the amount shown in the
consolidated balance sheet.
Licenses
The Company's products are based upon the licensed content of major motion
pictures and television shows and/or development agreements with major
entertainment studios. All of such license and development agreements to
which the Company currently is a party are for fixed terms that will expire
over the next one to five years. Although no licensor is required to extend
any license, the Company anticipates that the licensor under each agreement
will extend its terms, provided that the Company is in compliance with all
requirements of each license, including most significantly that the Company
has satisfied the applicable minimum royalty guarantees. In the event that
any licensor fails to renew its license agreement, then the subject license
will terminate, and the Company will no longer be entitled to sell the
licensed product. The loss of one or more of the licenses could have a
material adverse effect on the Company's revenues and operating results.
There can be no assurance that the Company will satisfy its performance
obligations under any license or development agreement or that, even if
such requirements are satisfied, all material licenses will be renewed.
Generally, the terms of a license agreement state that, upon any bankruptcy
or liquidation of the Company, licensing rights revert to the licensor.
Cash and Cash Equivalents - The Company considers all highly liquid
investments with original maturities of 90 days or less to be cash
equivalents.
Inventories - Inventories, which consist primarily of software and related
packaging materials, are stated at the lower of cost or market, with cost
determined on a first-in, first-out (FIFO) basis.
Property and Equipment - Property and equipment are stated at cost less
accumulated depreciation and amortization. Property and equipment are
depreciated using the straight-line method over the estimated useful lives
of the related assets, generally ranging from one and one-half to five
years. Leasehold improvements are amortized over the shorter of the lease
term or the estimated life of the improvement.
Long-Lived Assets - The Company periodically reviews the carrying value of
long-lived assets, and if undiscounted future cash flows are believed to be
insufficient to recover the remaining carrying value of a long-lived asset,
the carrying value is written down to its estimated fair value in the
period the impairment is identified.
Royalties - The Company enters into license agreements with movie studios,
actors, and sound developers for recognized movie and television properties
that require the Company to pay up-front minimum guarantees against future
royalties. The license agreements generally require the Company to pay a
percentage of sales of the products but no less than a specified amount
(the minimum guaranteed royalty). The Company records the minimum
guaranteed royalty as a liability and a related asset at the time the
agreement is consummated. The liability is extinguished as payments are
made to the license holders and the asset is expensed at the contractual
royalty rate based on actual net product sales. Royalty liabilities in
excess of the minimum guaranteed amount are recorded when such amounts are
earned by the licensor.
-9-
<PAGE>
The Company periodically assesses the recoverability of prepaid royalties
by determining whether the minimum guarantee will be recovered through
anticipated future sales on a product-by-product basis. Any amounts not
expected to be recovered are charged to operations in the period assessed
by management. For the years ended June 30, 2000, 1999 and 1998, $608,819,
$507,476, $225,000, respectively, of such royalties were written-off to
cost of sales in the consolidated statements of operations.
Income Taxes - Deferred income taxes are provided for temporary differences
between the financial statement and income tax bases of the Company's
assets and liabilities, based on enacted tax rates. A valuation allowance
is provided when it is more likely than not that some portion or all of the
deferred income tax assets will not be realized.
Revenue Recognition - Direct-to-the-customer sales are recognized when
merchandise is shipped to customers and are recorded net of discounts,
allowances, and estimated merchandise returns. While the Company has no
obligation to perform future services subsequent to shipment, the Company
provides telephone customer support as an accommodation to purchasers of
its products for a limited time. Costs associated with this effort are
charged to cost of sales as incurred in the consolidated statements of
operations. Revenue from third-party distributors is recognized as reported
by such distributors, net of estimated returns. Reserves for returns are
based on management's and third-party distributors' evaluation of
historical experience and current industry trends.
Software Development Costs - In accordance with Statement of Financial
Accounting Standards ("SFAS") No. 86, "Accounting for the Cost of
Capitalized Software to Be Sold, Leased or Otherwise Marketed," the Company
examines its software development costs after technological feasibility has
been established to determine if capitalization is required. Once
technological feasibility is established all software production costs will
be capitalized and reported at the lower of unamortized cost or net
realizable value until the product is available for general release to
consumers. Capitalized software will be amortized based on the remaining
estimated life of the product. As of June 30, 2000, capitalized software
costs amounted to $1,316,802. No amortization has been expensed as the
product(s) have not been completed nor available for distribution to
consumers.
Segment Reporting - As required by Statement of Financial Accounting
Standards ("SFAS") No. 131,"Disclosures about Segments of an Enterprise and
Related Information", the Company has reviewed its business activities and
determined that it does not have more than one operating segment as defined
by this statement. This determination was based on the management approach
which focuses on the way management organizes the Company's business
activities for making operating decisions and assessing performance. The
Company operates in one industry segment which includes the creation,
development, production, publishing and worldwide distribution of
interactive educational and entertainment software properties for personal
computers.
Net Income (Loss) per Common Share - The computations of the weighted-
average common shares and potential common shares used in the computation
of basic and diluted EPS are as follows:
<TABLE>
<CAPTION>
2000 1999 1998
<S> <C> <C> <C>
Basic EPS -
Weighted-average common shares outstanding
during the period 5,907,754 5,816,742 4,665,527
Incremental shares assumed to be outstanding
related to stock options granted - - 343,836
========= ========= =========
Diluted EPS -
Weighted-average common shares and
potential common shares during the period 5,907,754 5,816,742 5,009,363
========= ========= =========
</TABLE>
-10-
<PAGE>
As of June 30, 2000, potential dilutive securities representing 6,755,192
shares of common stocks were not included in the EPS calculation since
their effect would be antidilutive. Potential dilutive securities consisted
of 261,358 outstanding stock options, 6,253,824 stock warrants issued in
the IPO, and 240,000 stock warrants issued to the underwriters.
Warrants to purchase approximately 812,000, and 4,825,000 shares of the
Company's common stock at $4.40-$5.80 per share were outstanding for the
years ended June 30, 1999 and 1998, respectively, but were not included in
the computation of diluted EPS because the warrants were antidilutive.
New Accounting Pronouncements - In June 1998, the Financial Accounting
Standards Board issued Statement of Financial Standards No. 133,
"Accounting for Derivative Instruments and Hedging Activities" (SFAS No.
133). SFAS No. 133 requires companies to recognize all derivatives
contracts as either assets or liabilities in the balance sheet and to
measure them at fair value. If certain conditions are met, a derivative may
be specifically designated as a hedge, the objective of which is to match
the timing of gain or loss recognition on the hedging derivative with the
recognition of (i) the changes in the fair value of the hedged asset or
liability that are attributable to the hedged risk or (ii) the earnings
effect of the hedged forecasted transaction. For a derivative not
designated as a hedging instrument, the gain or loss is recognized in
income in the period of change. SFAS No. 133 is effective for all fiscal
quarters of fiscal years beginning after June 15, 2000. Historically, the
Company has not entered into derivatives contracts either to hedge existing
risks or for speculative purposes. Accordingly, the Company does not expect
adoption of the new standard on January 1, 2001 to affect its financial
statements.
In December 1999, the SEC staff released Staff Accounting Bulletin No. 101,
"Revenue Recognition in Financial Statements" ("SAB 101"). SAB 101 provides
interpretive guidance on the recognition, presentation and disclosure of
revenue in the financial statements. SAB 101 must be applied to the
financial statements no later than the quarter ending September 30, 2000.
The Company does not believe that the adoption of SAB 101 will have a
material affect on the Company's financial results.
In March 2000, the Financial Accounting Standards Board issued
Interpretation No. 44 ("FIN 44") Accounting for Certain Transactions
Involving Stock Compensation, an Interpretation of APB Opinion No. 25. FIN
44 clarifies the application of APB No. 25 for (a) the definition of
employee for purposes of applying APB No. 25, (b) the criteria for
determining whether a plan qualifies as a non-compensatory plan, (c) the
accounting consequences of various modifications to the terms of a
previously fixed stock option or award, and (d) the accounting for an
exchange of stock compensation awards in a business combination. FIN 44 is
effective July 2, 2000, but certain conclusions cover specific events that
occur after either December 15, 1998, or January 12, 2000. The Company has
adopted FIN 44 in accounting for the stock options granted during the year
ended June 30, 2000.
Reclassifications - Certain reclassifications have been made to the 1999
and 1998 consolidated financial statements to conform with the current
year's presentation.
2. INVENTORIES
Inventories consisted of the following as of June 30:
<TABLE>
<CAPTION>
2000 1999
<S> <C> <C>
Finished goods 113,681 229,992
Raw materials (components) 96,035 99,376
-------- --------
$209,716 $329,368
======== ========
</TABLE>
3. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following as of June 30:
<TABLE>
<CAPTION>
Useful
2000 1999 Lives
<S> <C> <C> <C>
Leasehold improvements $ 7,781 $ 7,781 5 years
Computer equipment 643,628 628,786 1.5 years
Office furniture and equipment 89,491 79,539 5 years
--------- ---------
740,900 716,106
Accumulated depreciation and amortization (596,379) (470,832)
--------- ---------
$ 144,521 $ 245,274
========= =========
</TABLE>
For the two years ended June 30, 2000 and 1999 depreciation expense was
$125,547 and 182,947, respectively and was included within general and
administrative expenses.
-11-
<PAGE>
4. COMMITMENTS AND CONTINGENCIES
Employment Contracts - The Company has entered into letters of employment
with four employees and a Succession Agreement with the CEO, including one
officers, which expire on various dates through December 2002 and provide
for certain expense allowances.
Future minimum base salaries, by year and in the aggregate, consist of the
following as of June 30, 2000:
<TABLE>
<CAPTION>
Years Ending
June 30,
<S> <C>
2001 $ 585,090
2002 312,836
2003 126,418
-----------
$ 1,024,344
</TABLE>
Certain of the employment agreements provide for commissions based on net
revenues through calendar year 2000 only. Commissions under employment
contracts for the years ended June 30, 2000, 1999 and 1998, amounted to
$2,403, $42,632 and $53,086, respectively, and are included in sales and
marketing expense in the consolidated statements of operations.
The Company and its officers and directors in the past have been, and in
the future the Company and/or its officers and directors may be, involved
in suits and actions incidental to the Company's business.
Operating Leases - The Company leases its facilities and certain equipment
under noncancelable operating leases that expire at various dates through
May 2002.
The facility lease expense is being recognized on a straight-line basis
over the term of the related leases. The excess of the expense recognized
over the amount paid is included in accounts payable and accrued expenses
in the consolidated balance sheets.Future minimum lease payments as of June
30, 2000, due through May 31, 2002 under such leases, are as follows:
<TABLE>
<CAPTION>
Operating Lease Rent Deferred
Leases Payments Expense Rent
<S> <C> <C> <C>
2001 144,698 140,031 4,667
2002 132,642 136,534 3,892
-------- -------- ------
$277,340 $276,565 $8,559
======== ======== ======
</TABLE>
Rent expense under operating lease agreements totaled $150,573, $156,511
and $150,516 for the years ended June 30, 2000, 1999 and 1998,
respectively, which are included in general and administrative expenses in
the consolidated statements of operations.
Capital Leases - The Company leased certain equipment and computers under
a capital lease obligation with interest at the rate of 13.0 per annum.
Distribution Agreements - On June 1, 1996, the Company entered into a two-
year distribution services agreement with SSIDS, which terminated on May
31, 1998. Until February 5, 1999, when the Company signed a new contract
with MD, they operated with no formal distribution agreement with these
entities. The agreement grants MD exclusive right to sell, distribute and
provide inventory, warehousing and fulfillment services for the Company's
licensed products, in certain defined markets and territories.
Pursuant to this agreement, MD made monthly payments to the Company in the
amount equal to its gross revenues, as defined, during such month from the
Company's products, less a distribution fee and reserve for returns equal
to stated percentages of the gross revenues and less certain other items,
-12-
<PAGE>
including out-of-pocket costs associated with inventory maintenance and
order fulfillment. The payments were due not later than 75 days after the
calendar month in question.
On March 14, 2000, the Company entered into a national sales representation
agreement with Strategic Marketing Partners, a leading manufacturers
product representation firm. Simultaneously, the Company's exclusive
distribution agreement with Macmillan Digital Publishing was terminated and
an orderly transition (as contemplated in the agreement) took place.
Macmillan's capabilities (sales and distribution) do not include the
ability to sell or distribute video game software as contemplated by the
Company. The Company will manage the Strategic Marketing Partners sales
force via a VP of National Sales and sign up retailers and independent
(non-exclusive) distributors as necessary.
Development Contracts - Periodically, the Company enters into certain
agreements with software developers whereby for specified development
services the Company will pay a fixed fee and/or a percentage of sales of
the product developed. For the years ended June 30, 2000, 1999 and 1998,
the Company paid a total of $1,351,000, $342,651 and $408,016,
respectively, under such agreements that are included in research and
development expenses in the consolidated statements of operations.
Litigation - On December 13, 1996, the Company filed suit in Superior Court
for the County of Los Angeles, California, against its former distributor,
Acclaim Distribution, Inc. On January 7, 1998, the Company and Acclaim
settled the lawsuit for the payment of $1,500,000 by Acclaim without any
admission of liability. The Company netted approximately $1,000,000 after
payment for legal, accounting and other costs associated with the lawsuit,
which is included in other income for the year ended June 30, 1998.
On April 24, 1998, the Company entered into a settlement agreement with
ASSI, Inc., NCD, Inc.; The Boston Group L.P.; Vincent J. Bitetti; Ulrich E.
Gottschling; Mark A. James; and Robert G. Kalik. Pursuant to the Settlement
Agreement, the Company has settled with prejudice two legal proceedings
that were pending against it, its Chairman and Chief Executive Officer
Vincent J. Bitetti, and its former President and Chief Operating Officer
Ulrich E. Gottschling, in Los Angeles Superior Court, which related to an
attempted expansion of the Company's Board of Directors and the election of
four persons to fill expansion seats. In connection with the settlement,
the Company (a) exchanged 1,100,000 shares of its common stock for the
remaining 4,816,657 common stock purchase warrants held by ASSI, Inc.; (b)
amended and restated its bylaws to provide for a seven-member Board of
Directors; (c) appointed Wayne Rogers, John Wholihan, Samuel Poole and
Richard Azevedo to fill vacancies on the Board of Directors; and (d)
entered into new employment agreements with Mr. Bitetti and Mr.
Gottschling. The fair market value of the common stock equaled the fair
market value of the warrants at the settlement date.
Pursuant to the settlement agreement, ASSI, Inc., NCD, Inc., Louis Habash
and the Company also entered into a lock-up agreement. Such agreement
provides that during the year ended May 31, 1999, ASSI, Inc., NCD, Inc.,
and Louis Habash (who is the beneficial owner of all of the voting
securities of ASSI, Inc. and NCD, Inc.) may not sell shares of the
Company's common stock beneficially owned by them in an aggregate amount in
excess of an amount determined by a formula, which equates to the
-13-
<PAGE>
product of approximately 94,620 shares times the number of full months,
commencing with the month of May 1998, which have elapsed since the
settlement.
Certain aspects of the settlement were submitted to the stockholders for
their approval at the annual stockholder meeting held on June 30, 1998. The
stockholders voted to approve those aspects of the settlement.
5. COMMON STOCK
Initial Public Offering (IPO) - On July 1, 1996, the Company issued
2,400,000 shares of common stock at $4.00 per share and 1,200,000
redeemable warrants at $.25 per warrant. Net proceeds totaled $7,372,980,
net of offering costs of $2,208,625, related to the common stock, and
$295,160 related to the redeemable warrants. On August 14, 1996, the
underwriters exercised a portion of their "over-allotment" option, pursuant
to the underwriting agreement, which resulted in the Company's issuing an
additional 160,000 shares of common stock at $4.00 per share and 171,775
redeemable warrants at $.25 per warrant. Net proceeds totaled $594,161, net
of offering costs of $88,783, related to the common stock, and $42,251
related to the redeemable warrants.
Each redeemable warrant entitles the holder to purchase one share of common
stock at $4.40 per share, subject to adjustment as defined, expiring
December 31, 2001. In the event that the redeemable warrants are called for
redemption, they will be exercisable for 30 days preceding the applicable
redemption date. Commencing on July 1, 1997, the redeemable warrants are
subject to redemption at $.25 per redeemable warrant if the average closing
bid price of the common stock equals or exceeds $5.60 per share for any 20
trading days within a period of 30 consecutive trading days ending on the
fifth trading day prior to the date of the notice or redemption.
The Company has also, in connection with the IPO, given the underwriter a
warrant for $50, which entitles the underwriter to purchase 240,000 shares
of common stock at $5.80 per share.
On July 7, 1996, in connection with the IPO, the Company issued 2,016,657
redeemable warrants in connection with the conversion of the note payable
to a related party of $500,000, plus accrued interest of $4,164.
The exercise price and number of common stock shares deliverable related to
the warrants issued in connection with the IPO are subject to adjustment.
The events that would trigger an adjustment are as follows: sale of common
stock for a consideration per share less than the Purchase Price, the
issuance of stock dividends to holders of common stock, a stock split or a
reverse stock split. Subsequent to June 30, 2000, the Company entered into
a transaction with TDK (Note 10) which triggered such an adjustment. The
Company is currently in the process of evaluating the effect on the
Purchase Price and number of redemable warrants.
6. STOCK OPTIONS AND WARRANTS
The 1992 Stock Option Plan - The Company adopted the 1992 Stock Option Plan
(the "1992 Plan") in May 1992, authorizing the issuance of up to 2,000,000
shares of common stock to employees, officers and directors of the Company.
Any shares that are subject to an award but are not used because the terms
and conditions of the award are not met, or any shares that are used by
participants to pay all or part of the purchase price of any
-14-
<PAGE>
option, may again be used for awards under the Plan. However, shares with
respect to which a stock appreciation right has been exercised may not
again be made subject to an award. On September 22, 1995, the Board of
Directors resolved that no additional grants shall be issued under the 1992
Plan.
For the year ended June 30, 1998, an aggregate of $323,351 was charged to
operating expenses for the options vested during 1998. No compensation
expense was charged to operating expenses for the year ended June 30, 1999
and 2000 because all options were vested at June 30, 1998.
The 1995 Stock Option Plan - Pursuant to the Company's restated 1995 stock
option plan (the "1995 Plan"), the Company may grant up to 1,000,000
options for shares of the Company's common stock.
Options under the 1995 Plan may be granted in the form of incentive stock
options or nonqualified stock options. The 1995 Plan terminates October 31,
2005 and is administered by a committee appointed by the Board of Directors
of the Company.
Incentive stock options under the 1995 Plan are limited to persons who are
employees of the Company and may not be granted at a price less than 100%
of the fair value of the stock as of the date of grant (110% as to any 10%
stockholder at the time of grant).
The term of each option may not exceed 10 years from the date of grant
(five years for any 10% stockholder). Vesting of the options is determined
by the committee on a case-by-case basis, and the options are not
exercisable unless the holder is currently employed with the Company. Upon
termination of employment, the holder has 30 days to exercise any options
held.
The 1999 Directors Stock Option Plan
Pursuant to the 1999 Director Stock Plan (the "1999 Plan"), each non-
employee director receives nonqualified stock options to acquire 10,000
shares of Common Stock upon appointment as a director, and receives
nonqualified stock options to acquire an additional 10,000 shares of Common
Stock for each additional year that the non-employee director continues to
serve on the Board of Directors. Such options previously were granted
pursuant to the 1995 Plan. Each option granted to a non-employee director
vests and becomes 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 expires on the earlier of ten years from the date the option was
granted, the expiration of the 1995 Plan or the 1999 Director Plan, as
applicable, or three weeks after the optionee ceases to be a director of
the Company. The exercise price of such options is 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 is subject to the other
provisions of the 1995 Plan or the 1999 Plan, as applicable.
-15-
<PAGE>
The following table summarizes option transactions during the three years
ended June 30, 2000 under both of the aforementioned plans:
<TABLE>
<CAPTION>
Weighted-
Average
Number Price
of Shares per Share
<S> <C> <C>
Balance, July 1, 1997 1,018,864 $2.32
Granted 771,099 $1.75
Exercised (140,875) $0.06
Canceled (593,193) $3.91
------------ --------
Balance, June 30, 1998 1,055,895 $1.34
Granted 60,000 $0.72
Exercised (219,428) $0.06
Canceled (231,248) $1.48
------------ --------
Balance, June 30, 1999 665,219 $1.66
Granted 90,000 $0.30
Exercised (42,394) $0.07
Canceled (451,457) $1.64
------------ --------
Balance, June 30, 2000 261,368 $1.48
============ ========
</TABLE>
The following summarizes pricing and term information for options
outstanding as of June 30, 2000:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
----------------------------------------------------------------------------
Weighted-
Number Average Weighted- Weighted-
Range of Outstanding Remaining Average Exercisable Average
Exercise at June 30, Contractual Exercise at June 30, Exercise
Prices 2000 Life Price 2000 Price
<S> <C> <C> <C> <C> <C>
$0.06 14,937 4.0 $ 0.06 14,937 $ 0.06
$0.625 - $1.1875 156,431 4.9 $ 0.56 95,556 $ 0.64
$2.094 - $2.50 55,000 4.0 $ 2.28 55,000 $ 2.28
$4.5625 - $5.00 35,000 3.4 $ 4.88 35,000 $ 4.88
---------- ----------
261,368 4.5 $ 1.48 200,493 $ 1.79
========== ==========
</TABLE>
The Company has adopted the disclosure-only provisions of SFAS 123,
"Accounting for Stock-Based Compensation." The estimated fair value of
options granted during 2000, 1999 and 1998 pursuant to SFAS No. 123 was
approximately $ 18,700, $33,140 and $538,027, respectively. Had the Company
adopted SFAS No. 123, pro forma net income (loss) would have been
($3,594,653), ($4,291,717) and $195,398 and pro forma basic net income
(loss) per share would have been $(0.61), $(0.74) and $0.04 for 2000, 1999
and 1998, respectively. The fair value of each option grant in 2000 was
estimated using the Black-Scholes option-pricing model with the following
weighted-average assumptions: dividend yield of zero, volatility of 30%, a
risk-free interest rate of 5.64%, and expected option lives of four years.
The fair value of each option grant in 1999 and 1998 was estimated using
the Black-Scholes option-pricing model with the following weighted-average
assumptions: dividend yield of zero, volatility of 111%, a risk-free
interest rate of 5.81%, and expected option lives of four years.
As of June 30, 2000, the Company had 6,253,824 stock warrants issued in the
IPO at an exercise price of $4.40 and 240,000 stock warrants issued to the
underwriters at an exercise price of $5.80.
-16-
<PAGE>
7. INCOME TAXES
The provision for income taxes for the years ended June 30, 2000, 1999 and
1998 comprises minimum state taxes only.
A reconciliation of the provision for income taxes with the expected income
tax (benefit) provision computed by applying the federal statutory income
tax rate to income (loss) before provision for income taxes for the years
ended June 30, 2000, 1999 and 1998 is as follows:
<TABLE>
<CAPTION>
2000 1999 1998
<S> <C> <C> <C>
Income tax (benefit) computed at federal
statutory tax rate $(1,112,986) $(1,392,174) $ 175,700
State and local taxes 2,400 1,600 1,600
Expenses not deductible for income
tax purposes 2,810 30,270 7,603
Limitation of net operating loss carry-forward
per IRC 382 1,083,082 - -
Other - (268,977) 9,362
Change in the valuation allowance 27,094 1,630,881 (192,665)
----------- ----------- ---------
$ 2,400 $ 1,600 $ 1,600
=========== =========== =========
</TABLE>
The components of the net deferred income tax asset recorded in the
accompanying consolidated balance sheets as of June 30, 2000 and 1999 are
as follows:
<TABLE>
<CAPTION>
2000 1999
<S> <C> <C>
Reserves and accrued liabilities $ 267,987 $ 118,856
Deferred Revenue $ 2,090,430 -
Net operating loss carryforwards 2,397,293 4,609,760
Valuation allowance (4,755,710) (4,728,616)
----------- -----------
$ - $ -
=========== ===========
</TABLE>
At June 30, 2000, the Company had federal and state net operating loss
carry-forwards of approximately $6,000,000 and $3,000,000, respectively,
available to offset future taxable federal and state income, respectively.
The federal and state carry-forwards expire in varying amounts through 2020
and 2005, respectively.
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<PAGE>
Due to the change in ownership provisions of the Tax Reform Act of 1986,
net operating loss carry-forwards for federal income tax reporting purposes
are subject to annual limitations. The change of ownership that occurred
during fiscal 1997, as a result of the IPO, caused the limitation of the
Company's net operating loss carry-forwards. Approximately 67% ($8,200,000)
of the net operating loss carry-forward was subject to limitation.
8. RELATED-PARTY TRANSACTIONS
A Director performed legal services on behalf of the Company. The Company
incurred approximately $250,000 for the year ended June 30, 1998 which is
included in general and administrative expenses. No such expenses were
incurred for the fiscal years ended 2000 and 1999.
9. LINE OF CREDIT
In September 1997, the Company entered into a factoring agreement with
Silicon Valley Financial Services. The factoring agreement provides for
borrowings of up to $1,500,000 of the Company's qualified accounts
receivable balance, as defined in the agreement, at a rate of 1.75% per
month of the average gross daily factoring account balance. The credit is
secured by all the assets of the Company and can be terminated by either
party upon 30 days notice. As of June 30, 2000, the Company had no
outstanding borrowings under the line of credit and is in the process of
obtaining renewal through September 30, 2001.
10. SUBSEQUENT EVENTS
On September 8, 2000, Sound Source Interactive, Inc. (the "Company") and
TDK USA Corporation, a New York corporation ("TDK"), entered into a common
stock purchase agreement (the "Purchase Agreement"), pursuant to which TDK
agreed to purchase, and the Company agreed to sell, a total of 16,667,000
shares of common stock, par value $.0001 per share of the Company (the
"Common Stock"), for the purchase price $.30 per share and an aggregate
purchase price of Five Million One Hundred Dollars ($5,000,100). The
Purchase Agreement contains representations, warranties, covenants, and
conditions customary for a transaction of this size and nature.
Upon the execution of the Purchase Agreement, TDK acquired 4,750,000 shares
of Common Stock for an aggregate purchase price of $1,425,000 (the "Initial
Closing"). Pursuant to the Purchase Agreement, TDK has agreed to purchase
an additional 11,917,000 shares of Common Stock for an aggregate purchase
price of $3,575,100 (the "Subsequent Closing"). The Subsequent Closing is
subject to the satisfaction of certain conditions, including (i) the filing
of amendments to the Company's Certificate of Incorporation (the "Charter
Amendment") to (a) change the name of the Company to "TDK Mediactive, Inc."
and (b) increase the number of shares of Common Stock the Company is
authorized to issue from 20,000,000 to 50,000,000 and (ii) (a) the
resignation of each of Richard Azevedo, Mark A. James and Samuel L. Poole
as directors of the Company and (b) the resulting vacancies having been
filled by the remaining directors appointment of nominees designated by
TDK. In the event that the directors described above shall not have
resigned as of the Subsequent Closing, TDK may waive such condition and
execute a Written Consent of Stockholders of the Company for the purpose of
removing from office those directors and electing in their place the TDK
nominees. There can be no assurance that all of the conditions will be
satisfied and that the Subsequent Closing will occur on the terms set forth
herein or at all.
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<PAGE>
Following the consummation of the Initial Closing, TDK became the Company's
largest stockholder owning approximately 45% of the outstanding Common
Stock. Upon the consummation of the Subsequent Closing and based upon the
number of shares of Common Stock currently outstanding, TDK will own
approximately 74% of the outstanding Common Stock.
Simultaneous with the Initial Closing, the Company and TDK entered into a
registration rights agreement (the "Registration Rights Agreement")
pursuant to which the Company granted to TDK certain registration rights
with respect to the Common Stock purchased and owned by TDK pursuant to the
Purchase Agreement.
Furthermore, simultaneous with the Initial Closing, the Company, TDK and
Mr. Vincent J. Bitetti entered into a lock-up agreement (the "Lock-Up
Agreement"), whereby Mr. Bitetti agreed to certain limitations on his
rights to sell or otherwise transfer any Common Stock that he now owns or
may acquire from the Company pursuant to options that he now holds.
The exercise price and number of common stock shares deliverable related to
the warrants issued in connection with the IPO are subject to adjustment.
The events that would trigger an adjustment are as follows: sale of common
stock for a consideration per share less than the Purchase Price, the
issuance of stock dividends to holders of common stock, a stock split or a
reverse stock split. Subsequent to June 30, 2000, the Company entered into
a transaction with TDK (Note 10) which triggered such an adjustment. The
Company is currently in the process of evaluating the effect on the
Purchase Price and number of redemable warrants.
*****
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