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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X]
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
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 number: 0-24936
7TH LEVEL, INC.
(Exact name of registrant as specified in its charter)
Delaware 75-2480669
(State of incorporation) (I.R.S. Employer Identification No.)
925 Westchester Avenue
White Plains, New York 10604
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (914) 682-4300
Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, $0.01 par value
(Title of Class)
Indicate by check mark whether the registrant (1) has 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 registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. X
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The approximate aggregate market value of the common stock held by
non-affiliates of the registrant as of March 15, 1999 was approximately
$180,635,373 or $6.875 per share. As of March 15, 1999, there were 30,639,435
outstanding shares of the registrant's common stock.
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the Registrant's definitive proxy statement to be filed with
the Securities and Exchange Commission no later than April 30, 1999 pursuant to
Regulation 14A of the Securities Exchange Act of 1934 are incorporated by
reference in Items 10 through 13 of Part III of this Form 10-K.
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Table of Contents
Page
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PART I
Item 1. Business 3
Item 2. Properties 14
Item 3. Legal Proceedings 14
Item 4. Submission of Matters to a Vote of Security Holders 15
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters 15
Item 6. Selected Financial Data 16
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 17
Item 8. Financial Statements and Supplementary Data 23
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 42
PART III
Item 10. Directors and Executive Officers of the Registrant 44
Item 11. Executive Compensation 44
Item 12. Security Ownership of Certain Beneficial Owners
and Management 44
Item 13. Certain Relationships and Related Transactions 44
PART IV
Item 14. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K 45
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Part I
ITEM 1. BUSINESS
General
7/th/ Level, Inc. was founded in 1993 with the goal of becoming a leading
developer and publisher of interactive entertainment and educational products as
well as a creator of state of the art tools and technologies. In 1998, our
research and development activities were focused primarily on developing and
enhancing our Agent7/TM/ technology. Agent7 is a technology that evolved from
our existing technology assets and enables animated characters to automatically
speak and gesture based on speaker-independent voice recognition and text-to-
speech synthesis. Agent7 characters can deliver virtually any kind of
information and provide interactivity to assist and instruct the average
Internet user.
We recognized that a large market for this technology would likely develop for
learning, education and enhanced communications. To establish a business plan
that could serve both as a revenue source and a showcase of our technology, we
searched for a viable and complementary partner with the appropriate technology
and content assets, distribution channel and management expertise.
Street Technologies, Inc. Acquisition
In February 1999, we acquired all of the outstanding stock of Street
Technologies, Inc., a privately held company, and began doing business as
7/th/Street.com, Inc. We began marketing and developing training solutions
delivered over intranets and the Internet.
Street was founded in 1995 with the mission of providing engaging, interactive,
training and learning content delivered over computer networks including the
Internet. To accomplish this mission, Street acquired StreamMaker/TM/, a
streaming technology, and hired its inventors. Streaming technology enables the
transmission and playback of continuous "streams" of multimedia content, such as
audio, video, graphics and animation without download. Street became an
aggregator of multimedia tutorials and training courses on a variety of
subjects. Street marketed and distributed these multimedia tutorials over the
Internet and corporate intranets through Street's internally developed
electronic commerce and administration systems.
In conjunction with our acquisition of Street, we appointed Stephen P. Gott,
Street's founder, Chairman of the Board, President and Chief Executive Officer,
as our President and Chief Executive Officer. Mr. Gott, a former Chief
Technology and Operations Officer at Lehman Brothers, was also appointed to our
Board of Directors. In addition, Richard S. Merrick, our Chief Executive
Officer, Curt W. Marvis our President, and Timothy J. Cahill, our Chief
Operating Officer, resigned from their respective positions. Mr. Merrick, who
still is a member of our Board of Directors, is currently facilitating the
transition of our operations to our new headquarters in White Plains, New York.
Marc E. Landy was appointed our Chief Financial Officer, which was the same
position he held with Street.
Business Strategy and Strategic Direction
Our goal is to become the world's leading provider of Internet and network
delivered learning, education and enhanced communications. Our mission is to
provide our customers, including consumers, corporations, government agencies
and educational organizations, with a complete solution for learning, education
and enhanced communications. To accomplish our goal, we have initiated the
following:
. Content Acquisition - We license or purchase effective and engaging
content by building and maintaining relationships with a variety of high
quality publishers and content providers covering a wide range of subjects.
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. Content Integration - We integrate our technologies with the content to
provide our customers and users with enhanced content. We refer to this
enhanced content as "7/th/ Street Enabled/TM/".
. Marketing and Distribution - Our marketing efforts consist of direct sales
through our own sales force, indirect sales through our authorized
resellers and e-commerce sales on the Internet. We distribute 7/th/ Street
Enabled content over computer networks and the Internet to provide easy
access to our customers.
. Research and Development - We are integrating Agent7 with StreamMaker to
enhance the sophistication of our products and services. When integrated
with our tutorials, Agent7 characters can synchronously speak the voiceover
dialog and gesture to specific items on the screen. We believe this will
result in increased user comprehension and retention of information. We are
constantly adding new features and functions to our technologies.
Name Change
Our Board of Directors has approved the change of the name of our company from
7/th/ Level, Inc. to 7/th/Street.com, Inc. Our name change will be effective if
approved by our stockholders.
Marketplace
For many years, organizations have fulfilled their requirements for education
and training primarily through instructor-led training, computer based training
and CD-ROM multimedia training. Each of these models has limitations.
Instructor-led training typically requires employees to attend classes at
off-site locations. Computer based training generally consists of text and
graphics that are downloaded over computer networks to a user's PC or accessed
through client server applications. Computer based training is limiting because
there is no audio and the entire training program must be downloaded before a
user can begin. In addition, there are significant costs from computer network
congestion and a high degree of internal technical support. CD-ROM's are
limiting because of the difficulty and expense in locating, managing and storing
the wide array of content on the CD-ROMs.
Our products and services overcome these limitations by streaming, rather than
downloading, the tutorials. Our content is enriched with graphics, audio and
animation. The highly compressed streams that contain the tutorials alleviate
computer network congestion. Our solutions include instant delivery over
computer networks, including the Internet, interactive multimedia tutorials,
individual assessment, a comprehensive administrative system and an intelligent
agent icon for communications. The outsourced hosting service we provide to our
customers is fundamental to our solutions. Our customers and we benefit from
this service because it greatly minimizes the technical support ordinarily
required for the delivery and internal maintenance of client server and other
web based applications installed on a customer's computer network. In addition,
we are enhancing our solutions with an Agent7 based guide that offers immediate
answers to user questions.
We have created or licensed over 200 tutorial titles. The subject matter of the
tutorials includes the following:
. Desktop applications including Windows 98 and Microsoft Office 97;
. Courses to prepare for Microsoft Certification;
. Programming courses including Visual Basic and HTML; and
. Business skills including time management and interviewing skills.
Products and Services
Consumer - Tutorials.com
We market interactive multimedia tutorials to consumers on the Internet through
our Tutorials.com web site. Users of Tutorials.com can choose from a variety of
titles covering a wide range of subjects including
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desktop application software, computer programming and English as a second
language. This online library is targeted to both the mass consumer audience who
frequently use the Internet as well as the large and growing segment of work at
home professionals and students who demand instantaneous results. Our goal is to
be universal so that Tutorials.com is linked to numerous web sites and web
searches for "tutorials" will always link to Tutorials.com. We own the domain
name "Tutorials.com" and are penetrating this market through the following
channels:
. Vertical Portal - We have and are continuing to enter into revenue sharing
arrangements with widely recognized, branded web sites or portals.
Tutorials.com is an educational content provider benefiting from that
site's local traffic. To date, an anchor tenant contract with AOL
represents our most widely recognized relationship.
. PC Manufacturers - We have and are continuing to enter into revenue sharing
arrangements with PC manufacturers. Under these arrangements, an icon on
the desktop links directly to Tutorials.com. We have entered into a
contract with Gateway 2000, Inc. which is our first step toward this
objective.
. Affiliates Program - We have and are continuing to extend our market
presence through our Affiliates Program, which enables associated web sites
to make our products available to their audiences. We have entered into an
agreement with GeoCities, in which we are among the first 16 merchants to
be exposed to its 3.5 million web site owners. Within the first two weeks,
over 8,000 web sites applied to join our Affiliates Program. We have also
entered into an agreement with Linkshare, which specializes in building
affiliate programs and provides us with access to over 65,000 web sites.
. Destination Site - We are marketing Tutorials.com as a destination web site
through a comprehensive marketing strategy designed to strengthen the
Tutorials.com brand name, increase customer traffic to the Tutorials.com
web site, build customer loyalty, encourage repeat purchases and develop
incremental revenue opportunities.
Corporations and Other Organizations - Learning University, StreamMaker and
Agent7
Our solutions for corporations and other organizations consist primarily of the
following products and services:
. Learning University/TM/
. StreamMaker/TM/, custom tutorial creation and conversion
. Agent7/TM/ and custom character creation
Learning University. - Learning University/TM/ 2.8, the current version of LU,
is an interactive education and learning web site that we maintain for our
customers. LU includes tutorials, administration, reporting and e-commerce
capabilities. LU provides a cost effective, value added service that we believe
is superior to that which an organization can deliver on its own. Our customers
can offer training to their employees, across a computer network, corporate
intranet or the Internet. LU allows each customer and its employees to tailor
training to their individual needs. LU enables users to practice and test skills
as they learn, utilizing simulation technologies that allow users to practice
many of the concepts introduced. After the completion of each course, users can
print a completion certificate indicating that they have successfully met all of
the requirements of the course. Users of LU can choose from a variety of titles
covering a wide range of subjects, including desktop application software,
computer programming and business skills.
StreamMaker - StreamMaker/TM/ 4.3, the current version of our authoring tool,
utilizes patent pending technology to produce fully synchronized, interactive,
CD-ROM quality multimedia streams that can be delivered through computer network
connections, including a 28.8 modem connection, without download. The benefits
of StreamMaker include:
. A proprietary method for graphics compression
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. A patent pending technology which ensures that the elements of a multimedia
production, including, audio, graphics, animation, video and text, are
synchronized
. The ability to develop interactive streams
. A design which facilitates integration with other technologies
To date, we have licensed StreamMaker to several companies including IBM and
Intuit.
Custom tutorial creation and conversion - We use StreamMaker to stream or
create "7/th/Street-Enabled" tutorials for our customers' web based applications
or proprietary software. We are currently marketing these services
to companies that have active web sites. Our services are intended to help our
customers educate their customers on the use of, navigation of, content of, and
products on their web sites. We also use StreamMaker to convert existing
content so that it can be streamed. In certain cases we may recommend
authorized consultants to our customers to create original or convert existing
content for them.
Agent7 and custom character creation - Agent7/TM/ version 1.2 is our
intelligent agent authoring tool that streams data to enable animated characters
to automatically speak and gesture based on speaker-independent voice
recognition and text-to-speech synthesis. The benefits of Agent7 include:
. The ability to reuse animation gestures with different dialogs. This saves
production costs and allows the modification of gestures and dialogs in
only minutes instead of days or weeks.
. The quality and impact of the animation experience exceeds the typical
quality experienced at normal Internet modem speeds by streaming animation
data, then assembling it on the PC.
. No special programming skills are necessary.
. Users can program interactivity to link the characters to web pages and
applications.
We currently have a library of approximately one hundred 2D and 3D animated
characters covering a broad array of styles from serious to humorous. We also
can create custom characters that represent a company's mascot or logo. Agent7
characters can deliver virtually any kind of information and provide
interactivity to assist and instruct the average Internet user. Agent7
characters can be delivered over the Internet in a variety of ways including
embedded into web pages and delivered in e-mails.
Our plan is to license Agent7 on a monthly service fee basis to customers for
the following applications:
. As navigational web guides, Agent7 characters can provide information about
what's new, where to find topical information and automatically take a user
to an area of interest.
. In a help desk application, Agent7 characters can respond to questions with
spoken answers and built-in links to relevant web pages.
. Agent7 characters can be used as "intelligent" icons that are placed on the
PC desktop to deliver learning tips and offer direct links to tutorials.
The Total Solution
We believe that there is a significant market opportunity for our flexible,
engaging and cost-effective education and training solutions. We believe that
the combination of our off the shelf and custom products and services will
attract customers who desire the convenience of one stop shopping. In addition,
we believe that once customers have purchased our products and services we will
have significant opportunities to sell additional products and services.
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Product Distribution - Corporations and Other Organizations
We market our products through direct and indirect sales channels.
Direct sales channel - On March 1, 1999 we began to market our products and
services directly to Fortune 1000 companies and government agencies. We market
a total learning solution through our combined offering of LU, technologies and
custom services. We generally license our tutorials through one year
agreements. In 1999, we plan to increase our current direct sales force from
four sales professionals to at least 17 sales professionals located in key
cities throughout the United States.
Indirect sales channel - We have entered and continue to enter into Reseller
Agreements with value added resellers. These resellers sell LU to corporations,
school systems and governmental agencies either under their own branded web
sites or with co-branded web sites. The resellers generally license the
tutorials through one-year agreements. Our success is not contingent upon any
single reseller.
Suppliers
We currently have relationships with approximately ten content providers. We
believe that we have assembled a critical mass of titles for market acceptance.
However we intend to broaden the scope of the subject matter and increase the
number of content providers. Some of the new subjects may include home
improvement, foreign languages and K-12 courseware.
E-Commerce and Infrastructure Technology
We have implemented web site management tools, search engines, transaction
processing and fulfillment services using a combination of our own proprietary
technologies and commercially available, licensed technologies. Our current
strategy is to create and enhance our proprietary technologies and to license or
acquire commercially developed technologies for other applications where
available and appropriate.
Our systems administrators and network managers monitor and operate our web
sites, network operations and transaction processing systems. The continued
uninterrupted operation of our web sites and transaction processing systems is
essential to our business. We use the services of an Internet service provider
to obtain connectivity to the Internet.
Competition
Internet and Web Based Training
The Internet and web based training market is new, rapidly evolving and
intensely competitive. Our current and potential competitors include:
. Other web based training companies including ZD, Inc.
. Traditional computer based training companies including
CBT Systems and NETg
. Instructor led training companies
. CD-ROM companies and video companies
. Publishers of instructional books
. Companies that provide help desk services
Currently, computer based training is more common than web based training and
may continue to be widely accepted. Furthermore, the web based training market
requires its customers to have Internet access. The computer based training
industry has several dominant, more financially secure players including CBT
Systems and NETg, both of which have entered the web based training market.
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Multimedia Streaming Technology
The two major providers of streaming technology are Microsoft and RealNetworks.
We believe that StreamMaker is different than other streaming technologies
because we engineered it specifically for use in training and distance learning
applications. However, both Microsoft and RealNetworks have substantial
resources. In addition Macromedia has strong CD-ROM authoring technologies which
it has been evolving into Internet capable technologies.
Agent technology
The digital animation and "intelligent agent" products and services industry is
intensely competitive, rapidly changing and significantly affected by new
product introductions and other market activities of industry participants. We
are aware of numerous competitors that provide products and services similar to
those offered by us including the following:
. Animated character software vendors, including Microsoft, Macromedia,
Extempo, ToggleThis, 3D Planet, Atomic 3D, Pulse and Parable
. Recommendation and agent software vendors, including Net Perceptions,
Autonomy and Aptex
. Q&A natural language response systems vendors, including Teknimedia,
Big Science, Inference and c-serv
In addition, with the rapid expansion of the Internet, it is likely that
additional competitors will enter the digital animation and "intelligent agent"
market. Increased competition may result in the development of products which
are superior to ours, or are perceived by the market to be superior, which could
cause price reductions, reduced gross margins and loss of market share for us.
Intellectual Property and Licenses
Our success and ability to compete effectively will depend, in part, on our
ability to protect our intellectual property. We rely primarily on a
combination of statutory and common law copyright, trademark and trade secret
laws, customer licensing agreements, employee and third-party nondisclosure
agreements and other methods to protect our proprietary rights. We have applied
for several patents that are necessary for the operation of our business. We
may not be issued these patents based on our applications or future
applications, and even if these patents are issued they may not be sufficiently
broad to protect our rights.
We have limited mechanisms to prevent or inhibit unauthorized use, but we
generally require the execution of a license agreement that restricts copying
and use of our products. If unauthorized copying or misuse of our products were
to occur to any substantial degree, then our business would be materially
adversely affected. It may be possible for a third-party to copy or otherwise
obtain and use our tutorials or technologies without authorization, or to
develop similar tutorials or technologies independently.
We use employee and third-party confidentiality and non-disclosure agreements to
protect our trade secrets and unpatented know-how. We require our employees to
assign to us all rights in any proprietary information or technology made or
contributed by the employee during his or her employment with us. In addition,
we regularly enter into non-disclosure agreements with third parties including
consultants, potential strategic partners and customers. Unfortunately, these
agreements cannot guarantee the confidentiality of our trade secrets or
unpatented know-how, nor can they prevent third parties from independently
developing substantially equivalent proprietary information or copying,
developing, or otherwise obtaining and using our proprietary information without
authorization.
We may resort to litigation to enforce our intellectual property rights, to
determine the validity and scope of the proprietary rights of others, or to
defend ourselves against claims of infringement or invalidity by others. While
we are not currently engaged in any intellectual property litigation or
proceedings, we may be in the future. An adverse outcome in a litigation or
similar proceeding could subject us to significant liabilities to third parties,
require disputed rights to be licensed from others, or require us to cease
marketing or using certain products or services. The cost of addressing any
intellectual property litigation, both in legal fees and the diversion of
management resources, regardless of whether the claim is valid, could be
significant.
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Third parties may claim that our current or future products infringe on their
proprietary rights. We may be increasingly subject to these claims as the
number of products and competitors in the education and training industry grows
and the functionality of products in the marketplace overlaps. Any of these
claims, with or without merit, could result in costly litigation or might
require us to enter into royalty or licensing agreements. These royalty or
license agreements, if required, may not be available on terms acceptable to us,
if at all.
Employees
As of March 15, 1999 we had a total of 62 full-time employees, of whom 16 were
engaged in sales and marketing, 37 in product development, production and
customer support, and 9 in management, administration and finance.
Substantially all of the employees work in our offices in Richardson, Texas;
Golden, Colorado or White Plains, New York. None of our employees are subject
to a collective bargaining agreement and we have not experienced any work
stoppages. We believe that our relationship with our employees is good.
We may not be able to retain our key executives and engineers. As an
organization that is currently integrating the business plans and technologies
of two companies, we heavily rely on the two principal executive officers of the
two companies as well as the inventors of our two main technology platforms. We
expect to continue to hire additional product development, sales and marketing,
production and accounting staff. We may not be successful in attracting,
retaining or motivating key personnel. Our inability to hire and retain
qualified personnel or the loss of the services of key personnel could have a
material adverse effect upon our business.
Additional factors that may affect our future results
You should carefully consider the following risk factors and other information
included in this Form 10-K. The risks and uncertainties described below are not
the only ones we face. Additional risks and uncertainties not presently known
to us or that we currently deem immaterial also may impair our business
operations. If any of the following risks materialize, our business could be
materially adversely affected.
We have a limited operating history.
As an early-stage Internet company, we have an evolving and unpredictable
business model. In addition, we face intense competition and must effectively
manage our growth and respond quickly to rapid changes in customer demands and
industry standards. We may not succeed in addressing these challenges and risks.
We have an accumulated deficit and anticipate further losses.
We have incurred significant losses since we began doing business. As of
December 31, 1998, we had an accumulated deficit of approximately $85 million.
To succeed we must invest in marketing, promoting and developing our products,
technologies and operating infrastructure. In addition, the expenses associated
with our recent acquisition of Street will adversely affect our operating
results.
The successful combination of 7/th/ Level and 7/th/ Street.com, including the
successful integration of Agent7 and StreamMaker, will require substantial
effort.
The diversion of the attention of management and difficulties encountered in the
transition process could have an adverse impact on our ability to realize the
full benefits of the merger. The successful combination of the two companies
will also require coordination of our sales and marketing efforts. In addition,
the process of combining the two organizations could cause the interruption of,
or loss of momentum in, our activities.
Due to our limited operating history and the unpredictability of our industry,
we cannot accurately forecast our revenues.
We base our current and future expense levels on our investment plans and
estimates of future revenues. Our expenses are to a large extent fixed. We may
not be able to adjust our spending
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quickly if our revenues fall short of our expectations. Further, we may make
pricing, purchasing, service, marketing, acquisition or financing decisions that
could adversely affect our business results.
Our quarterly operating results will fluctuate for many reasons, including:
. Our ability to retain existing customers, attract new customers and satisfy
our customers' demand
. Our ability to acquire content and manage our content relationships
. Changes in gross margins of our current and future products, services and
markets
. Introduction of our new web sites, services and products or those of our
competitors
. Changes in usage of the Internet and online services and consumer
acceptance of the Internet and electronic commerce
. Timing of upgrades and developments in our systems and infrastructure
. The level of traffic on our web sites
. The effects of acquisitions and other business combinations, and related
integration
. Technical difficulties, system downtime or Internet brownouts
You should not rely on period-to-period comparisons of our financial results to
forecast our future performance. Our future operating results may fall below
the expectations of securities analysts or investors, which would likely cause
the trading price of our common stock to decline.
We face rapid technological change and frequent new product introductions.
The markets for our products and services are characterized by rapid
technological change, frequent new product introductions and evolving industry
standards. We believe that our future success depends upon our ability to
develop and market products and services that incorporate and apply new
technologies, and our ability to enhance and expand our existing product lines
and services. We will need to spend significant amounts of capital to develop,
market and enhance our products and services to meet and take advantage of
technological changes. We may not be:
. Able to develop or market new products or services successfully
. Successful in commercially developing new products and services
. Able to respond effectively to technological changes, new industry
standards, or new products or services offered by our competitors
. Able to raise sufficient capital when required to implement our strategies
Our future success will depend upon, among other factors, the extent to which
companies continue to adopt web based training programs, the proliferation of
multimedia PCs inside corporations and the acceptance of the Internet as a
viable distribution medium. If our solutions do not become widespread or we do
not achieve market acceptance, or are unable to anticipate technological change
or evolving industry standards and successfully introduce new products our
business, results of operations, and financial condition could be adversely
affected.
We depend upon strategic alliances or relationships.
We depend upon third parties for several critical elements of our business
including technology, content development and distribution activities.
Technology - Technology critical to our products and solutions including speech
recognition and the speech synthesis engine are licensed from third parties. We
have improved these technologies and applied them in unique ways with our other
proprietary techniques. If the licensors were to terminate our license
agreements we may have to make substantial expenditures to develop or license
replacement technology. This could adversely affect the performance of our
business.
Content Development - Some of our licensed content is available from a limited
number of resources. Currently, seventy-five percent (75%) of our tutorials are
licensed from two sources; Viagrafix
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and NIIT. Although to date we have been able to license adequate tutorials, our
inability in the future to obtain content from third parties, or to develop our
own content could result in delays in product introductions or shipments. We
depend on the quality and reliability of the tutorials licensed and timely
delivery of these tutorials by our sources. Although we have agreements
specifying the terms of the licenses, these agreements may not be enforceable.
We believe that we can arrange alternate sources for some or all of these
tutorials, but the inability of any of these content providers to provide these
tutorials to us on a timely basis could affect the performance of our business.
Distribution Activities - We currently have relationships with online services
and Internet content providers including AOL, GeoCites and Linkshare.
Additionally, we have relationships with authorized resellers. Under our
agreement with AOL, its members will have direct access to Tutorials.com.
GeoCities and Linkshare market our Affiliates Program to their customers. These
distribution agreements typically are not exclusive and may be terminated upon
certain conditions.
We face a risk of system failure.
Our operations depend to a significant extent on our ability to maintain our
computer and telecommunications systems. Currently, we are using one major
Internet service provider. We must also protect our systems against damage from
fire, natural disaster, power loss, telecommunications failure or similar
events. Our business depends in significant part on our operations center in
Golden, Colorado. Although we have arranged for off-site back-up for our
network control, this measure does not eliminate the risk to our operations from
a natural disaster or system failure. In addition, growth of our customer base
may strain the capacity of our computer operations center and telecommunications
systems and/or lead to degradations in performance or system failure. Any
damage to or loss of our computer and telecommunications networks including our
operations center could adversely affect the performance of our business.
A large portion of our revenues comes from a small number of customers.
At present, a relatively small group of our customers are responsible for a
significant percentage of our revenue. For example, for the year ended December
31, 1998, royalties and production fees from our largest customer accounted for
34 % of net revenue. Although we believe that our current relationships
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with our customers are generally good, the loss of one or more of our major
customers could affect the performance of our business.
The market price of our common stock is volatile.
The trading price of our common stock can fluctuate significantly. For example,
during the 52-week period ended March 26, 1999, the market price of our stock
ranged from $1.25 to $12.625. The market price of our common stock may fluctuate
in response to certain events and factors. For example, On March 5, 1999, we
announced an agreement with AOL to offer training to AOL members through
Tutorials.com. As a result of the announcement, on the following Monday March
8, 1999, the stock price ranged from $5.00 to $8.884 with a trading volume of
38,259,000 shares.
The Internet is an evolving commercial venue. We consider building and
maintaining key marketing and technology relationships an important factor in
our success. In addition these relationships are likely to impact the trading
price of our common stock.
A drop in the market price of our common stock may adversely affect our business
and financing opportunities. In addition, the stock market in general and the
market prices for Internet-related companies in particular have experienced
volatility that often has been unrelated to the operating performance of these
companies.
Certain events could result in a dilution of your ownership of our common stock.
As of February 28, 1999, we had 30,547,560 shares of common stock outstanding
and 5,509,490 common stock equivalents including convertible preferred stock,
warrants and stock options. The exercise prices and conversion prices, as the
case may be, of the common stock equivalents range from $.01 and $11.50 per
share. These securities also provide for antidilution protection upon the
occurrence of stock splits, redemptions, mergers and other similar transactions.
If one or more of these events occurs the number of shares of our common stock
that may be acquired upon conversion or exercise would increase. If converted
or exercised these securities will result in a dilution to your percentage
ownership of our common stock.
Under the terms of a subscription agreement, Fletcher International Limited
purchased 1,666,667 shares of our common stock for $5,000,000, or $3.00 per
share, and rights to purchase an additional 100,000 and 650,000 shares of common
stock for $.01 and $4.50, respectively. The subscription agreement provides
that at our election and as long as the market price of our common stock is
greater than $3.00 per share, Fletcher is obligated to purchase up to an
additional $5,000,000 of common stock at market prices when we elect to exercise
our right. Fletcher's obligation to purchase additional shares is contingent
upon the effectiveness of a registration statement to resell Fletcher's shares.
In addition, Fletcher may receive additional shares of common stock if our
common stock does not meet certain price targets or if we do not have an
effective registration statement for the resale of Fletcher's shares. Any
additional issuances to Fletcher would further dilute your percentage ownership
of our common stock.
Under the terms of the Agreement and Plan of Merger, we issued 4,948,182 shares
of our common stock and 21,644 shares of our Series D Preferred Stock to the
Street stockholders. The Street stockholders' shares of Series D Preferred
Stock will automatically convert into 7,214,666 shares of our common stock if
approved by our common stockholders. The conversion of Series D Preferred Stock
would further dilute your percentage ownership of our common stock.
12
<PAGE>
FORWARD-LOOKING STATEMENTS IN THIS FORM 10-K MAY NOT PROVE TO BE ACCURATE
This Form 10-K contains or incorporates forward-looking statements including
statements regarding, among other items, our business strategy, growth strategy,
and anticipated trends in our business. We may make additional written or oral
forward-looking statements from time to time in filings with the SEC or
otherwise. When we use the words "believe," "expect," "anticipate," "project"
and similar expressions, this should alert you that this is a forward-looking
statement. Forward-looking statements speak only as of the date the statement
is made.
These forward-looking statements are based largely on our expectations. They
are subject to a number of risks and uncertainties, some of which cannot be
predicted or quantified and are beyond our control. Future events and actual
results could differ materially from those set forth in, contemplated by, or
underlying the forward-looking statements. Statements in this Form 10-K or made
in documents incorporated into this Form 10-K, describe factors that could
contribute to or cause differences between our expectations and actual results.
We have described many of these factors in this Form 10-K. Because of these
risks and uncertainties, the forward-looking information contained in this Form
10-K may not in fact occur or prove to be accurate. All subsequent written and
oral forward-looking statements attributable to us or persons acting on our
behalf are expressly qualified in their entirety by this section.
13
<PAGE>
ITEM 2. PROPERTIES
The Company leases the following facilities:
<TABLE>
<CAPTION>
Location Use Sq. Expiration Renewal Notes
-------- --- --- ---------- ------- -----
Date Option
---- ------
<S> <C> <C> <C> <C> <C>
White Plains, New York Headquarters Office 3,965 6/14/99 None 1
Golden, Colorado Research & Development
and Production 5,900 3/06/00 None
Richardson, Texas Research & Development 6,170 3/31/02 None 2
Richardson, Texas Sub-Leased 23,500 7/31/99 None 3
Glendale, California Office 37,680 9/30/02 None 4
</TABLE>
(1) The Company is currently negotiating a new lease for an office in the same
vicinity.
(2) This was the Company's headquarters until February 19, 1999. The Company
plans to sublet most of this facility as soon as a suitable sublessee can be
found and the necessary approvals are obtained from the landlord.
(3) This was the Company's headquarters until August 1998. Since that time the
entire facility has been subleased.
(4) This facility was the Company's production studio until early 1998.
Beginning December 1, 1998 the Company subleased 75% of this facility to a third
party for approximately 100% of the rent it pays to the landlord. The sublease
expires on September 30, 2002. The Company plans to use the balance of the space
for meetings with potential and existing West Coast customers.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in certain claims and lawsuits that are generally
incidental to its business. The Company is vigorously contesting all such
matters and believes that their ultimate resolution will not have a material
adverse effect on the Company's financial position, results of operations or
cash flows.
14
<PAGE>
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the fourth
quarter of fiscal 1998.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
Our common stock is quoted on the NASDAQ National Market System under the symbol
"SEVL". At March 15, 1999, we had more than 450 record holders of our common
stock as reported by our transfer agent. The following table sets forth the
range of high and low bid quotations for our common stock as reported by the
NASDAQ National Market System during the periods as indicated.
Quarter Ended High Low
------------- ---- ---
March 31, 1997 $ 5.00 $2.88
June 30, 1997 4.00 1.50
September 30, 1997 3.94 1.63
December 31, 1997 3.44 1.38
March 31, 1998 2.13 1.25
June 30, 1998 12.63 1.38
September 30, 1998 5.45 1.75
December 31, 1998 5.00 1.94
The Company has not paid cash dividends on its common stock and presently
intends to continue a policy of retaining any earnings for reinvestment in its
business.
On December 15, 1998, we sold the following securities to Fletcher International
Limited for $5 million:
. 1,666,667 shares of our common stock
. An option to purchase 650,000 shares of our common stock for $4.50 per
share exercisable until December 15, 2003
. An option to purchase 100,000 shares of our common stock for $.01 per share
exercisable until December 15, 2003
We believe that the sale of our securities to Fletcher was a transaction by an
issuer not involving a public offering within the meaning of Section 4(2) of the
Securities Act. We did not offer our securities by a general solicitation. The
only purchaser of our securities was Fletcher which represented to us that it
was an "accredited investor" as defined in Rule 501 of the Securities Act.
15
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial data for 7th Level as of the
dates and for the periods indicated. The data should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the financial statements and related notes thereto included
elsewhere in this Report.
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------------------------------------------
1994 1995 1996 1997 1998
Actual Combined(1) Actual Actual Actual Actual
----------- ------------ ------------- ---------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
(in thousands, except per share amounts)
Statement of Operations
Data:
Net revenues (2)............. $ 4,103 $ 4,708 $ 12,161 $ 20,549 $ 10,499 $ 1,571
Loss from
operations................. (6,260) (6,064) (15,581) (25,508) (23,790) ( 8,282)
Net loss (6,453) (6,301) (14,603) (24,253) (22,458) (10,958)
Dividends on Preferred
Stock....................... - - - - - 338
Beneficial conversion
feature in association
with Preferred Stock........ - - - - - 5,479
Net loss available to
Common Shareholders......... (6,453) (6,301) (14,603) (24,253) (22,458) (16,775)
Basic and diluted loss
per Common Share............ (0.85) - (1.33) (1.80) (1.64) (1.03)
Basic and diluted weighted
average shares outstanding.. 7,888 - 10,961 13,442 13,697 16,355
<CAPTION>
Year Ended December 31,
----------------------------------------------------------------
1994 1995 1996 1997 1998
----------- ------------ ------------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Balance Sheet Data:
Total assets................ $26,403 $54,562 $ 38,933 $ 9,855 $ 13,016
Long-term debt (including
Current portion)........... 5,738 859 6,790 946 194
Stockholders' equity......... 19,184 48,265 24,652 2,459 9,783
</TABLE>
_________________
(1) Gives effect to the results from 7th Level, Inc. and the 7th Level Sole
Proprietorship on a combined basis.
(2) Net of allowance for product returns, stock balancing rights and
allowances.
16
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following information should be read in conjunction with the consolidated
financial statements and the notes thereto. This analysis is provided pursuant
to applicable Securities and Exchange Commission regulations and is not intended
to serve as a basis for projections of future events.
Overview
7/th/ Level, Inc. was founded in 1993 with the goal of becoming a leading
developer and publisher of interactive entertainment and educational products as
well as a creator of state of the art tools and technologies. In 1998, our
research and development activities were focused primarily on developing and
enhancing our Agent7/TM/ technology. We recognized that appropriate applications
of this technology were in the delivery of learning, education and enhanced
communications. To strengthen our position in the marketplace, we searched for a
viable and complementary partner with the appropriate technology assets,
distribution channel and management expertise.
In February 1999, we acquired all of the outstanding stock of Street
Technologies, Inc, a privately held company, and changed the name of Street to
7/th/Street.com, Inc. 7/th/Street markets and develops technology based
training solutions delivered over intranets and the Internet. Our Board of
Directors has approved the change of the name of our company from 7/th/ Level,
Inc. to 7/th/Street.com, Inc. and the renaming of the new subsidiary. Our name
change will be effective if approved by our stockholders.
We continued to use cash and operate at a loss during 1998, (See "Liquidity and
Capital Resources") however, we were able to significantly reduce expenses. We
continue to review, evaluate and revise the Company's operations and priorities.
Results of Operations
Comparison of Years Ended December 31, 1998 and December 31, 1997
The Company's strategy change in 1997 continued to impact all of its operations
in 1998. As previously disclosed and as described above, the Company has
transitioned from the CD-ROM games business and is leveraging the underlying
software technologies in the new business strategy. Net revenues decreased 85%
to $1,571,398 for the year ended December 31, 1998 compared to $10,499,021 for
the year ended December 31, 1997. The 85% decrease in net revenues reflects the
shift in business strategy as the first of the new products on the Agent7
platform was formally released late in the third quarter of 1998 and
accordingly, no significant revenues have been realized. In 1998, product sales
related to Agent7 were approximately 12% of net revenues. The remaining 88% was
from various sources including royalty streams from our discontinued CD-ROM game
business and reversals of prior period returns and price protection allowances
in excess of actual returns and price protections. In contrast, during 1997,
all of our revenue was associated with the CD-ROM game business. In 1997,
product sales constituted approximately 40% of net revenue. The remaining 60%
was from other sources, including the sale of a title in the final stages of
development, Dominion, for $1,800,000, non-refundable advance royalties of
$1,480,000 for Python titles, and approximately $1,200,000 from Microsoft for
development and initial royalties on the Barney Actimates titles. Sales to
customers outside of the United States were 25% and 20% of net revenue in 1998
and 1997, respectively.
For the year ended December 31, 1998, cost of revenues was $233,454 or 15% of
net revenues. During 1998 cost of revenues consisted primarily of royalties and
development. Cost of revenues for the year ended December 31, 1997 was
$4,541,960 or 43% of net revenue, including product development, manufacturing,
and royalties and licensing. The total cost of revenues as a percentage of net
revenues fluctuated from year to year as a result of significant differences in
the make up of the revenue. We expect fluctuations in gross margin in the future
as changes occur in the composition of the revenues and the associated cost of
revenues.
17
<PAGE>
Research and product development expenses were $3,629,786 and $17,436,042 for
the years ended December 31, 1998 and 1997, respectively. Research and product
development costs decreased in 1998 as the Company continued to reduce headcount
and related expenditures. Approximately $700,000 related to the closing of the
international localization studios is included in the 1997 amount. During 1998
we completed this process and reversed $250,000 in over accruals. Research and
production development expenses decreased 79% in 1998, excluding the one-time
closing expenses recorded in 1997. In 1998, research and product development
expenses included $2,189,934 for production expenses and $1,439,852 for software
research and development expenses. Research and product development expenses
for 1997 included $6,356,696 of production expenses, $5,873,907 for software
research and development and $5,205,440 for expenses of the companies acquired
in 1995 and 1996 and closed or sold during 1997. Because a large portion of the
1997 staffing cuts, in connection with the change in the strategic direction of
the Company, were implemented late in the year and continued into 1998 the
benefit was not fully realized until 1998.
Sales and marketing expenses were $555,593 and $6,118,011 for the years ended
December 31, 1998 and 1997, respectively. Sales and marketing expenses for 1998
included $142,158 of expenses for advertising, marketing and public relations
and $413,435 of expenses related to internal staffing. Included in the 1997
amount is approximately $965,000 related to the closing of our international
sales offices. The 1997 expenses included $2,425,056 of expenses for
advertising, marketing and public relations and $3,692,955 of expenses related
to internal staffing. Excluding costs for closing our international sales
offices, sales and marketing expenses decreased approximately $4,597,000 or 89%
in 1998 compared to 1997. As a percentage of net revenues, sales and marketing
expenses related to internal staffing decreased to 26% in 1998 from 35% in 1997.
Likewise, the advertising, marketing and public relations expenses decreased to
9% from 24% as a percentage of net revenues in 1998 compared to 1997.
General and administrative expenses for the year ended December 31, 1998 were
$5,428,783 compared with $5,683,859 for the year ended December 31, 1997.
Approximately $1,379,000 of the 1998 total is attributable to stock grants to
two of the company's directors. Additionally, the Company incurred higher legal
and professional fees in 1998 that also contributed to the general and
administrative fees continuing to remain almost unchanged compared to the 1997
amounts.
Amortization of intangible assets was $6,072 for the year ended December 31,
1998 compared to $509,444 for the year ended December 31,1997. Of the 1997
amount, approximately $450,000 represents the early write off of the
amortization of intangible assets acquired in the 1995 acquisition of Lanpro
Corporation and Lanpro Localization Center, Inc. These assets were acquired on
December 29, 1995 and were being amortized over periods up to seven years;
however, the assets were written off when we closed our offices in San Francisco
and Tokyo.
Interest income was $333,346 for the year ended December 31, 1998 compared to
$340,434 for the year ended December 31, 1997. Interest expense was $1,731,403
and $121,321 for the years ended December 31, 1998 and 1997, respectively.
Approximately $1,657,000 related to amortization of debt issuance costs and
accretion of debt discount was included in the amount for 1998. (See Note 4 to
the Consolidated Financial Statements).
Other expenses were $1,277,352 for the year ended December 31, 1998 compared to
other income of $1,113,504 for the year ended December 31, 1997. During 1998,
we disposed of assets at a net loss of approximately $1,500,000 that was offset
by reversals of accrued royalty expense in excess of actual liabilities in the
amount of $237,500. In November 1997, we sold our PyroTechnix subsidiary which
included the sale of the Return to Krondor game title and a license for our
TopGun technology and recognized a gain of approximately $1,033,000 which
resulted in the significant other income amount. For the year ended December
31, 1997, our PyroTechnix subsidiary recognized revenues of approximately
$320,000, cost of revenues of approximately $317,000 and operating expenses of
approximately $1,527,000.
18
<PAGE>
Comparison of Years Ended December 31, 1997 and December 31, 1996
Our strategy change in 1997 impacted all of our operations. Net revenues
decreased 49% to $10,499,021 for the year ended December 31, 1997 compared to
$20,548,725 for the year ended December 31, 1996. In 1997, product sales
constituted approximately 40% of net revenue. The remaining 60% was from other
sources, including the sale of a title in the final stages of development,
Dominion, for $1,800,000, non-refundable advance royalties of $1,480,000 for
Python titles, and approximately $1,200,000 from Microsoft for development and
initial royalties on the Barney Actimates titles. In contrast, approximately
50% of 1996 net revenues came from product sales and the remaining 50% was from
licensing, OEM (Original Equipment Manufacturer) and development contracts.
Sales to customers outside of the United States in 1997 were similar to 1996 and
approximated 23% of net revenue.
Cost of revenues for the year ended December 31, 1997 was $4,541,960 or 43% of
net revenue, including product development, manufacturing, and royalty and
licensing costs of $1,641,749, $1,181,787 and $1,718,424, respectively. For the
year ended December 31, 1996, cost of revenues was $8,298,647 or 40% of net
revenues. Although the total cost of revenues as a percentage of net revenues
was comparable between years, the 1997 revenues from the sale of Dominion and
advance royalties for Python referred to above had a very low cost associated
therewith which was offset by a much higher relative cost of revenues associated
with the development contracts.
Research and product development expenses were $17,436,042 and $21,402,287 for
the years ended December 31, 1997 and 1996, respectively. Research and product
development costs decreased in 1997 as we reduced headcount and related
expenditures. Approximately $700,000 related to the closing of the
international localization studios is included in the 1997 amount. Research and
production development expenses decreased 22% in 1997, excluding the one-time
closing expenses, compared to 1996. Research and product development expenses
for 1997 included $6,356,696 of production expenses, $5,873,907 for software
research and development and $5,205,440 for expenses of the companies acquired
in 1995 and 1996 (as described in Note 4 to the Financial Statements) to provide
expertise in the development of 3D technology and graphics design and to provide
the capabilities needed to expand into the Asia Pacific market.
Sales and marketing expenses were $6,118,011 and $11,409,102 for the years ended
December 31, 1997 and 1996, respectively. Included in the 1997 amount is
approximately $965,000 related to the closing of our international sales
offices. Sales and marketing expenses for 1997 included $2,425,056 of expenses
for advertising, marketing and public relations and $3,692,955 of expenses
related to internal staffing. For 1996, expenses of $6,327,266 for advertising,
marketing and public relations and $5,081,836 related to internal staffing were
incurred. Excluding costs for closing our international sales offices, sales
and marketing expenses decreased approximately $6,250,000 or 55% in 1997
compared to 1996. As a percentage of net revenues, sales and marketing expenses
related to internal staffing increased to 35% in 1997 from 25% in 1996.
However, the advertising, marketing and public relations expenses decreased to
23% from 31% as a percentage of net revenues in 1997 compared to 1996.
General and administrative expenses for the year ended December 31, 1997 were
$5,683,859 compared with $4,827,618 for the year ended December 31, 1996.
Approximately $400,000 of the increase of $856,241 is associated with expenses
related to employee resignations in the first quarter of 1997. Additionally, we
incurred higher legal and professional fees in 1997 which contributed to the
increase in general and administrative expenses compared to 1996.
Amortization of intangible assets was $509,444 for the year ended December 31,
1997 compared to $119,428 for the year ended December 31, 1996, and primarily
represents amortization of intangible assets acquired in the Lanpro Acquisition
(See Note 4 to the Financial Statements.) These assets were acquired on
December 29, 1995 and were being amortized over periods up to seven years;
however, the assets were written off when we closed our offices in San Francisco
and Tokyo.
19
<PAGE>
Interest income was $340,434 for the year ended December 31, 1997 compared with
$1,332,578 in the year ended December 31, 1996. This change was due to lower
average cash balances available for investment during 1997. Interest expense
was $121,321 and $76,511 for the years ended December 31, 1997 and 1996,
respectively. Approximately $188,000 of interest expense was capitalized as a
cost of financing the acquisition of a tract of land and office building
construction during 1996.
Other income was $1,113,504 for the year ended December 31, 1997 compared with
other expense of $445 for the year ended December 31, 1996. In November 1997,
we sold our PyroTechnix subsidiary which included the sale of the Return to
Krondor game title and a license to our TopGun technology and recognized a gain
of approximately $1,033,000 which resulted in the significant increase over the
1996 amount. For the year ended December 31, 1997, our PyroTechnix subsidiary
recognized revenues of approximately $320,000, cost of revenues of approximately
$317,000 and operating expenses of approximately $1,527,000.
Liquidity and Capital Resources
We have incurred significant losses since inception including operating losses
of approximately $8.3 million, $23.8 million and $25.5 million for the years
ended December 31, 1998, 1997 and 1996, respectively. The Independent Auditors'
Report related to our December 31, 1997 consolidated financial statements
contained an explanatory paragraph that reflected their concern about our
ability to meet our anticipated operating requirements during 1998 without
obtaining additional financing. During 1998, we obtained additional financing as
more fully described below. The Report of Independent Public Accountants related
to our December 31, 1998 consolidated financial statements was issued without
qualification.
During 1998, we raised over $14.3 million dollars, net of offering expenses, in
connection with private placements to fund operations. Furthermore, at our
election, we have the right to sell up to $5,000,000 in Common Stock
under an existing agreement under certain conditions.
Cash and cash equivalents increased $8,750,623 during the year to $11,215,702 at
December 31, 1998. The increase is the result of the $10,000,000 private
placement funded in May 1998 and a $5,000,000 private placement funded in
December 1998, offset by operating activities during 1998. Net cash used in
operating activities was $6,302,646, which included a net loss of $10,957,698
for the year ended December 31, 1998, offset by non cash items such as charges
for stock grants, amortization of debt issuance costs, accretion of debt
discount, as well as depreciation and amortization expenses. Approximately
$900,000 of cash was provided in 1998 from the issuance of Common Stock
associated with exercises of stock options, stock purchase agreements and stock
warrants. We also sold surplus equipment resulting in a loss on disposition of
approximately $1.5 million, and significantly curtailed capital expenditures,
with disbursements of approximately $44,000, in 1998 compared to approximately
$437,000 in the 1997.
In May 1998, we sold, pursuant to a private placement, Senior Secured Promissory
Notes ("Notes") in the aggregate principal amount of $4,500,000 and warrants to
purchase 675,000 shares of Common Stock at an exercise price of $0.01 per share.
We allocated approximately $1,200,000 of the proceeds from the Notes to the
warrants based on the relative fair values of the Notes and the warrants.
Accordingly, we amortized the related debt discount to interest expense over the
period from May 6, 1998 (date of issuance) to July 13, 1998 (date of exchange).
On July 13, 1998, the holders of the Notes exchanged the Notes for 4,500 shares
of our Series B Convertible Preferred Stock, $0.01 par value per share ("Series
B Convertible Preferred Stock"), and warrants to purchase 1,125,000 shares of
Common Stock at an exercise price of $0.01 per share. As of March 15, 1999, all
of the Series B Convertible Preferred Stock has been converted and all of the
warrants have been exercised.
In May 1998, we also sold, pursuant to a private placement, shares of Series A
Preferred Stock in the aggregate amount of $5,500,000 and warrants for 1,375,000
shares of Common Stock at an exercise price of $0.01 per share. We allocated
approximately $2,500,000 of the proceeds from the Series A Preferred Stock to
the warrants based on the relative fair values of the Series A Preferred Stock
and the warrants. All of such warrants were exercised in June 1998. On July 13,
1998, the exchange of 5,500 shares of Series A Preferred Stock for 5,500 shares
of Series B Convertible Preferred Stock was effected. As of March 15, 1999, all
of the Series B Convertible Preferred Stock has been converted and all of the
warrants have been exercised.
20
<PAGE>
In December 1998, we sold, pursuant to a subscription agreement, 1,666,667
shares of common stock for $5,000,000, or $3.00 per share, and rights to
purchase an additional 100,000 and 650,000 shares of common stock for $.01 and
$4.50, respectively, to Fletcher International Limited. At our sole option, as
long as the market price of our common stock is greater than $3.00 per share and
we have an effective registration statement for the resale of Fletcher's shares,
Fletcher is obligated to purchase up to an additional $5,000,000 of common stock
at market prices. In addition, Fletcher may receive additional shares of common
stock if our common stock does not meet certain price targets or if we do not
register the resale of Fletcher's shares by certain dates.
To date, we continue to use cash and operate at a loss. Our ability to achieve
positive cash flow depends upon a variety of factors, including the timely
introduction and market success of our products, the costs of developing,
producing and marketing such products, adoption of the Internet as a medium of
commerce and communications and various other factors, some of which may be
beyond our control. If we require additional capital, we would seek such
funding through additional public or private financing, although there can be no
assurance that we will be able to obtain such financing.
We are in the process of reviewing our current operations with a view towards
reducing redundancies created by our recent merger and creating an operating
environment conducive to the pursuit of our new business strategy. As a
consequence of this review, which is expected to be completed by the end of
first quarter 1999, we expect to record write-downs and other charges in 1999
beginning with our first quarter financial statements. Based upon the
determinations made to date in connection with the implementation of our plan,
we will record charges of approximately $2 million in our first quarter
financial statements.
Recently Issued Accounting Principles
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income"
("SFAS No. 130"). SFAS No. 130 requires disclosure of all components of
comprehensive income on an annual and interim basis. Comprehensive income is
defined as the change in equity of a business enterprise during a period from
transactions and other events and circumstances from nonowner sources. SFAS No.
130 is effective for fiscal years beginning after December 15, 1997. The
adoption had no impact on the Company's consolidated financial position, results
of operations or cash flows.
In June 1997, the FASB issued SFAS No. 131, "Disclosures About Segments of an
Enterprise and Related Information" ("SFAS No. 131"). SFAS No. 131 requires
certain financial and supplementary information to be disclosed on an annual and
interim basis for each reportable segment of an enterprise. SFAS No.131 is
effective for fiscal years beginning after December 15, 1997. Comparative
information for earlier years presented is to be restated. The adoption had no
impact on the Company's consolidated financial position, results of operations
or cash flows.
In March 1998, the American Institute of Certified Public Accountants issued
Statement of Position ("SOP") 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use". SOP 98-1 requires computer
software costs associated with internal use software to be charged to operations
as incurred until certain capitalization criteria are met. SOP 98-1 is
effective beginning January 1, 1999. The Company does not expect adoption of
this statement to have a material impact on its consolidated financial position,
results of operations or cash flows.
Year 2000 Impact
Many currently installed computer systems may be coded to accept only two-digit
entries in the date code field and cannot distinguish 21st century dates from
20th century dates. As a result, many software and computer systems may need to
be upgraded or replaced. We are in the process of assessing the Year 2000 issue
and expect to complete the program in the second quarter of 1999. To date we
have not incurred material costs. We do not believe that the cost of additional
actions will have a material effect on our consolidated financial position,
results of operations or cash flows. Our current systems and products may
contain undetected errors or defects with Year 2000 date functions that may
result in material
21
<PAGE>
costs. In addition, we utilize third-party equipment, software and content,
including non-information technology systems that may not be Year 2000
compliant. We are in the process of completing our activities relative to
assessing whether our internally developed software, third-party systems and
non-information technology systems are adequately addressing the Year 2000
issue. Failure of third-party equipment, software or content to operate properly
with regard to the Year 2000 issue could require unanticipated expenses, which
could have a material adverse effect on our business. We are assessing whether
our suppliers are adequately addressing their Year 2000 compliance issues. We
have initiated formal communications with our significant suppliers and service
providers to determine the extent to which their systems or services may be
vulnerable if they fail to address and correct their own Year 2000 issues. We
cannot guarantee that the systems of suppliers or other companies on which we
rely will be Year 2000 compliant. We are in the process of developing a
contingency plan that will address situations that may result should Year 2000
compliance for critical operations not be fully achieved in 1999.
22
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to Financial Statements and Financial Statement Schedule
Financial Statements:
24 Report of Independent Public Accountants
25 Independent Auditors' Report
26 Consolidated Balance Sheets as of December 31, 1998 and 1997
27 Consolidated Statements of Operations for the years ended
December 31, 1998, 1997 and 1996
28 Consolidated Statements of Stockholders' Equity for the years
ended December 31, 1998, 1997 and 1996
29 Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996
30 Notes to Consolidated Financial Statements
Financial Statement Schedule:
S-1 Schedule II - Valuation and Qualifying Accounts for the years
ended December 31, 1998, 1997 and 1996
All other schedules are omitted because they are not applicable or the required
information is shown in the financial statements or notes thereto.
23
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of
7th Level, Inc.:
We have audited the accompanying consolidated balance sheet of 7th Level, Inc.,
(a Delaware corporation) as of December 31, 1998, and the related consolidated
statement of operations, stockholders' equity, and cash flows for the year then
ended. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion .
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of 7th Level, Inc. as
of December 31, 1998, and the results of its operations and its cash flows for
the year then ended in conformity with generally accepted accounting principles.
Our audit was made for the purpose of forming an opinion on the basic
consolidated financial statements taken as a whole. The schedule listed in the
index of consolidated financial statements is presented for purposes of
complying with the Securities and Exchange Commissions rules and is not part of
the basic consolidated financial statements. This schedule has been subjected to
the auditing procedures applied in the audit of the basic consolidated financial
statements and, in our opinion, fairly states in all material respects the
financial data required to be set forth therein in relation to the basic
consolidated financial statements taken as a whole.
New York, New York
March 17, 1999
Arthur Andersen LLP
24
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
7/th/ Level, Inc.:
We have audited the accompanying consolidated balance sheet of 7/th/ Level, Inc.
as of December 31, 1997, and the related consolidated statements of operations,
stockholders' equity, and cash flows for each of the years in the two year
period ended December 31, 1997. In connection with our audits of the
consolidated financial statements, we also have audited the financial statement
schedule for the years ended December 31, 1997 and 1996 as listed in the
accompanying index for such years. These consolidated financial statements and
financial statement schedule are the responsibility of the Company's management.
Our responsibility is to express an opinion on these consolidated financial
statements and financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of 7/th/ Level, Inc. as
of December 31, 1997 and the results of their operations and their cash flows
for each of the years in the two year period ended December 31, 1997, in
conformity with generally accepted accounting principles. Also, in our opinion,
the related financial statement schedule for the years ended December 31, 1997
and 1996, when considered in relation to the basic financial statements taken as
a whole, presents fairly, in all material respects, the information set forth
therein.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in note 3 to
the consolidated financial statements, the Company has suffered recurring losses
since inception and does not currently have sufficient resources to meet its
anticipated operating requirements during 1998, which conditions raise
substantial doubt about the Company's ability to continue as a going concern.
Management's plans in regard to these matters are also described in note 3. The
consolidated financial statements and financial statement schedule do not
include any adjustments that might result from the outcome of these
uncertainties.
KPMG LLP
Dallas, Texas
January 30, 1998
25
<PAGE>
7TH LEVEL, INC.
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
--------------- ---------------
ASSETS
<S> <C> <C>
Cash and cash equivalents $11,215,702 $2,465,079
Accounts receivable, net of allowances of $963
and $1,126,524 42,317 1,112,026
Inventories - 18,477
Other current assets 286,238 752,847
--------------- ---------------
Total current assets 11,544,257 4,348,429
Fixed assets, net 1,399,652 4,960,560
Intangible assets, net 7,059 13,132
Other assets 65,421 532,605
=============== ===============
Total assets $13,016,389 $9,854,726
=============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable $197,962 $1,111,732
Accrued expenses 2,172,692 4,549,868
Current portion of notes payable 485,135 79,318
Current portion of capital lease obligations 148,493 172,439
Other current liabilities 183,114 630,567
--------------- ---------------
Total current liabilities 3,187,396 6,543,924
Notes payable - 377,027
Notes payable to related parties - 108,108
Other 45,916 366,212
--------------- ---------------
Total liabilities 3,233,312 7,395,271
Commitments and contingencies (Note 11)
Stockholders' equity:
Series B Convertible Preferred Stock, par value $0.01
per share, 100,000 shares authorized; 1,395 and
0 shares issued and outstanding, in 1998 and 1997,
respectively ($1,395,000 liquidation value) 628,800 -
Common Stock, par value $0.01 per share,
100,000,000 shares authorized; 23,763,622 and
13,783,736 shares issued and outstanding in
1998 and 1997, respectively 237,636 137,837
Additional capital 93,965,769 70,642,628
Accumulated deficit (85,049,128) (68,333,578)
Cumulative translation adjustment - 12,568
--------------- ---------------
Total stockholders' equity 9,783,077 2,459,455
=============== ===============
Total liabilities and stockholders' equity $13,016,389 $9,854,726
=============== ===============
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
26
<PAGE>
7TH LEVEL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
1998 1997 1996
------------- ------------- -------------
<S> <C> <C> <C>
Net revenues $ 1,571,398 $ 10,499,021 $ 20,548,725
Cost of revenues 233,454 4,541,960 8,298,647
------------- ------------- -------------
Gross profit 1,337,944 5,957,061 12,250,078
------------- ------------- -------------
Operating expenses:
Research and product development 3,629,786 17,436,042 21,402,287
Sales and marketing 555,593 6,118,011 11,409,102
General and administrative 5,428,783 5,683,859 4,827,618
Amortization of intangible assets 6,072 509,444 119,428
------------- ------------- -------------
Total operating expenses 9,620,234 29,747,356 37,758,435
------------- ------------- -------------
Operating loss (8,282,290) (23,790,295) (25,508,357)
Interest expense (1,731,403) (121,321) (76,511)
Interest income 333,346 340,434 1,332,578
Other (expense) income (1,277,352) 1,113,504 (445)
------------- ------------- -------------
Net loss $ (10,957,699) $ (22,457,678) $ (24,252,735)
Dividends on Preferred Stock 337,807 - -
Beneficial conversion feature in association
with Preferred Stock (Note 3) 5,479,138 - -
------------- ------------- -------------
Net loss available to Common Shareholders $ (16,774,644) $ (22,457,678) $ (24,252,735)
============= ============= =============
Basic and diluted loss per Common Share $ (1.03) $ (1.64) $ (1.80)
============= ============= =============
Weighted average basic and diluted
shares outstanding 16,355,158 13,696,730 13,442,101
============= ============= =============
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
27
<PAGE>
7TH LEVEL, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
Common Stock Convertible Convertible
------------------------------ Preferred Preferred
Shares Amount Series A Series B
-------------- --------------- --------------- --------------
<S> <C> <C> <C> <C>
Balance at December 31, 1995 13,078,464 $ 130,785 $ - $ -
Common Stock issued under
Stock Option Plan and
Stock Purchase Plan 184,719 1,847 - -
Common Stock issued for
acquisitions 280,732 2,807 - -
Common Stock issued for
conversion of debt 22,607 226 - -
Common stock issued on
exercise of warrants 13,000 130 - -
Foreign currency translation
adjustment - - - -
Unrealized loss on investments - - - -
Net loss - - - -
-------------- --------------- --------------- ---------------
Balance at December 31, 1996 13,579,522 $ 135,795 $ - $ -
Common Stock issued under
Stock Option Plan and
Stock Purchase Plan 198,580 1,986 - -
Common stock issued on
exercise of warrants 5,634 56 - -
Common stock issued for
consulting services 40,000 400 - -
Cancellation of unearned
Common Stock issued as
contingent purchase
consideration (40,000) (400) - -
Foreign currency translation
adjustment - - - -
Unrealized gain on investments - - - -
Net loss - - - -
-------------- --------------- --------------- ---------------
Balance at December 31, 1997 13,783,736 $ 137,837 $ - $ -
Issuance of Series A Preferred Stock
(net of issuance costs of $3,020,862) - - 2,479,138 -
Issuance costs in connection with Notes - - - -
Beneficial Conversion Feature - - - -
Conversion of Series A Preferred Stock
to Series B Preferred Stock - - (2,479,138) 2,479,138
Conversion of Notes to Series B Preferred Stock - - - 3,000,000
Common Stock issued on conversion of
Series B Preferred Stock 4,302,500 43,025 - (4,850,338)
Common Stock dividends 106,692 1,067 - -
Common Stock issued in private placement 1,666,667 16,667 - -
Warrants issued to Non-employees - - - -
Common Stock issued upon exercise of warrants 2,813,584 28,136 - -
Common Stock Granted to Officers 765,000 7,650 - -
Common Stock issued under
Stock Option Plan and
Stock Purchase Plan 325,443 3,254 - -
Compensation expense on options issued
to non-employees - - - -
Foreign currency translation adjustment - - - -
Net loss - - - -
============== =============== =============== ===============
Balance at December 31, 1998 23,763,622 $ 237,636 $ - $ 628,800
============== =============== =============== ===============
</TABLE>
<TABLE>
<CAPTION>
Cumulative Unrealized Total
Additional Translation Gain (loss) on Accumulated Stockholders'
Capital Adjustment Investments Deficit Equity
---------------- --------------- --------------- ---------------- ----------------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1995 $69,168,061 $ (14,923) $ 21,791 $ (21,040,243) $48,265,471
Common Stock issued under
Stock Option Plan and
Stock Purchase Plan 764,989 - - - 766,836
Common Stock issued for
acquisitions 331,318 - - (582,922) (248,797)
Common Stock issued for
conversion of debt 79,497 - - - 79,723
Common stock issued on
exercise of warrants 3,245 - - - 3,375
Foreign currency translation
adjustment - 66,116 - - 66,116
Unrealized loss on investments - - (27,602) - (27,602)
Net loss - - - (24,252,735) (24,252,735)
---------------- --------------- --------------- ---------------- ----------------
Balance at December 31, 1996 $70,347,110 $ 51,193 $ (5,811) $ (45,875,900) $24,652,387
Common Stock issued under
Stock Option Plan and
Stock Purchase Plan 326,634 - - - 328,620
Common stock issued on
exercise of warrants 1,404 - - - 1,460
Common stock issued for
consulting services 74,600 - - - 75,000
Cancellation of unearned
Common Stock issued as
contingent purchase
consideration (107,120) - - - (107,520)
Foreign currency translation
adjustment - (38,625) - - (38,625)
Unrealized gain on investments - - 5,811 - 5,811
Net loss - - - (22,457,678) (22,457,678)
---------------- --------------- --------------- ---------------- ----------------
Balance at December 31, 1997 $70,642,628 $ 12,568 $ - $ (68,333,578) $ 2,459,455
Issuance of Series A Preferred Stock
(net of issuance costs of $3,020,862) 2,789,738 - - - 5,268,876
Issuance costs in connection with Notes 1,467,452 - - - 1,467,452
Beneficial Conversion Feature 5,479,138 - - (5,479,138) -
Conversion of Series A Preferred Stock
to Series B Preferred Stock - - - - -
Conversion of Notes to Series B Preferred Stock 1,500,000 - - - 4,500,000
Common Stock issued on conversion of
Series B Preferred Stock 4,807,313 - - - -
Common Stock dividends 277,602 - - (278,713) (44)
Common Stock issued in private placement 4,683,333 - - - 4,700,000
Warrants issued to Non-employees 31,451 - - - 31,451
Common Stock issued upon exercise of warrants (136) - - - 28,000
Common Stock Granted to Officers 1,379,295 - - - 1,386,945
Common Stock issued under
Stock Option Plan and
Stock Purchase Plan 867,221 - - - 870,475
Compensation expense on options issued
to non-employees 40,734 - - - 40,734
Foreign currency translation adjustment - (12,568) - - (12,568)
Net loss - - - (10,957,699) (10,957,699)
================ =============== =============== ================ ================
Balance at December 31, 1998 $93,965,769 $ - $ - $ (85,049,128) $ 9,783,077
================ =============== =============== ================ ================
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
28
<PAGE>
7TH LEVEL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
1998 1997 1996
----------------- ----------------- -----------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $ (10,957,698) $ (22,457,678) $ (24,252,735)
Adjustments to reconcile net loss to net cash
used in operating activities:
Non-cash compensation and interest 3,108,032 - -
Depreciation and amortization 1,806,365 4,180,144 2,564,609
Loss (gain) on sale of assets 1,518,504 (1,115,800) -
Gain on early retirement of debt - (10,142) -
Other 187,865 75,000 -
Changes in assets and liabilities, net of acquisitions:
Accounts receivable 1,069,709 5,149,670 650,585
Inventories 18,477 551,846 (181,297)
Other current assets 466,611 865,059 (592,837)
Other assets 467,184 533,438 (366,529)
Accounts payable (913,771) (1,059,444) 883,866
Other current liabilities (3,073,924) (65,720) 1,554,554
----------------- ----------------- -----------------
Net cash used in operating activities (6,302,646) (13,353,627) (19,739,784)
----------------- ----------------- -----------------
Cash flows from investing activities:
Proceeds from sale of assets 98,214 6,593,010 -
Purchase of short-term investments - - (7,965,007)
Proceeds from sales of short-term investments - 4,491,367 13,158,205
Equity investment - - (400,000)
Acquisitions, net of cash acquired (paid) - - (771,966)
Capital expenditures (43,968) (436,409) (9,643,055)
----------------- ----------------- -----------------
Net cash provided by (used in) investing activities 54,246 10,647,968 (5,621,823)
----------------- ----------------- -----------------
Cash flows from financing activities:
Net proceeds from private placement of Common Stock 4,700,000 - -
Net proceeds from issuance of Preferred Stock 5,268,876 - -
Net proceeds from debt issuance 4,310,900 - -
Proceeds from bank line of credit - - 6,000,000
Repayment of bank line of credit - (5,625,000) (375,000)
Repayment of notes payable to related parties - (125,000) -
Principal payments under capital lease obligations (186,877) (232,746) (163,365)
Issuance of Common Stock under Stock Option and
Stock Purchase Plan 870,474 330,080 766,836
Other 35,650 - 3,375
----------------- ----------------- -----------------
Net cash provided by (used in) financing activities 14,999,023 (5,652,666) 6,231,846
----------------- ----------------- -----------------
Effect of exchange rate changes on cash and
cash equivalents - 25,032 (12,084)
----------------- ----------------- -----------------
Net increase (decrease) in cash and cash
equivalents 8,750,623 (8,333,293) (19,141,845)
Cash and cash equivalents, beginning of period 2,465,079 10,798,372 29,940,217
----------------- ----------------- -----------------
Cash and cash equivalents, end of period $ 11,215,702 $ 2,465,079 $ 10,798,372
================= ================= =================
Supplemental disclosure of cash flow information--
Cash paid for interest $ 74,853 $ 204,915 $ 352,562
================= ================= =================
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
29
<PAGE>
7TH LEVEL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
1. Incorporation and Nature of Business
7th Level, Inc. (the "Company") was incorporated under the laws of the State of
Delaware on April 28, 1993. The Company has been engaged in the business of
developing entertainment and educational software. In April 1998, the Company
announced a strategy to become a leading developer of Internet media preparation
tools and technologies. In February 1999, 7th Level Merger Corporation, a
wholly-owned subsidiary of the Company, merged with Street Technologies, Inc.
(the "Merger"). (See Note 12)
The Company has incurred significant losses since inception including operating
losses of approximately $8.3 million, $23.8 million and $25.5 million for the
years ended December 31, 1998, 1997 and 1996, respectively.
In August 1997 the Company announced a new strategy, by leveraging its existing
core technology, to transition from being a self-funded content developer and
publisher to position itself as a supplier of custom solutions and services,
tools and technologies. As part of that shift in strategy, the Company divested
itself of its games development groups and new titles under development. The
Company also closed its international localization and sales offices including
those in San Francisco, Tokyo and Munich and sold its PyroTechnix, Inc.
subsidiary during 1997. In fourth quarter 1998 the production facilities
located in Glendale, California were closed. Research and product development
and sales and marketing expenses include approximately, $700,000 and $965,000,
respectively, related to the closing of the international localization and sales
offices. In the year ended December 31, 1998, the Company was able to reverse
into income certain reserves established in 1997 as it was able to settle
certain liabilities and commitments for approximately $523,000 less than
anticipated.
During fiscal 1998, the Company raised over $14.3 million, net of offering
expenses, in connection with private placements (See Note 3) to fund operations.
Furthermore, at the Company's election, as defined, the Company has the right to
sell shares of Common Stock under a Subscription Agreement in exchange for an
additional $5,000,000, as defined (See Note 3).
2. Summary of Significant Accounting Policies
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the
Company and its wholly owned subsidiaries. All significant intercompany
transactions and accounts have been eliminated.
Use of Estimates
The preparation of consolidated 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
reporting period. Actual results could differ from those estimates.
The Company's estimates and future results could be affected adversely by a
number of uncertainties related to its new software products. Such factors
include, but are not limited to market acceptance; ability to obtain sales
volumes and adequate prices; the Company's sustained commitment of resources to
further develop and market the technology; and the technological competitive
advantage of these new products.
Revenue Recognition
The Company recognizes revenue in accordance with the provisions of Statement of
Position No. 97-2, "Software Revenue Recognition". The Company generates
revenue primarily from interactive software product sales, licensing agreements
and product development agreements. Software product sales are recognized as
revenue upon shipment of the products to customers, provided that there are no
significant vendor obligations and collection of
30
<PAGE>
7TH LEVEL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
the related receivable is probable. The Company accounts for insignificant
vendor obligations and post-contract support at the time of product delivery by
accruing such estimated costs or recognizing them ratably as the obligations are
fulfilled. Provision for estimated returns including distributors' stock
balancing rights and allowances is recorded at the time of sale.
Revenues from development contracts are recognized as the services are performed
under the terms of the respective contracts. The Company had deferred revenues
of approximately $3,000 and $385,000 included in other current liabilities
associated with development and licensing contracts at December 31, 1998 and
1997, respectively.
Revenues from products licensed to original equipment manufacturers ("OEMs")
consisting of one-time license fees and contracts for minimum advances against
future unit licenses are recognized when the criteria for revenue recognition
under Statement of Position No. 97-2 are met, as discussed above. Additional
royalty use or unit copy royalty fees are recognized when they are earned
pursuant to the license agreements and upon notification of shipment from the
OEMs.
Research and Product Development Expenditures
The Statement of Financial Accounting Standards ("SFAS") No. 86 "Accounting for
the Costs of Computer Software to be Sold, Leased or Otherwise Marketed",
provides for the capitalization of certain software development costs once
technological feasibility has been established. In addition, the Company
evaluates the recoverability of any capitalized costs as provided by generally
accepted accounting principles. To date, no such costs have been capitalized as
the impact on the consolidated financial statements for all periods presented
would be immaterial.
Fair Value of Financial Instruments
The carrying values of cash, cash equivalents, accounts receivable and accounts
payable approximate fair value due to their short maturities.
Advertising Costs
Advertising costs, included in sales and marketing expenses, are charged as an
expense when they are incurred. Advertising costs were $178,300, $1,542,175 and
$4,816,231 for the years ended December 31, 1998, 1997 and 1996, respectively.
Cash and Cash Equivalents
The Company considers all highly liquid investments with original maturities of
three months or less to be cash equivalents. Cash and cash equivalents consist
of money market funds, commercial paper, U.S. Treasury securities and other debt
securities. The Company had cash equivalents of approximately $11,200,000 and
$2,300,000 at December 31, 1998 and 1997, respectively.
Other Current Assets
Other current assets include prepaid insurance, prepaid royalties, interest
receivable, other receivables, and other miscellaneous prepaid expenses.
Inventories
Inventories, which are comprised of software product components and finished
goods, are carried at the lower of cost, determined on a first-in first-out
basis, or market.
31
<PAGE>
7TH LEVEL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
Fixed Assets
Fixed assets are recorded at cost and are depreciated over three to five years
depending upon the estimated useful life of the asset. Leasehold improvements
and assets under capital leases are amortized over the shorter of the estimated
useful life of the asset or the term of the lease.
Intangible Assets
At December 31, 1998 intangible assets consisted of various patents, copyrights,
and trademarks, technological know-how, assembled workforce and goodwill
acquired in acquisitions. Intangible assets are being amortized on a straight
line basis over estimated useful lives of three to seven years. The Company
assesses the recoverability of intangible assets in accordance with SFAS No. 121
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," by determining whether the amortization of the intangible
assets over their remaining lives can be recovered through projected
undiscounted future cash flows. During 1997, in connection with the sale of a
3D game and the closure of its Asia Pacific localization and sales offices, the
Company wrote off the remaining intangible assets and the related accumulated
amortization acquired in certain prior business combinations. Combined, these
totaled approximately $610,000.
Other Assets
At December 31, 1997 other assets consisted primarily of restricted cash placed
in escrow for a planned merger that was not completed and restricted cash which
collateralized a letter of credit and other miscellaneous balances.
Foreign Currency Translation
For the Company's subsidiaries outside the United States, the functional
currency is the local currency of the country in which the subsidiary is
domiciled. The Company applies SFAS No. 52 "Accounting for the Translation of
Foreign Currency Transactions and Foreign Currency Financial Statements".
Accordingly, assets and liabilities of the subsidiaries outside of the United
States are translated into U.S. dollars at year end exchange rates. Income and
expense items are translated at average rates of exchange prevailing during the
year. The adjustments resulting from translating the financial statements of
these subsidiaries are reflected as cumulative translation adjustments and
included in stockholders' equity. Foreign currency transaction gains and losses
are recognized when they occur. Such amounts are not material in any of the
periods presented. During 1998 the Company closed down its foreign operations
and accordingly the adjustment was removed from the separate component of equity
and reported as a part of the loss on cessation of these operations.
Royalties
Royalties are accrued based on net revenues, pursuant to contractual agreements
with talent for various products published by the Company. Royalty expense is
included in the cost of revenues.
Loss per Share
In 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No. 128,
"Earnings Per Share" ("SFAS No. 128"). This statement established standards for
computing and presenting earnings per share. This statement is effective for
periods ending after December 15, 1997. In February 1998, the Securities and
Exchange Commission ("SEC") issued Staff Accounting Bulletin ("SAB") No. 98.
This bulletin revised the SEC's guidance for calculating earnings per share with
respect to equity security issuances before an initial public offering ("IPO")
and is effective for fiscal years ending after December 15, 1997. The prior
years' earnings per share have been retroactively restated to reflect the
adoption of SFAS No. 128 and SAB No. 98.
32
<PAGE>
7TH LEVEL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
Basic earnings per share was determined by dividing net loss by the weighted
average common shares outstanding during the period. Diluted earnings per share
was determined by dividing net loss by diluted weighted average shares
outstanding. Diluted weighted average shares reflects the dilutive effect, if
any, of common equivalent shares and nominal issuances. Common equivalent
shares include common stock options and warrants to the extent their effect is
dilutive, based on the treasury stock method. Nominal issuances arise when a
company issues common stock, options or warrants to purchase common stock or
other potentially dilutive instruments for nominal consideration, as defined by
SAB No. 98, in the periods preceding an IPO. During the period preceding the
Company's IPO, the Company did not have any nominal issuances.
The calculations of basic and dilutive weighted average shares outstanding are
as follows:
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1998 1997 1996
------------------------------------------
<S> <C> <C> <C>
Basic weighted average
Common shares 16,355,158 13,696,730 13,442,101
outstanding
Weighted average Common
equivalent shares -- -- --
------------------------------------------
Diluted weighted
average shares
outstanding 16,355,158 13,696,730 13,442,101
==========================================
</TABLE>
Diluted weighted average shares outstanding do not include 3,903,679 and
1,405,109 common equivalent shares at December 31, 1998 and 1997, respectively,
as their effect would be anti-dilutive.
Income Taxes
The Company accounts for income taxes in accordance with Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS No. 109").
SFAS No. 109 requires recognition of deferred tax assets and liabilities for the
future tax consequences of temporary differences between the financial statement
carrying amounts and the tax bases of assets and liabilities.
At December 31, 1998 and 1997, the Company had operating loss carryforwards
available to offset future federal taxable income of approximately $70 million
and $60 million, respectively. Deferred tax assets relating to the operating
losses have been fully offset by a valuation allowance. Accordingly, no income
tax benefit has been recorded. These operating loss carryforwards expire at
various dates through 2018 and under Section 382 of the Internal Revenue Code
may be limited due to ownership changes.
Reclassifications
Certain prior year balances have been reclassified to conform to the current
year presentation.
New Accounting Pronouncements
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income"
("SFAS No. 130"). SFAS No. 130 requires disclosure of all components of
comprehensive income on an annual and interim basis. Comprehensive income is
defined as the change in equity of a business enterprise during a period from
transactions and other events and circumstances from nonowner sources. SFAS No.
130 is effective for fiscal years beginning after December 15, 1997. The
adoption had no impact on the Company's consolidated financial position, results
of operations or cash flows.
33
<PAGE>
7TH LEVEL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
In June 1997, the FASB issued SFAS No. 131, "Disclosures About Segments of an
Enterprise and Related Information" ("SFAS No. 131"). SFAS No. 131 requires
certain financial and supplementary information to be disclosed on an annual and
interim basis for each reportable segment of an enterprise. SFAS No.131 is
effective for fiscal years beginning after December 15, 1997. Comparative
information for earlier years presented is to be restated. The adoption had no
impact on the Company's consolidated financial position, results of operations
or cash flows.
In March 1998, the American Institute of Certified Public Accountants issued
Statement of Position ("SOP") 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use". SOP 98-1 requires computer
software costs associated with internal use software to be charged to operations
as incurred until certain capitalization criteria are met. SOP 98-1 is
effective beginning January 1, 1999. The Company does not expect adoption of
this statement to have a material impact on its consolidated financial position,
results of operations or cash flows.
3. Business Combinations and Private Placements
PyroTechnix Acquisition
On March 1, 1996, the Company acquired all of the outstanding capital stock of
PyroTechnix, Inc. ("PyroTechnix") for 300,000 shares of the Company's Common
Stock. The acquisition was accounted for as a pooling of interests. The
operating results for PyroTechnix were not material to the combined results of
the two companies for all periods prior to the acquisition and therefore results
for those periods have not been restated.
The Company sold its PyroTechnix subsidiary in November 1997 and recognized a
gain of approximately $1,033,000, which is included as non-operating income in
the accompanying consolidated statement of operations for the year ended
December 31, 1997. Included in the consolidated statements of operations are
losses from operations of PyroTechnix of approximately $1,524,000 and $307,000,
respectively, for the years ended December 31, 1997 and 1996.
Private Placement
In May 1998, the Company sold, pursuant to a private placement, Secured
Promissory Notes ("Notes") in the aggregate principal amount of $4,500,000 and
warrants for 675,000 shares of Common Stock at an exercise price of $0.01 per
share. The Company allocated approximately $1,200,000 of the proceeds from the
Notes to the warrants based on the relative fair values of the Notes and the
warrants. Accordingly, the Company amortized the related debt discount to
interest expense over the period from May 6, 1998 (date of issuance) to July 13,
1998 (date of exchange - see below). All of such warrants were exercised in
June 1998. On July 9, 1998, the Company obtained stockholder approval for, among
other things, an increase in its authorized Common Stock (the "Certificate of
Amendment") at its 1998 Annual Meeting of Stockholders. The Certificate of
Amendment was filed on July 10, 1998. On July 13, 1998, the holders of the
Notes exchanged the Notes for 4,500 shares of the Company's Series B Convertible
Preferred Stock, $0.01 par value per share and warrants to purchase 1,125,000
shares of Common Stock at an exercise price of $0.01 per share. The Company
allocated $3,000,000 to Series B Convertible Preferred Stock and $1,500,000 to
warrants in accounting for the exchange.
In May 1998, the Company also sold, pursuant to a private placement, shares of
Series A Preferred Stock in the aggregate amount of $5,500,000 and warrants for
1,375,000 shares of Common Stock at an exercise price of $0.01 per share. The
Company allocated approximately $2,500,000 of the proceeds from the Series A
Preferred Stock to the warrants based on the relative fair values of the Series
A Preferred Stock and the warrants. All of such warrants were exercised in June
1998. On July 13, 1998, after the Certificate of Amendment was approved by the
Company's stockholders and was filed with the Secretary of State of the State of
Delaware, the exchange of 5,500 shares of Series A Preferred Stock for 5,500
shares of Series B Convertible Preferred Stock was effected.
34
<PAGE>
7TH LEVEL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
The Certificate of Designations, Preferences and Rights of Series B Convertible
Preferred Stock (the "Certificate of Designations") provides that on the
original issue date of the Series B Convertible Preferred Stock, the holders of
the Series B Convertible Preferred Stock will have the right to nominate two
members of the Board of Directors of the Company. The Series B Convertible
Preferred Stock ranks senior and prior to the Common Stock and to all other
classes or series of stock issued by the Company. Dividends accrue on the
shares of Series B Convertible Preferred Stock at the rate of 8% per annum;
provided, however, that in the event the Company fails to redeem the Series B
Convertible Preferred Stock on or before April 30, 2005 (the "Anniversary
Redemption Date"), pursuant to the Certificate of Designations, the dividend
rate on the Series B Convertible Preferred Stock shall increase 2% per annum on
each anniversary of the Anniversary Redemption Date. Annual dividends are
cumulative and are payable quarterly in arrears when and as declared by the
Company's Board of Directors. These shares have a liquidation preference of
$1,000 per share. The Series B Convertible Preferred Stock is convertible
immediately into Common Stock, initially at a conversion price of $2.00 per
share, subject to adjustment. The shares of Series B Convertible Preferred
Stock may be redeemed, at the option of the Company, at $1,000 per share on or
after the Anniversary Redemption Date. Upon a change of control, the Company
may offer to redeem such shares at $2,000 per share or the Company may issue to
each holder of Series B Convertible Preferred Stock warrants exercisable for
250,000 shares of Common Stock for each 1,000 shares of Series B Convertible
Preferred Stock owned by such holder at an exercise price of $0.01 per share.
The Company also has optional redemption rights at any time after i) completion
of an underwritten public offering by the Company with gross proceeds to the
Company of at least $20,000,000 and a price per share of Common Stock of at
least $4.00 per share, subject to adjustment, or ii) after the Company's Common
Stock shall have traded at an average price in excess of $4.00 per share,
subject to adjustment, for 20 consecutive trading days and the aggregate market
value of the Common Stock held by non-Affiliates of the Company is at least
$35,000,000. The holders of Series B Convertible Preferred Stock also are
entitled to certain preemptive rights, co-sale rights and registration rights.
For the year ended December 31, 1998, the Company was required to increase the
loss attributable to common stockholders, as a result of the beneficial
conversion feature which arose due to the increase in the market price of the
Company's Common Stock from the date the Company received commitments with
respect to the $10,000,000 financing (April 20, 1998) to the date of issuance of
the Series B Convertible Preferred Stock (July 13, 1998). The beneficial
conversion feature is based upon the difference between the market price of the
5,000,000 shares of Common Stock into which the Series B Convertible Preferred
Stock is convertible and the carrying value of the Series B Convertible
Preferred Stock on the date of authorized issuance, but is limited (as discussed
above) to the proceeds received with respect to each security issued. As the
Company allocated $3,000,000 of proceeds to the Series B Convertible Preferred
Stock, and approximately $2,500,000 of proceeds to the Series A Preferred Stock,
the amount of the beneficial conversion feature is approximately $5,500,000. The
one-time occurrence was accounted for similar to a non-cash dividend and had no
effect on the Company's net loss or aggregate stockholders' equity.
In December 1998, the Company sold, pursuant to a subscription agreement,
1,666,667 shares of Common Stock for $5,000,000, or $3.00 per share, and rights
to purchase an additional 100,000 and 650,000 shares of Common Stock for $.01
and $4.50, respectively, to Fletcher International Limited ("Fletcher"). The
Subscription Agreement provides that, at the Company's election, and as long as
the market price of the Company's Common Stock is greater than $3.00 per share
and the Company has an effective registration statement for the resale of
Fletcher's shares, Fletcher is obligated to purchase up to an additional
$5,000,000 of Common Stock at market prices when the Company elects to exercise
its right to sell shares to Fletcher. In addition, Fletcher may receive
additional shares of Common Stock if the Company's Common Stock does not meet
certain price targets or if the Company does not register the resale of
Fletcher's shares by certain dates, as defined.
35
<PAGE>
7TH LEVEL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
4. Fixed Assets, net
Fixed assets, at cost, as of December 31, 1998 and 1997 consisted of the
following:
<TABLE>
<CAPTION>
1998 1997
-------------- --------------
<S> <C> <C>
Equipment $ 3,877,804 $ 6,960,778
Leasehold improvements 335,000 2,903,346
Furniture and fixtures 243,393 410,360
--------------- ---------------
4,456,197 10,274,484
Less: accumulated
depreciation and
amortization ( 3,056,545) ( 5,313,924)
--------------- ---------------
$ 1,399,652 $ 4,960,560
=============== ===============
</TABLE>
The Company leases certain office equipment under capital lease agreements. At
December 31, 1998 and 1997, respectively, the carrying value of capital assets
was $193,360 and $388,906, net of accumulated amortization of $317,308 and
$208,664.
During 1998 the Company disposed of approximately $1.8 million of net capital
assets as a result of a reduction in capacity and recognized a loss in the
December 31, 1998 consolidated financial statements related to this disposition
of these assets of approximately $1.5 million.
In April 1997 the Company sold its office building, which was under
construction, for $5.6 million, and as a result, recognized a gain of
approximately $95,000.
5. Accrued Expenses
Accrued liabilities consist of the following at December 31, 1998 and 1997:
<TABLE>
<CAPTION>
1998 1997
------------ --------------
<S> <C> <C>
Accrued office closing costs $ 264,646 $1,064,702
Accrued royalties 346,597 859,475
Accrued discounts and 677,850 806,953
allowances
Accrued legal and corporate 295,000 361,374
expenses
Accrued compensation 120,310 565,377
Accrued interest and taxes 31,075 169,353
Other 437,214 722,634
------------ -------------
$2,172,692 $4,549,868
============ =============
</TABLE>
36
<PAGE>
7TH LEVEL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
6. Debt
As of December 31, 1998 and 1997 the Company's debt was as follows:
<TABLE>
<CAPTION>
1998 1997
---------------- --------------
<S> <C> <C>
7% Convertible Note Payable, dated
February 11, 1994; annual interest
payments; notes are convertible, in
whole but not in part, at the
option of the holder at
approximately 283 shares of Common
Stock for each $1,000 principal
amount outstanding. Remaining
principal balance due February 11,
1999 and satisfied (See Note 12
b). Included in this amount is
$108,108 due to related parties. $485,135 $485,135
Other -- 79,318
------------------ ----------------
Total $485,135 $564,453
Less current portion
485,135 79,318
Long term payables $ -- $485,135
================== ================
</TABLE>
Interest expense to related parties on the above debt was $7,568 for each of the
years ended December 31, 1998 and 1997.
7. Stockholders' Equity
Common Stock
On July 9, 1998 the shareholders of the Company authorized an increase in the
number of shares of Common Stock from 20,000,000 to 100,000,000, par value $0.01
per share (the "Common Stock").
Preferred Stock
There are 100,000 shares of Preferred Stock, par value of $0.01 per share,
authorized and 1,395 shares were outstanding as of December 31, 1998. The Board
of Directors is authorized to provide for the issuance of the shares of
Preferred Stock in one or more series and to establish the number of shares
included in any such series and to fix the designation, powers, preferences and
rights of the shares of any such series.
In May 1998, the Company sold, pursuant to a private placement, 5,500 shares of
Series A Preferred Stock. On July 13, 1998 the Notes were exchanged for 4,500
shares of the Series B Convertible Preferred Stock (See Note 3). In a separate
transaction the Series A Preferred Stock was exchanged for 5,500 shares of
Series B Convertible Preferred Stock. During the fourth quarter of 1998, 8,605
shares of the Series B Convertible Preferred Stock were converted into 4,302,500
shares of Common Stock.
Stock Compensation Plans
The Company has granted options to certain employees, directors and outside
consultants to purchase Common Stock outside of any defined plans and under an
incentive stock option plan. The option price represents estimated fair value
at the date of grant.
Under the 7/th/ Level, Inc. Amended and Restated Incentive Stock Option Plan
(the "Incentive Stock Option Plan"), the Company may grant options to its
employees for up to 3,200,000 shares of Common Stock. As of December
37
<PAGE>
7TH LEVEL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
31, 1998 the Incentive Stock Option Plan had 228,275 option shares outstanding
and 1,790,435 shares available to grant. Of the 228,275 shares outstanding
45,500 shares are subject to the Option Share Repurchase Agreement with certain
stockholders and no new shares will be issued upon the exercise of grants.
Pursuant to the Option Share Repurchase Agreement, the Company had the right to
purchase up to 948,000 shares of Common Stock from certain stockholders at
$0.003 per share. The Company may invoke this right in the event certain
outstanding options (exercisable for an identical number of shares) are
exercised. The Company intends to satisfy its obligations to issue shares of
Common Stock upon any exercise of such associated options by delivering to the
exercising optionee(s) shares of treasury stock, thereby resulting in no change
in the number of outstanding shares of Common Stock. At December 31, 1998,
545,500 options associated with the Option Share Repurchase Agreement had been
exercised at a weighted average exercise price of $0.163 per share (and an
identical number of shares of Common Stock had been purchased by the Company
pursuant to the Option Share Repurchase Agreement).
At December 31, 1998, 469,500 options subject to the Option Share Repurchase
Agreement with a weighted average exercise price of $0.253 per share had been
canceled. Notwithstanding the cancellation of certain options, the stockholders
who are party to the Option Share Repurchase Agreement agreed that 112,500
shares of Common Stock underlying such canceled options would remain subject to
the agreement. During 1998, 69,000 shares were assigned to outstanding options.
Accordingly, all the 45,500 shares remaining under the Option Share Repurchase
Agreement have corresponding option grants.
Transactions in stock options under the Incentive Stock Option Plan are
summarized as follows:
<TABLE>
<CAPTION>
Option Share Weighted Weighted
Repurchase Average Exercise Average
Agreement Price Stock Options Exercise Price
---------------------------------------------------------------------
<S> <C> <C> <C> <C>
Balance at December 31, 1995 222,000 $0.715 1,485,250 $ 8.61
Granted - - 2,662,750 7.27
Exercised (85,250) 0.450 (102,800) 2.14
Canceled (15,000) 0.003 (1,832,374) 11.08
------------------------------- ---------------------------------
Balance at December 31, 1996 121,750 $0.990 2,212,826 $ 5.26
Granted - - 267,500 3.12
Exercised (69,250) 0.083 ( 95,625) 1.11
Canceled (1,500) 0.003 (1,343,436) 5.36
------------------------------- ---------------------------------
Balance at December 31, 1997 51,000 $2.244 1,041,265 $ 4.96
Granted - - 516,825 1.72
Exercised (41,500) 0.634 ( 308,115) 2.65
Reassigned 69,000 1.250 ( 69,000) 1.25
Canceled (33,000) 3.561 ( 998,200) 4.90
------------------------------- ---------------------------------
Balance at December 31, 1998 45,500 $1.250 182,775 $ 1.44
======================================================================
</TABLE>
38
<PAGE>
7TH LEVEL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
Transactions in stock options to employees, directors and consultants outside
either of the formal plans mentioned above are summarized as follows:
<TABLE>
<CAPTION>
Weighted
Average
Stock Options Exercise Price
---------------------------------
<S> <C> <C>
Balance at December 31, 1996 - $ -
Granted 737,500 3.76
Exercised - -
Canceled - -
---------------------------------
Balance at December 31, 1997 737,500 $3.76
Granted 3,056,500 1.98
Exercised ( 11,000) 1.32
Canceled ( 956,000) 3.26
---------------------------------
Balance at December 31, 1998 2,827,000 $2.02
=================================
</TABLE>
The Company has granted to directors options to purchase Common Stock under a
non-employee directors' stock option plan with vesting over four years. Under
the 7/th/ Level Inc. Amended and Restated 1994 Non-Employee Directors' Stock
Option Plan (the "Directors' Plan"), the Company may grant options to its non-
employee directors for up to 125,000 shares of Common Stock. In 1998, 65,000
shares outstanding under the Directors' Plan were cancelled in exchange for new
options granted outside this plan. All of the 125,000 shares authorized under
the Directors' Plan were deregistered. At December 31, 1998, no options were
outstanding.
In May 1998, the Company exchanged with two board members their options to
purchase 715,000 shares of Common Stock for 765,000 shares of Common Stock for
$0.01 per share. The Company recognized a compensation charge of $1,377,000
related to this stock issuance.
Subsequent to year end, three members of the Board of Directors exercised
options to purchase 775,000 shares of Common Stock for the aggregate amount of
approximately $1.6 million. In connection with these exercises, the Company
received promissory notes from these individuals in the approximate amount of
$1.3 million.
The following table summarizes information about Incentive Stock Option Plan and
non-plan stock options outstanding at December 31, 1998:
<TABLE>
<CAPTION>
Total options outstanding Total options exercisable
---------------------------------------------------- -------------------------
Weighted
average Weighted Weighted
Range of Number remaining average Number average
exercise prices outstanding contractual life exercise price exercisable exercise price
- ----------------------------------------------------------------- -----------------------------
<S> <C> <C> <C> <C> <C>
$ .003 - 1.99 214,750 8.72 years $ 1.25 190,125 $ 1.25
2.00 - 4.99 2,830,525 9.25 years 2.01 490,775 2.00
5.00 - 11.50 10,000 7.38 years 11.50 5,000 11.50
----------- ----------
3,055,275 685,900
=========== ==========
</TABLE>
Options vest over varying time periods ranging from zero to four years. During
1998 and 1996 respectively, 527,500 and 1,217,250 outstanding options were
repriced at the then current market value. Such options are included in both
the granted and canceled options reported in the above schedule.
The Company's Employee Stock Purchase Plan allows eligible employees to
authorize the Company to withhold from 1% to 10% of gross earnings to purchase
shares of the Company's Common Stock. Shares are purchased by participants at
the lower of 85% of fair market value at either the beginning or purchase date
of each 24 month
39
<PAGE>
7TH LEVEL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
offering period. Purchase dates are every six months. As of December 31, 1998,
300,000 shares were authorized for purchase pursuant to the plan and 223,436
shares had been issued.
The Company adopted SFAS No. 123, "Accounting for Stock Based Compensation",
during 1996 and elected to continue to apply the intrinsic value method provided
under Accounting Principles Board ("APB") Opinion No. 25 and related
interpretations in accounting for its stock based compensation plans described
above. If compensation costs for the Company's stock-based compensation plans
had been determined under the fair value method the Company's net loss
available to common shareholders per share would have been increased to the pro
forma amounts indicated below:
<TABLE>
<CAPTION>
1998 1997 1996
-------------- -------------- --------------
<S> <C> <C> <C> <C>
Net loss As Reported $(16,774,644) $(22,457,678) $(24,252,735)
Pro forma (19,523,711) (25,466,761) (29,004,105)
Basic and diluted loss per
Common share As Reported $ (1.03) $ (1.64) $ (1.80)
Pro forma (1.19) (1.86) (2.16)
</TABLE>
The fair value of each option grant and employee purchase rights are estimated
on the date of grant using the Black-Scholes option-pricing model with the
following weighted-average assumptions: no dividend yield; expected volatility
of 67 to 211 percent; risk free interest rates of 5.2 to 6.5 percent; and
variable expected lives of zero, two and one-half and five years, depending on
the characteristics of the individual grants. The pro forma amounts are based
upon assumptions that the Company's management believes are reasonable; however,
the Company has a relatively short history on which to base these estimates.
The assumptions used in option pricing models significantly affect the estimated
value of stock benefits and, accordingly, the pro forma amounts do not purport
to represent the Company's results of operations for any future period.
Warrants
In connection with a $2,000,000 bridge loan agreement entered into in 1994
between the Company and certain existing stockholders prior to the initial
public offering, the Company issued warrants to purchase 350,000 shares of
Common Stock at $7.50 per share. The warrants expire October 11, 1999. At
December 31, 1998, 278,195 of these warrants were outstanding.
In connection with the acquisition of PyroTechnix, the Company assumed the
liability for outstanding warrants of PyroTechnix. There were warrants for
5,000 shares of PyroTechnix common stock and as of December 31, 1997, 19,268
shares of the Company's Common Stock had been issued to cover the exercise of
all of these warrants.
In May 1998, in connection with the private placements (See Note 3), the Company
issued warrants to purchase 675,000 and 1,375,000 shares of Common Stock at an
exercise price of $0.01 per share. The Company allocated approximately
$1,200,000 and $2,500,000, respectively, of the total proceeds of $10,000,000 to
these warrants. All of the warrants were exercised in June 1998. In connection
with the exchange of the Notes issued in the above mentioned private placement
the Company issued additional warrants to purchase 1,125,000 shares of Common
Stock at an exercise price of $0.01 per share. During 1998, 750,000 shares of
Common Stock were issued upon the exercise of the warrants and warrants for
375,000 shares remained outstanding at December 31, 1998. Subsequent to year
end all of these warrants were exercised.
In December 1998, as part of the stock subscription agreement between the
Company and Fletcher, the Company issued rights to purchase an additional
100,000 and 650,000 shares of Common Stock for $.01 and $4.50, respectively (See
Note 3). As of December 31, 1998, all of these rights remain outstanding.
40
<PAGE>
7TH LEVEL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
8. Leases
The Company leases office facilities in California and Texas and certain office
equipment under operating leases that expire at various dates through 2002.
Rental expense for operating leases amounted to $461,638, $911,385 and $904,948
for 1998, 1997 and 1996, respectively.
Minimum payments under leases expiring subsequent to December 31, 1998 are as
follows:
<TABLE>
<CAPTION>
Capital Operating
Year Leases Leases
---- ------------- ------------
<S> <C> <C>
1999 $161,218 $ 449,888
2000 47,412 320,459
2001 3,328 330,905
2002 -- 205,760
--------- ----------
Total $211,958 $1,307,012
==========
Less amount representing
interest (17,549)
--------
Present value
of minimum lease payments 194,409
========
</TABLE>
9. Major Customers and Concentration of Credit Risk
SFAS No. 105, "Disclosure of Information About Financial Instruments with Off-
Balance-Sheet Risk and Financial Instruments with Concentrations of Credit
Risk", requires disclosure of any significant off balance sheet and credit risk
concentration. The Company has no significant off-balance-sheet concentration
of credit risk such as foreign currency exchange contracts or other hedging
arrangements. Financial instruments that subject the Company to credit risk
consist of cash and cash equivalents and accounts receivable. The Company
places its temporary cash in financial institutions. For the years ended
December 31, 1998 and 1997, two and five customers represented approximately 47%
and 50% of the Company's total net revenues, respectively. Sales to customers
located outside the United States represent approximately 25% and 20% of the
Company's total sales for the years ended December 31, 1998 and 1997,
respectively.
10. Employee Benefit Plan
The Company sponsors a 401(k) plan for its employees whereby employees that
qualify for participation under the plan can contribute up to 15% of their
salary, on a before tax basis, subject to a maximum contribution limit as
determined by the Internal Revenue Service. The Company matched participant
contributions 50% up to a maximum of 6% of a participant's salary. For the
years ended December 31, 1998, 1997 and 1996, the Company made contributions to
the plan of approximately $48,000, $220,000 and $280,000, respectively.
11. Commitments and Contingencies
The Company is involved in other claims and lawsuits that are generally
incidental to its business. The Company is vigorously contesting all such
matters and believes that their ultimate resolution will not have a material
adverse effect on the Company's consolidated financial position, results of
operations or cash flows.
12. Subsequent Events
a. Street Technologies, Inc. Acquisition
In February 1999, the Company acquired Street Technologies, Inc., a company that
uses streaming technology to market and sale its extensive catalog of online
training course products. Effective as of the date of the merger,
41
<PAGE>
7TH LEVEL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
Street Technologies, Inc. changed its name to 7thStreet.com, Inc. To consummate
the transaction, the Company issued 4,948,182 shares of Common Stock and 21,644
shares of Series D 8% Preferred Stock (the "Series D Stock") with an aggregate
liquidation preference of $21,643,970. Upon the receipt of Common Stockholders
approval to convert, the Series D Stock will convert into Common Stock at $3.00
per share. The Series D 8% Preferred Stockholders are entitled to participate
with the Common Stockholders in dividends and distributions and to vote on most
matters on an "as converted" basis with the Common stockholders and as a
separate class, except for the vote on whether to convert the Series D Stock.
The total value of the transaction is approximately $36 million and will be
accounted for using the purchase method of accounting.
b. Conversion of 7% Convertible Notes Payable
The 7% Convertible Notes Payable were due and payable on February 11, 1999 (See
Note 6). To induce the holders to convert the note into Common Stock the
Company on February 10, 1999, offered the holders the right to convert at a
price equal to 85% of the then current market rate of the stock. During
February 1999, the Company issued 186,982 shares of Common Stock in exchange for
$458,108 of current notes payable. Accordingly, the Company recognized interest
expense in the amount of $114,618. As of March 17, 1999 the remaining balance
of $27,027 has not been paid to the one remaining holder.
42
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURES
As of January 15, 1999, we replaced our principal accountant KPMG LLP with
Arthur Andersen LLP. Our decision to change accountants was recommended by our
Board of Directors.
KPMG LLP's report on our consolidated financial statements as of December 31,
1997 and 1996 and for each of the years in the three-year period ended December
31, 1997 contained a separate paragraph stating that "the Company has suffered
recurring losses since inception and does not currently have sufficient
resources to meet its anticipated operating requirements during 1998, which
conditions raise substantial doubt about the Company's ability to continue as a
going concern. Management's plans in regard to these matters are also described
in Note 3. The consolidated financial statements and financial statement
schedule do not include any adjustments that might result from the outcome of
these uncertainties."
On April 20, 1998, we received commitments for an aggregate $10 million
financing which was comprised of $4.5 million principal amount of senior secured
promissory notes and $5.5 million liquidation preference of non-convertible
preferred stock. The terms of the financing provided that upon stockholder
approval the non-convertible preferred stock would be automatically exchanged
into convertible preferred stock and the holders of the senior secured
promissory notes would have the option of exchanging their notes into
convertible preferred stock. On July 13, 1998, an aggregate of $10 million
liquidation preference of our Series B Convertible Preferred Stock was issued to
the holders of the senior secured promissory notes and non-convertible preferred
stock. Between April 20, 1998 and July 13, 1998, the market price of our common
stock increased such that the conversion price of the Series B Convertible
Preferred Stock was greater than the market price of our common stock on April
20, 1998 but less than the market price of our common stock on July 13, 1998.
Due to the beneficial conversion feature of the Series B Convertible Preferred
Stock, we were required to increase the loss attributable to common stockholders
for the quarter ended September 30, 1998. The one-time occurrence was accounted
for similar to a non-cash dividend and had no effect on our net loss or
aggregate stockholders' equity.
KPMG LLP informed us about the accounting treatment of the beneficial conversion
feature. Management then requested KPMG LLP to look into alternative accounting
treatments. Management believes that its inquiries and discussions regarding
this matter did not constitute a disagreement. However, KPMG LLP has informed
us that in view of all the circumstances surrounding the discussions about this
issue this matter constitutes a disagreement as contemplated by Item 4 of Form
8-K and Item 304(a)(1) of Regulation S-K. Upon KPMG LLP informing us that in
KPMG's opinion there was no alternative accounting treatment, we followed the
advice of KPMG LLP and accounted for the Series B Convertible Preferred Stock as
described above to the satisfaction of KPMG LLP.
We have authorized KPMG LLP to respond fully to the inquiries of Arthur Andersen
LLP concerning the subject matter of the beneficial conversion feature.
The following is the response submitted to the SEC by KPMG LLP:
"We were previously principal accountants for 7th Level, Inc. and under the date
of January 30, 1998, we reported on the consolidated financial statements of 7th
Level, Inc. and subsidiaries as of December 31, 1997 and 1996 and for each of
the years in the three-year period ended December 31, 1997. On January 15,
1999, our appointment as principal accountants was terminated. We have read 7th
Level, Inc.'s statements included under Item 4 of its Form 8-K dated January 15,
1999, and agree with such statements, except that we are not in a position to
agree or disagree with 7th Level, Inc.'s statement that the change in principal
accountants was recommended by the Company's Board of Directors."
After the change in accountants took place it came to the Company's attention
that at the November 18, 1998 meeting of the Emerging Issues Task Force, the
staff of the Securities Exchange Commission ("SEC") issued a statement regarding
how issuers should account for convertible securities. The minutes dealt with,
among other things, the observation, by the Task Force, that in certain
circumstances, the intrinsic value of the beneficial conversion feature may be
greater than the proceeds received from the sale of the convertible instrument.
In those situations, the Task Force reached a tentative conclusion that the
amount of the discount assigned to the beneficial
43
<PAGE>
conversion feature should be limited to the amount of proceeds received.
As a result of the foregoing, the Company has restated the financial statements
contained in the Quarterly Report on Form 10-Q for the three and nine month
periods ended September 30, 1998. The Company has reduced the beneficial
conversion feature originally recorded in the amount of approximately
$15,000,000 to approximately $5,500,000. The impact of such restatement on the
Company's Condensed Consolidated Statement of Operations and Balance Sheet is as
follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, 1998 September 30, 1998
As Originally As Originally
------------- -------------
As Restated Reported As Restated Reported
----------- ------------- ------------ -------------
<S> <C> <C> <C> <C>
Net Loss available to common stockholders ($7,922,802) ($17,414,526) ($15,474,901) ($24,966,625)
Loss per Common Share ($ .45) ($1.00) ($1.00) ($1.62)
September 30, 1998
As Restated As Originally
------------ -------------
Reported
-------------
Additional Capital $ 83,990,864 $93,482,588
Accumulated Deficit ($83,635,328) ($93,127,052)
</TABLE>
44
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item is incorporated by reference from our
definitive proxy statement to be filed with the Securities and Exchange
Commission no later than April 30, 1999 pursuant to Regulation 14A of the
Exchange Act of 1934.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference from our
definitive proxy statement to be filed with the Securities and Exchange
Commission no later than April 30, 1999 pursuant to Regulation 14A of the
Exchange Act of 1934.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
The information required by this item is incorporated by reference from our
definitive proxy statement to be filed with the Securities and Exchange
Commission no later than April 30, 1999 pursuant to Regulation 14A of the
Exchange Act of 1934.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference from our
definitive proxy statement to be filed with the Securities and Exchange
Commission no later than April 30, 1999 pursuant to Regulation 14A of the
Exchange Act of 1934.
45
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
<TABLE>
<CAPTION>
<C> <S>
(a)(1)-- The financial statements filed as part of this Report at Item 8 are listed in the Index to Financial
Statements and Financial Statement Schedule on page 22 of this Report.
(a)(2)-- The financial statement schedule filed as part of this Report at Item 8 is listed in the Index to Financial
Statements and Financial Statement Schedule on page 22 of this Report.
(a)(3)-- The following documents are filed or incorporated by reference as exhibits to this Report:
*****************2.1-- Agreement and Plan of Merger dated as of February 16, 1999, by and among 7th Level, Inc., 7th Level Merger
Corporation, Steet Technologies, Inc. and the stock holders of Street Technologies, Inc. named herein.
**3(i)-- Restated Certificate of Incorporation of 7th Level, Inc. (the "Company").
*3(ii)-- Bylaws of the Company as adopted by the Board of Directors of the Company as of May 14, 1993; as amended by
Amendment No. 1 thereto dated February 11, 1994.
**4.1-- Form of Bridge Loan Warrant.
************4.2-- Form of Warrant
************4.3-- Certificate of Designation of Series A Preferred Stock
************4.4-- Certificate of Designation of Series C Preferred Stock
4.5-- Certificate of Designation of Series D Preferred Stock
*10.1-- Stock Purchase Agreement entered into as of the 11th day of February, 1994 by and among the Company and the
Purchasers listed on Exhibit A thereto.
*10.2-- Stockholders' Agreement entered into as of the 11th day of February, 1994 by and among the Company and
George D. Grayson, Robert A. Ezrin, the George D. and Kathy Grayson Irrevocable Trust, David R. Henkel, Onyx
Partners, Inc., W. Scott Page, James E. Shepherd, Robert A. Tercek, Entec Associates, Mezzonen S.A., Merv
Adelson, Andrew Adelson, Tarragona Fund, Inc., and Zenga Investments, Ltd. (the "Investors").
*10.3-- Letter Agreement dated May 28, 1993 from Onyx Partners, Inc. ("Onyx") to the Company.
*10.4-- Option Share Repurchase Agreement entered into as of the 11th day of February, 1994, by and among the
Company, George D. Grayson, Robert A. Ezrin and W. Scott Page.
**10.5-- Amended and Restated Incentive Stock Option Plan of 7th Level, Inc.
**10.6-- Employee Stock Purchase Plan of 7th Level, Inc.
*10.7-- Assignment and Assumption Agreement entered into as of the 11th day of February, 1994 by and among the
Company and 7th Level, a sole proprietorship.
*10.8-- Employment Agreement entered into as of April 28, 1993 by and among the Company and George D. Grayson.
*10.9-- Letter Agreement dated as of January 20, 1994 from the Company to David R. Henkel.
</TABLE>
46
<PAGE>
<TABLE>
<CAPTION>
<C> <S>
*10.10-- Asset Purchase Agreement entered into as of the 24th day of March, 1994, by and among the Company and
MetroLight.
*10.11-- Software License Agreement entered into as of the 24th day of March, 1994, by and among the Company and
MetroLight.
*10.12-- Assumption Agreement entered into as of the 24th day of March, 1994, by and among the Company and
MetroLight.
*10.13-- Registration Rights Agreement entered into as of the 24th day of March, 1994, by and among the Company and
MetroLight.
*10.14-- Letter Agreement dated as of November 11, 1993 from Python (Monty) Pictures, Ltd. to the Company.
*10.15-- Letter Agreement dated as of June 8, 1993 relating to the services of Howie Mandel and accepted and agreed
to on September 2, 1993 by the Company and Alevy Productions, Inc.
**10.16-- Distribution Agreement entered into as of January 11, 1994 by and between the Company and Ingram Micro Inc.
(Portions have been omitted and filed separately with the Commission in accordance with Rule 406 of the
Securities Act of 1933, as amended, and the Registrant's request for confidential treatment.)
*10.17-- Letter Agreement dated May 3, 1994 from the Company to Charles Fleischer.
**10.18-- Form of Exchange Agreement dated September __, 1994 among the Company and the Investors.
**10.19-- Letter Agreement dated August 30, 1994 from Python (Monty) Pictures Ltd. to the Company.
***10.20-- Letter Agreement dated September 16, 1994 from International Business Machines Corporation to the Company.
**10.21-- Letter Agreement dated May 25, 1994 from the Company to Bill Plympton.
**10.22-- Letter Agreement dated August 15, 1994 from Quincy Jones--David Salzman Entertainment to the Company.
**10.23-- Letter Agreement dated July 29, 1994 from Imperial Bank to the Company.
**10.24-- Letter Agreement dated September 6, 1994 from the Company to Imperial Bank.
**10.25-- Form of Bridge Loan Agreement dated as of July 13, 1994 among the Company and each Lender which is a
signatory thereto.
****10.26-- Amended and Restated 1994 Non-Employee Directors' Stock Option Plan of the Company.
***10.27-- Form of 7% Convertible Note Due February 11, 1999.
***10.28-- Loan Modification Agreement effective the 21st day of July, 1994 between the Company and George D. Grayson.
*****10.29-- Agreement made as of the 28th day of September, 1994, by and between Entec Associates ("Entec") and the
Company, including exhibits thereto.
*****10.30-- Lock-Up Agreement made and entered into the 26th day of September, 1994 by and among Entec and the Company.
*******10.31-- Registration Rights Agreement entered into as of the 23rd day of February, 1995 by and among the Company and
Todd Porter, Jeremiah O'Flaherty, Gregory Harvey, Stephen Kennedy, Harry Wenzel and Robert Legg.
</TABLE>
47
<PAGE>
<TABLE>
<CAPTION>
<C> <S>
******10.32-- 7th Level, Inc. 7% Subordinated Notes Due 1996.
********10.33-- Letter Agreement dated June 27, 1995 from Disney Interactive, Inc. ("Disney") to the Company.
*********10.34-- Letter agreement dated August 31, 1995 by and between Morgan Creek Interactive, Inc. and the Company
(portions of which have been omitted and filed separately with the Commission in accordance with Rule 406 of
the Securities Act of 1933, as amended, and the Company's request for confidential treatment.
**********10.35-- Imperial Bank - Credit Terms and Conditions; $6,000,000 Note; $5,000,000 Note; General Security Agreement;
Mortgage, Assignment and Grant of Security Interest with Respect to Trademarks; and Mortgage, Assignment and
Grant of Security Interest with Respect to Copyrights and Other Collateral, all dated September 6, 1996.
************10.36-- Securities Purchase Agreement dated as of May 6, 1998, by and among the Company, Alpine Associates, a New
Jersey Limited Partnership ("Alpine") and East West Capital Associates, Inc. ("Capital")
************10.37-- Security Agreement dated as of May 6, 1998, by and among the Company, Capital, Alpine and Alpine, as
collateral agent for itself and Capital.
************10.38-- Senior Secured Promissory Note in the aggregate principal amount of $3,000,000 issued to Alpine.
************10.39-- Senior Secured Promissory Note in the aggregate principal amount of $1,500,000 issued to Capital.
************10.40-- Securities Purchase Agreement dated as of May 6, 1998, between the Company and the Purchasers parties
thereto.
************10.41-- Registration Rights Agreement dated May 6, 1998 by and among the Company and the Purchasers parties thereto
************10.42-- Specimen of Preferred Stock certificate.
*************10.43-- Employment Agreement dated as of April 20, 1998 by and between the Company and Richard S. Merrick.
**************10.44-- Subscription Agreement dated as of December 14, 1998, by and between 7/th/ Level, Inc. and Fletcher
International Limited.
10.45-- Employment Agreement dated as of February 16, 1999 by and between the Company and Stephen Gott.
23.1-- Consent of KPMG LLP.
23.2-- Consent of Arthur Andersen LLP
27-- Financial Data Schedule
***********99.1-- Press release concerning the merger of 7/th/ Level, Inc. with Pulse Entertainment, Inc.
***************99.2-- Press release of 7/th/ Level, Inc. dated April 22, 1998 concerning cancellation of proposed merger with
Pulse Entertainment, Inc. and commitments and terms for $4.5 million bridge loan and $10 million private
placement.
****************99.3-- Unaudited Pro Forma Condensed Balance Sheet of 7/th/ Level, Inc. as of May 31, 1998.
(b)-- Registrant filed a Current Report on Form 8-K , dated December 14, 1998, in respect to the Subscription
Agreement with Fletcher International Limited under which Fletcher invested $5 million of equity into
Registrant and has agreed to an equity line of credit for an additional $5 million.
</TABLE>
__________________________________
48
<PAGE>
<TABLE>
<CAPTION>
<S> <C>
* Filed as an Exhibit to the Company's Registration Statement on Form S-1 (File No. 33-79092) filed with the
Commission on May 18, 1994, and incorporated by reference herein.
** Filed as an Exhibit to Amendment No. 1 to the Company's Registration Statement on Form S-1 (File No. 33-79092)
filed with the Commission on September 19, 1994, and Incorporated by reference herein.
*** Filed as an Exhibit to Amendment No. 2 to the Company's Registration Statement on Form S-1 (File No. 33-79092)
filed with the Commission on September 28, 1994, and Incorporated by reference herein.
**** Filed as an Exhibit to Amendment No. 3 to the Company's Registration Statement on Form S-1 (File No. 33-79092)
filed with the Commission on October 14, 1994, and incorporated by reference herein.
***** Filed as an Exhibit to Amendment No. 4 to the Company's Registration Statement on Form S-1 (File No. 33-79092)
filed with the Commission on October 19, 1994, and incorporated by reference herein.
****** Filed as an Exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994.
******* Filed as an Exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1994.
******** Filed as an Exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995.
********* Filed as an Exhibit to Amendment No. 1 to the Company's Registration Statement on Form S-1 (File No. 33-96522)
filed with the Commission on September 12, 1995 and Incorporated by reference herein.
********** Filed as an Exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996.
*********** Filed as an Exhibit to the Company's Report on Form 8-K (File No. 000-24936) filed with the Commission on December
9, 1997 and incorporated by reference herein.
************ Filed as an Exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1998.
************* Filed as an Exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1998
************** Filed as an Exhibit to the Company's Report on Form 8-K (File No. 000-24936) filed with the Commission on April
23, 1998 and incorporated by reference herein
*************** Filed as an Exhibit to the Company's Report on Form 8-K (File No. 000-24936) filed with the Commission on July 9,
1998 and incorporated by reference herein.
**************** Filed as an Exhibit to the Company's Report on Form 8-K (File No. 000-24936) filed with the Commission on December
14, 1998 and incorporated by reference herein.
***************** Filed as and Exhibit to the Company's Current Report on Form 8-K (File No. 000-24936) filed with the Commission on
February 25, 1999 and incorporated by reference herein.
</TABLE>
49
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of White
Plains and State of New York, on March 30, 1999.
7TH LEVEL, INC.
By: /s/ MARC E. LANDY
---------------------------------------
Marc E. Landy
Chief Financial Officer
Pursuant to the requirements of the Securities and Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title
<S> <C>
/s/ MERV ADELSON
- ------------------------------------ Director March 30, 1999
(Merv Adelson)
/s/ JAMES A. CANNAVINO
- ------------------------------------ Director March 29, 1999
(James A. Cannavino)
/s/ ROBERT ALAN EZRIN
- ------------------------------------ Vice Chairman of the Board and March 27, 1999
(Robert Alan Ezrin) Director
/s/ STEPHEN P. GOTT
- ------------------------------------ President, Chief Executive Office and March 30, 1999
(Stephen P. Gott) Director (Principal Executive Officer)
/s/ MARC E. LANDY
- ------------------------------------ Chief Financial Officer and Vice March 30, 1999
(Marc E. Landy) President (Principal Financial Officer)
/s/ RICHARD S. MERRICK
- ------------------------------------ Director March 30, 1999
(Richard S. Merrick)
/s/ DONALD SCHUPAK
- ------------------------------------ Chairman of the Board and Director March 30, 1999
(Donald Schupak)
</TABLE>
50
<PAGE>
7TH LEVEL, INC.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
Balance at Balance at
Beginning End of
Description of Period Additions Deductions Period
- ---------------------------------- ------------- -------------------- ------------- -------------------
<S> <C> <C> <C> <C>
Allowance for sales returns,
doubtful accounts and price
concessions
Year ended December 31, 1998: $1,126,524 $ 4,007 $1,129,568 $ 963
Year ended December 31, 1997: 1,565,291 3,062,581 3,501,348 1,126,524
Year ended December 31, 1996: 1,209,866 5,194,196 4,830,716 1,565,291
Reserve for Inventory Obsolescence
Year ended December 31, 1998: $ 718,082 $ 0 $ 718,082 $ 0
Year ended December 31, 1997: 302,951 415,131 -0- 718,082
Year ended December 31, 1996: 102,000 295,821 94,870 302,951
</TABLE>
S-1
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit
Number Document Description
- --------- -------------------------------------------------------------------------------------
<S> <C>
**3(i)-- Restated Certificate of Incorporation of 7th Level, Inc. (the "Company").
*3(ii)-- Bylaws of the Company as adopted by the Board of Directors of the Company as of May 14, 1993; as amended by
Amendment No. 1 thereto dated February 11, 1994.
*****************2.1-- Agreement and Plan of Merger, dated as of February 16, 1999, by and among 7th Level, Inc., 7th Level Merger
Corporation, Steet Technologies, Inc. and the stock holders of Street Technologies, Inc. named therein.
**4.1-- Form of Bridge Loan Warrant.
************4.2-- Form of Warrant
************4.3-- Certificate of Designation of Series A Preferred Stock
************4.4-- Certificate of Designation of Series C Preferred Stock
4.5-- Certificate of Designation of Series D Preferred Stock
*10.1-- Stock Purchase Agreement entered into as of the 11th day of February, 1994 by and among the Company and the
Purchasers listed on Exhibit A thereto.
*10.2-- Stockholders' Agreement entered into as of the 11th day of February, 1994 by and among the Company and
George D. Grayson, Robert A. Ezrin, the George D. and Kathy Grayson Irrevocable Trust, David R. Henkel, Onyx
Partners, Inc., W. Scott Page, James E. Shepherd, Robert A. Tercek, Entec Associates, Mezzonen S.A., Merv
Adelson, Andrew Adelson, Tarragona Fund, Inc., and Zenga Investments, Ltd. (the "Investors").
*10.3-- Letter Agreement dated May 28, 1993 from Onyx Partners, Inc. ("Onyx") to the Company.
*10.4-- Option Share Repurchase Agreement entered into as of the 11th day of February, 1994, by and among the
Company, George D. Grayson, Robert A. Ezrin and W. Scott Page.
**10.5-- Amended and Restated Incentive Stock Option Plan of 7th Level, Inc.
**10.6-- Employee Stock Purchase Plan of 7th Level, Inc.
*10.7-- Assignment and Assumption Agreement entered into as of the 11th day of February, 1994 by and among the
Company and 7th Level, a sole proprietorship.
*10.8-- Employment Agreement entered into as of April 28, 1993 by and among the Company and George D. Grayson.
*10.9-- Letter Agreement dated as of January 20, 1994 from the Company to David R. Henkel.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Document Description
- --------- -------------------------------------------------------------------------------------
<S> <C>
*10.10-- Asset Purchase Agreement entered into as of the 24th day of March, 1994, by and among the Company and
MetroLight.
*10.11-- Software License Agreement entered into as of the 24th day of March, 1994, by and among the Company and
MetroLight.
*10.12-- Assumption Agreement entered into as of the 24th day of March, 1994, by and among the Company and
MetroLight.
*10.13-- Registration Rights Agreement entered into as of the 24th day of March, 1994, by and among the Company and
MetroLight.
*10.14-- Letter Agreement dated as of November 11, 1993 from Python (Monty) Pictures, Ltd. to the Company.
*10.15-- Letter Agreement dated as of June 8, 1993 relating to the services of Howie Mandel and accepted and agreed
to on September 2, 1993 by the Company and Alevy Productions, Inc.
**10.16-- Distribution Agreement entered into as of January 11, 1994 by and between the Company and Ingram Micro, Inc.
(Portions have been omitted and filed separately with the Commission in accordance with Rule 406 of the
Securities Act of 1933, as amended, and the Registrant's request for confidential treatment.)
*10.17-- Letter Agreement dated May 3, 1994 from the Company to Charles Fleischer.
**10.18-- Form of Exchange Agreement dated September __, 1994 among the Company and the Investors.
**10.19-- Letter Agreement dated August 30, 1994 from Python (Monty) Pictures Ltd. to the Company.
***10.20-- Letter Agreement dated September 16, 1994 from International Business Machines Corporation to the Company.
**10.21-- Letter Agreement dated May 25, 1994 from the Company to Bill Plympton.
**10.22-- Letter Agreement dated August 15, 1994 from Quincy Jones--David Salzman Entertainment to the Company.
**10.23-- Letter Agreement dated July 29, 1994 from Imperial Bank to the Company.
**10.24-- Letter Agreement dated September 6, 1994 from the Company to Imperial Bank.
**10.25-- Form of Bridge Loan Agreement dated as of July 13, 1994 among the Company and each Lender which is a
signatory thereto.
****10.26-- Amended and Restated 1994 Non-Employee Directors' Stock Option Plan of the Company.
***10.27-- Form of 7% Convertible Note Due February 11, 1999.
***10.28-- Loan Modification Agreement effective the 21st day of July, 1994 between the Company and George D. Grayson.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Document Description
- --------- -------------------------------------------------------------------------------------
<S> <C>
*****10.29-- Agreement made as of the 28th day of September, 1994, by and between Entec Associates ("Entec") and the
Company, including exhibits thereto.
*****10.30-- Lock-Up Agreement made and entered into the 26th day of September, 1994 by and among Entec and the Company.
*******10.31-- Registration Rights Agreement entered into as of the 23rd day of February, 1995 by and among the Company and
Todd Porter, Jeremiah O'Flaherty, Gregory Harvey, Stephen Kennedy, Harry Wenzel and Robert Legg.
******10.32-- 7th Level, Inc. 7% Subordinated Notes Due 1996.
********10.33-- Letter Agreement dated June 27, 1995 from Disney Interactive, Inc. ("Disney") to the Company.
*********10.34-- Letter agreement dated August 31, 1995 by and between Morgan Creek Interactive, Inc. and the Company
(portions of which have been omitted and filed separately with the Commission in accordance with Rule 406 of
the Securities Act of 1933, as amended, and the Company's request for confidential treatment.
**********10.35-- Imperial Bank - Credit Terms and Conditions; $6,000,000 Note; $5,000,000 Note; General Security Agreement;
Mortgage, Assignment and Grant of Security Interest with Respect to Trademarks; and Mortgage, Assignment and
Grant of Security Interest with Respect to Copyrights and Other Collateral, all dated September 6, 1996.
************10.36-- Securities Purchase Agreement dated as of May 6, 1998, by and among the Company, Alpine Associates, a New
Jersey Limited Partnership ("Alpine") and East West Capital Associates, Inc. ("Capital")
************10.37-- Security Agreement dated as of May 6, 1998, by and among the Company, Capital, Alpine and Alpine, as
collateral agent for itself and Capital.
************10.38-- Senior Secured Promissory Note in the aggregate principal amount of $3,000,000 issued to Alpine.
************10.39-- Senior Secured Promissory Note in the aggregate principal amount of $1,500,000 issued to Capital.
************10.40-- Securities Purchase Agreement dated as of May 6, 1998, between the Company and the Purchasers parties
thereto.
************10.41-- Registration Rights Agreement dated May 6, 1998 by and among the Company and the Purchasers parties thereto
************10.42-- Specimen of Preferred Stock certificate.
*************10.43-- Employment Agreement dated as of April 20, 1998 by and between the Company and Richard S. Merrick.
**************10.44-- Subscription Agreement dated as of December 14, 1998, by and between 7/th/ Level, Inc. and Fletcher
International Limited.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Document Description
- --------- -------------------------------------------------------------------------------------
<S> <C>
10.45-- Employment Agreement dated as of February 16, 1999 by and between the Company and Stephen Gott.
23.1-- Consent of KPMG LLP
23.2-- Consent of Arthur Andersen LLP
27-- Financial Data Schedule
***********99.1-- Press release concerning the merger of 7/th/ Level, Inc. with Pulse Entertainment, Inc.
***************99.2-- Press release of 7/th/ Level, Inc. dated April 22, 1998 concerning cancelation of proposed merger with Pulse
Entertainment, Inc. and commitments and terms for $4.5 million bridge loan and $10 million private
placement.
****************99.3-- Unaudited Pro Forma Condensed Balance Sheet of 7/th/ Level, Inc. as of May 31, 1998.
</TABLE>
__________________________________
* Filed as an Exhibit to the Company's Registration Statement
on Form S-1 (File No. 33-79092) filed with the Commission on
May 18, 1994, and incorporated by reference herein.
** Filed as an Exhibit to Amendment No. 1 to the Company's
Registration Statement on Form S-1 (File No. 33-79092) filed
with the Commission on September 19, 1994, and Incorporated
by reference herein.
*** Filed as an Exhibit to Amendment No. 2 to the Company's
Registration Statement on Form S-1 (File No. 33-79092) filed
with the Commission on September 28, 1994, and Incorporated
by reference herein.
**** Filed as an Exhibit to Amendment No. 3 to the Company's
Registration Statement on Form S-1 (File No. 33-79092) filed
with the Commission on October 14, 1994, and incorporated by
reference herein.
***** Filed as an Exhibit to Amendment No. 4 to the Company's
Registration Statement on Form S-1 (File No. 33-79092) filed
with the Commission on October 19, 1994, and incorporated by
reference herein.
****** Filed as an Exhibit to the Company's Quarterly Report on Form
10-Q for the quarter ended September 30, 1994.
******* Filed as an Exhibit to the Company's Annual Report on Form
10-K for the year ended December 31, 1994.
******** Filed as an Exhibit to the Company's Quarterly Report on Form
10-Q for the quarter ended June 30, 1995.
********* Filed as an Exhibit to Amendment No. 1 to the Company's
Registration Statement on Form
<PAGE>
S-1 (File No. 33-96522) filed with the Commission on
September 12, 1995 and Incorporated by reference herein.
********** Filed as an Exhibit to the Company's Quarterly Report on Form
10-Q for the quarter ended September 30, 1996.
*********** Filed as an Exhibit to the Company's Report on Form 8-K (File
No. 000-24936) filed with the Commission on December 9, 1997
and incorporated by reference herein.
************ Filed as an Exhibit to the Company's Quarterly Report on Form
10-Q for the quarter ended March 31, 1998.
************* Filed as an Exhibit to the Company's Quarterly Report on Form
10-Q for the quarter ended June 30, 1998
************** Filed as an Exhibit to the Company's Report on Form 8-K (File
No. 000-24936) filed with the Commission on April 23, 1998
and incorporated by reference herein
*************** Filed as an Exhibit to the Company's Report on Form 8-K (File
No. 000-24936) filed with the Commission on July 9, 1998 and
incorporated by reference herein.
**************** Filed as an Exhibit to the Company's Report on Form 8-K (File
No. 000-24936) filed with the Commission on December 14, 1998
and incorporated by reference herein.
***************** Filed as an Exhibit to the Company's Current Report on Form
8-K (File No. 000-24936) filed with the Commission on
February 25, 1999 and incorporated by reference herein.
<PAGE>
EXHIBIT 4.5
CERTIFICATE OF DESIGNATIONS, PREFERENCES
AND RIGHTS OF SERIES D PREFERRED
STOCK OF 7TH LEVEL, INC.
7TH LEVEL, INC., a corporation organized and existing under the
General Corporation Law of the State of Delaware (the "Corporation"), DOES
HEREBY CERTIFY THAT:
Pursuant to authority conferred upon the Board of Directors (the
"Board") by the Certificate of Incorporation of the Corporation (the
"Certificate of Incorporation") and pursuant to the provisions of (S)151 of the
Delaware General Corporation Law, the Board, at a meeting held on February 16,
1999, adopted the following resolution providing for the voting powers,
designations, preferences and rights, and the qualifications, limitations and
restrictions of the Series D Preferred Stock.
WHEREAS, the Certificate of Incorporation provides for two classes of
shares known as common stock, $.01 par value per share (the "Common Stock"), and
preferred stock, $.01 par value per share (the "Preferred Stock"); and
WHEREAS, the Board is authorized by the Certificate of Incorporation
to provide for the issuance of the shares of Preferred Stock in one or more
series, and by filing a certificate pursuant to the applicable law of the State
of Delaware, to establish from time to time the number of shares to be included
in any such series and to fix the voting powers, designations, preferences and
rights of the shares of any such series and the qualifications, limitations and
restrictions thereof.
NOW, THEREFORE, BE IT RESOLVED, that the Board deems it advisable to,
and hereby does, designate a Series D Preferred Stock and fixes and determines
the voting powers, designations, preferences and rights, and the qualifications,
limitations and restrictions relating to the Series D Preferred Stock as
follows:
1. Designation. The shares of such series of Preferred Stock shall be
designated "Series D Preferred Stock" (referred to herein as the "Series D
Stock").
2. Authorized Number. The number of shares constituting the Series D
Stock shall be 35,000.
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3. Ranking. The Series D Stock shall rank, as to dividends, rights upon
liquidation, dissolution or winding up, junior to the Corporation's currently
outstanding Series B Convertible Preferred Stock (the "Series B Stock"), and
senior and prior to the Common Stock and to all other classes or series of stock
issued by the Corporation, currently and in the future, except as otherwise
approved by the affirmative vote or consent of the holders of shares of Series D
Stock pursuant to Section 9(c) hereof. The Corporation agrees that it shall not
issue any additional shares of Series B Stock after the Original Issue Date.
(All equity securities of the Corporation to which the Series D Stock ranks
prior, whether with respect to dividends or upon liquidation, dissolution,
winding up or otherwise, including the Common Stock, are collectively referred
to herein as "Junior Securities," all equity securities of the Corporation with
which the Series D Stock ranks on a parity, whether with respect to dividends or
upon liquidation, dissolution, winding up or otherwise, are collectively
referred to herein as "Parity Securities," and all equity securities of the
Corporation to which the Series D Stock ranks junior, whether with respect to
dividends or upon liquidation, dissolution, winding up or otherwise, including
the Series B Stock, are collectively referred to herein as "Senior Securities").
4. Dividends.
(a) Dividend Accrual and Payment. Dividends, whether or not
declared, shall accrue on the shares of Series D Stock from the date of the
issuance of the shares of Series D Stock (the "Original Issue Date") (or if
shares of Series D Stock are issued after the Original Issue Date, the
"Subsequent Issue Date") at the rate of 8% per share per annum (expressed as a
percentage of the $1,000 per share liquidation preference (the "Dividend
Rate")); provided, that if the Approval date (as defined in Section 6(a)) occurs
on or before July 31, 1999, then no dividends shall be paid; provided, however,
that if the Approval Date does not occur within twelve months of the Original
Issue Date, the dividend rate on the Series D Stock shall increase by 2% for
every six months that the Approval Date does not occur following the first
anniversary of the Original Issue Date. The holders of shares of Series D Stock
shall be entitled to receive such dividends when and as declared by the Board,
in cash or shares of Series D Stock valued at the Series D Issue Price (as
defined below), out of assets legally available for such purpose, quarterly in
arrears on the 30th day of January, April, July or October of each year (each of
such dates being a "Dividend Payment Date"), commencing July 30, 1999; provided
that any dividends payable in Series D Stock shall accrue rather than be paid.
Such dividends shall be paid to the holders of record at the close of business
on the date specified by the Board at the time such dividend is declared,
provided, however, that such date shall not be more than 60 nor less than 10
days prior to the applicable Dividend Payment Date. Dividends on the Series D
Stock shall be cumulative and shall accrue on each share whether or not earned,
from and after the Dividend Payment Date coincident with or next preceding the
issuance of such share; provided, however, that dividends payable on the first
Dividend Payment Date shall so accrue from and after the date immediately
succeeding the Original Issue Date. If the Original Issue Date or the
Subsequent Issue Date, as the case may be, is on a date which does not coincide
with a Dividend Payment Date, then the dividend accrual period applicable to
such shares shall be the
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period from the Original Issue Date or the Subsequent Issue Date, as the case
may be, through whichever of January, April, July or October next occurs after
the Original Issue Date or the Subsequent Issue Date, as the case may be. If the
date fixed for payment of a final liquidating distribution on any shares of
Series D Stock, or the date on which any shares of Series D Stock are redeemed
or converted into Common Stock does not coincide with a Dividend Payment Date,
then subject to the provisions hereof relating to such payment, redemption or
conversion, the final dividend accrual period applicable to such shares shall be
the period from whichever of January, April, July or October most recently
precedes the date of such payment, conversion or redemption through the
effective date of such payment, conversion or redemption. The dividend amount
payable per share shall be adjusted for any combinations or divisions or similar
recapitalizations affecting the shares of Series D Stock. So long as any shares
of Series D Stock are outstanding, (i) the amount of all dividends paid with
respect to the shares of Series D Stock pursuant to this Section 4(a) shall be
paid pro rata to the holders entitled thereto and (ii) holders of the shares of
Series D Stock shall be entitled to receive the dividends provided for in this
Section 4(a) in preference to and in priority over any dividends upon any Junior
Securities.
(b) Participation Rights. In addition to and subject to the payment
of any Liquidation Payments (as defined below), the holders of the shares of
Series D Stock shall be paid an aggregate amount equal to 22% of all dividends,
payments and distributions payable with respect to the Common Stock including,
without limitation, payment resulting from any liquidation, dissolution or
winding up of the Corporation, merger or sale of substantially all of the
Corporation's assets with such amount to be allocated pro rata among the shares
of Series D Stock.
(c) Dividends on Fractional Shares. Each fractional share of Series
D Stock outstanding shall be entitled to a ratably proportionate amount of all
dividends accruing with respect to each outstanding share of Series D Stock
pursuant to Section 4(a) hereof, and all such dividends with respect to such
outstanding fractional shares shall be fully cumulative and shall accrue
(whether or not declared), and shall be payable in the same manner and at such
times as provided for in Section 4(a) hereof with respect to dividends on each
outstanding share of Series D Stock.
5. Liquidation.
(a) Liquidation Procedure. Upon any liquidation, dissolution or
winding up of the Corporation, whether voluntary or involuntary, the holders of
the shares of Series D Stock shall be entitled, after all distributions and
payments are made upon any Senior Securities and before any distribution or
payment is made upon any Junior Securities, to be paid an amount equal to (i)
$1,000 per share of Series D Stock, representing the liquidation preference per
share of the Series D Stock (as adjusted for any combinations, divisions or
similar recapitalizations affecting the shares of Series D Stock) (the "Series D
Issue Price"), plus (ii) all accrued and unpaid dividends on the Series D Stock
to such date (together with the Series D Issue Price, the "Liquidation
Payments"). If upon any liquidation, dissolution or winding up of the
Corporation,
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whether voluntary or involuntary, the assets to be distributed among the holders
of Series D Stock shall be insufficient to permit payment in full to the holders
of Series D Stock of the Liquidation Payments, then the entire assets of the
Corporation shall be distributed ratably among such holders in proportion to the
full respective distributive amounts to which they are entitled after all
distributions and payments are made upon any Senior Securities.
(b) Remaining Assets. Upon any liquidation, dissolution or winding
up of the Corporation, whether voluntary or involuntary, after the holders of
Series D Stock shall have been paid in full the Liquidation Payments, the
remaining assets of the Corporation may be distributed ratably per share in
order of preference to the holders of Junior Securities in accordance with their
terms and to the holders of the Series D Preferred Stock in accordance with
their participation rights set forth in Section 4(b).
(c) Notice of Liquidation. Written notice of a liquidation,
dissolution or winding up of the Corporation, whether voluntary or involuntary,
stating a payment date, the amount of the Liquidation Payments and the place
where said Liquidation Payments shall be payable, shall be given by mail,
postage prepaid, not less than 30 days prior to the payment date stated therein,
to each holder of record of Series D Stock at his post office address as shown
by the records of the Corporation.
(d) Fractional Shares. The Liquidation Payments with respect to each
outstanding fractional share of Series D Stock shall be equal to a ratably
proportionate amount of the Liquidation Payments with respect to each
outstanding share of Series D Stock.
6. Mandatory Conversion.
(a) Conversion. Subject to the limitations set forth below, on the
date (the "Approval Date") that is one day after the stockholders of the
Corporation approve the issuance of 20% or more of the outstanding Common Stock
(the "Issuance") in connection with the Corporation's acquisition of Street
Technologies, Inc. ("Street"), the Series D Stock shall be converted
automatically, without any further action by the holder of such shares and
whether or not the certificates representing such shares are surrendered to the
Corporation, into the number of fully paid and nonassessable shares of Common
Stock equal to the quotient of (x) the aggregate liquidation preference of the
shares of Series D Stock outstanding divided by (y) the Conversion Price (as
defined below) then in effect . The holders of shares of Series D Stock by
acceptance of the shares of Series D Stock agree to vote in favor of the
Issuance. Upon the conversion of shares of Series D Stock as provided in this
Section 6, the Corporation shall pay all then accrued but unpaid dividends on
the Series D Stock to the holders of the Series D Stock in additional shares of
Common Stock valued at the Market Price (as defined below) thereof on the date
of such payment.
(b) Conversion Price; Converted Shares. The initial conversion price
per share of the Series D Stock (the "Conversion Price") shall be equal to
$3.00, subject to
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adjustment as provided in Section 7. If any fractional interest in a share of
Common Stock would be deliverable upon conversion of Series D Stock, the
Corporation shall pay in lieu of such fractional share an amount in cash equal
to the Conversion Price of such fractional share (computed to the nearest one
hundredth of a share) in effect at the close of business on the date of
conversion. Any shares of Series D Stock which have been converted shall be
cancelled and all dividends on converted shares shall cease to accrue and the
certificates representing shares of Series D Stock so converted shall represent
the right to receive (i) such number of shares of Common Stock into which such
shares of Series D Stock are convertible, plus (ii) cash payable for any
fractional share, plus (iii) all accrued but unpaid dividends relating to such
shares through the date of conversion. Amounts payable with respect to the
foregoing clause (iii) shall be paid in accordance with the provisions set forth
in Section 6(a). The Board shall at all times, so long as any shares of Series D
Stock remain outstanding, reserve a sufficient number of authorized but unissued
shares of Common Stock to be issued in satisfaction of the conversion rights and
privileges aforesaid.
As used herein, "Market Price" means, with respect to the shares of
Common Stock, (a) if the shares are listed or admitted for trading on any
national securities exchange or included in The Nasdaq National Market or
Nasdaq SmallCap Market, the last reported sales price as reported on such
exchange or market; (b) if the shares are not listed or admitted for
trading on any national securities exchange or included in The Nasdaq
National Market or Nasdaq SmallCap Market, the average of the last reported
closing bid and asked quotation for the shares as reported on the National
Association of Securities Dealers Automated Quotation System ("NASDAQ") or
a similar service if NASDAQ is not reporting such information; (c) if the
shares are not listed or admitted for trading on any national securities
exchange or included in The Nasdaq National Market or Nasdaq SmallCap
Market or quoted by NASDAQ or a similar service, the average of the last
reported bid and asked quotation for the shares as quoted by a market maker
in the shares (or if there is more than one market maker, the bid and asked
quotation shall be obtained from two market makers and the average of the
lowest bid and highest asked quotation). In the absence of any available
public quotations for the Common Stock, the Board shall determine in good
faith the fair value of the Common Stock, which determination shall be set
forth in a certificate by the Secretary of the Corporation.
(c) Issue Taxes. The Corporation shall pay all issue taxes, if any,
incurred in respect of the issue of shares of Common Stock on conversion. If a
holder of shares of Series D Stock specifies that the shares of Common Stock to
be issued on automatic conversion are to be issued in a name or names other than
the name or names in which such Series D Stock stand, then the Corporation shall
not be required to pay any transfer or other taxes incurred by reason of the
issuance of such shares of Common Stock to the name of another, and if the
appropriate transfer taxes shall not have been paid to the Corporation or the
transfer agent for the Series D Stock at the time of automatic conversion of the
Series D Stock, the shares of Common Stock issued upon conversion thereof may be
registered in the name or names in which the Series D Stock were registered,
despite the instructions to the contrary.
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(d) Valid Issuance. All shares of Common Stock which may be issued
in connection with the conversion provisions set forth herein shall, upon
issuance by the Corporation, be validly issued, fully paid and nonassessable,
free from preemptive rights and free from all taxes, liens or charges with
respect thereto created or imposed by the Corporation.
7. Adjustment of Conversion Price. The number and kind of securities
issuable upon the conversion of the Series D Stock and the Conversion Price
shall be subject to adjustment from time to time in accordance with the
following provisions:
(a) Certain Definitions. For purposes of this Certificate of
Designations:
(i) The term "Additional Shares of Common Stock" shall mean
all shares of Common Stock issued, or deemed to be issued by the
Corporation pursuant to paragraph (e) of this Section 7, after the
Original Issue Date except:
(A) issuances of Common Stock, Convertible Securities
and/or Options granted or approved to be granted by the Board or
a committee thereof on or prior to the Original Issue Date;
(B) issuances of Common Stock, Convertible Securities
and/or Options to officers, employees, consultants or directors;
provided that such issuances pursuant to this clause (B) in the
aggregate do not exceed more than 5% of the shares of Common
Stock outstanding, as determined on a fully-diluted basis (the
"Management Securities"); and
(C) issuances of Common Stock or Series D Stock resulting
from the provisions of the Agreement and Plan of Merger, dated as
of February 16, 1999 (the "Merger Agreement"), by and among the
Corporation, 7/th/ Level Merger Corporation, Street and the
stockholders of Street named therein, and in each case the
documents executed, filed or delivered in connection therewith.
(ii) The term "Common Stock" shall mean (A) the Common Stock
and (B) the stock of the Corporation of any class, or series within a
class, whether now or hereafter authorized, which has the right to
participate in the distribution of either earnings or assets of the
Corporation without limit as to the amount or percentage.
(iii) The term "Convertible Securities" shall mean any evidence
of indebtedness, shares or other securities (other than the Series D
Stock) convertible into or exercisable or exchangeable for Common
Stock.
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(iv) The term "Options" shall mean any and all rights, options
or warrants (other than the Management Securities) to subscribe for,
purchase or otherwise in any manner acquire Common Stock or
Convertible Securities.
(b) Subdivision or Combination of Shares. In case outstanding shares
of Common Stock shall be subdivided, the Conversion Price shall be
proportionately reduced as of the effective date of such subdivision, or as of
the date a record is taken of the holders of Common Stock for the purpose of so
subdividing, whichever is earlier. In case outstanding shares of Common Stock
shall be combined, the Conversion Price shall be proportionately increased as of
the effective date of such combination, or as of the date a record is taken of
the holders of Common Stock for the purpose of so combining, whichever is
earlier.
(c) Stock Dividends. In case shares of Common Stock are issued as a
dividend or other distribution on the Common Stock (or such dividend is
declared), the Conversion Price shall be adjusted, as of the date a record is
taken of the holders of Common Stock for the purpose of receiving such dividend
or other distribution (or if no such record is taken, as at the earliest of the
date of such declaration, payment or other distribution), to the Conversion
Price determined by multiplying the Conversion Price in effect immediately prior
to such declaration, payment or other distribution by a fraction (i) the
numerator of which shall be the number of shares of Common Stock outstanding
immediately prior to the declaration or payment of such dividend or other
distribution, and (ii) the denominator of which shall be the total number of
shares of Common Stock outstanding immediately after the declaration or payment
of such dividend or other distribution. In the event that the Corporation shall
declare or pay any dividend on the Common Stock payable in any right to acquire
Common Stock for no consideration, then the Corporation shall be deemed to have
made a dividend payable in Common Stock in an amount of shares equal to the
maximum number of shares issuable upon exercise of such rights to acquire Common
Stock.
(d) Issuance of Additional Shares of Common Stock. If the Corporation
shall issue any Additional Shares of Common Stock (including Additional Shares
of Common Stock deemed to be issued pursuant to paragraph (e) below) after the
Original Issue Date (other than as provided in the foregoing subsections (b) and
(c)), for no consideration or for a consideration per share less than the Market
Price in effect on the date of and immediately prior to such issue, then in such
event, the Conversion Price shall be reduced, concurrently with such issue, to a
price equal to the quotient obtained by dividing:
(A) an amount equal to (x) the total number of shares of
Common Stock outstanding immediately prior to such issuance or sale
multiplied by the Market Price in effect immediately prior to such
issuance or sale, plus (y) the aggregate consideration received or
deemed to be received by the Corporation upon such issuance or sale,
by
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(B) the total number of shares of Common Stock outstanding
immediately after such issuance or sale.
(e) Deemed Issue of Additional Shares of Common Stock. Except as set
forth in subsection (a) above, if the Corporation at any time or from time to
time after the Original Issue Date shall issue any Convertible Securities or
Options or shall fix a record date for the determination of holders of any class
of securities then entitled to receive any such Options or Convertible
Securities, then the maximum number of shares (as set forth in the instrument
relating thereto without regard to any provisions contained therein designed to
protect against dilution) of Common Stock issuable upon the exercise of such
Options, or, in the case of Convertible Securities and Options therefor, the
conversion or exchange of such Convertible Securities, shall be deemed to be
Additional Shares of Common Stock issued as of the time of such issue of Options
or Convertible Securities or, in case such a record date shall have been fixed,
as of the close of business on such record date, provided that in any such case
in which Additional Shares of Common Stock are deemed to be issued:
(i) no further adjustments in the Conversion Price shall be
made upon the subsequent issue of Convertible Securities or shares of
Common Stock upon the exercise of such Options or the issue of Common
Stock upon the conversion or exchange of such Convertible Securities;
(ii) if such Options or Convertible Securities by their terms
provide, with the passage of time or otherwise, for any increase or
decrease in the consideration payable to the Corporation, or increase
or decrease in the number of shares of Common Stock issuable, upon the
exercise, conversion or exchange thereof, the Conversion Price
computed upon the original issuance of such Options or Convertible
Securities (or upon the occurrence of a record date with respect
thereto), and any subsequent adjustments based thereon, upon any such
increase or decrease becoming effective, shall be recomputed to
reflect such increase or decrease insofar as it affects such Options
or the rights of conversion or exchange under such Convertible
Securities (provided, however, that no such adjustment of the
Conversion Price shall affect Common Stock previously issued upon
conversion of the Series D Stock);
(iii) upon the expiration of any such Options or any rights of
conversion or exchange under such Convertible Securities which shall
not have been exercised, the Conversion Price computed upon the
original issue of such Options or Convertible Securities (or upon the
occurrence of a record date with respect thereto), and any subsequent
adjustments based thereon, shall, upon such expiration, be recomputed
as if:
(A) in the case of Options or Convertible Securities, the
only Additional Shares of Common Stock issued were the shares of
Common
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Stock, if any, actually issued upon the exercise of such Options
or the conversion or exchange of such Convertible Securities and
the consideration received therefor was the consideration
actually received by the Corporation (x) for the issue of all
such Options, whether or not exercised, plus the consideration
actually received by the Corporation upon exercise of the Options
or (y) for the issue of all such Convertible Securities which
were actually converted or exchanged plus the additional
consideration, if any, actually received by the Corporation upon
the conversion or exchange of the Convertible Securities; and
(B) in the case of Options for Convertible Securities,
only the Convertible Securities, if any, actually issued upon the
exercise thereof were issued at the time of issue of such
Options, and the consideration received by the Corporation for
the Additional Shares of Common Stock deemed to have been then
issued was the consideration actually received by the Corporation
for the issue of all such Options, whether or not exercised, plus
the consideration deemed to have been received by the Corporation
upon the issue of the Convertible Securities with respect to
which such Options were actually exercised.
(iv) No readjustment pursuant to clause (ii) or (iii) above
shall have the effect of increasing the Conversion Price to an amount
which exceeds the lower of (x) the Conversion Price on the original
adjustment date or (y) the Conversion Price that would have resulted
from any issuance of Additional Shares of Common Stock between the
original adjustment date and such readjustment date.
(v) In the case of any Options which expire by their terms not
more than 30 days after the date of issue thereof, no adjustment of
the Conversion Price shall be made until the expiration or exercise of
all such Options, whereupon such adjustment shall be made in the same
manner provided in clause (iii) above.
(f) Determination of Consideration. For purposes of this Section 7,
the consideration received by the Corporation for the issue of any Additional
Shares of Common Stock shall be computed as follows:
(i) Cash and Property. Such consideration shall:
(A) insofar as it consists of cash, be the aggregate
amount of cash received by the Corporation; and
(B) insofar as it consists of property other than cash,
be computed at the fair value thereof at the time of the issue,
as determined in good faith by the vote of a majority of the
Board or if the Board cannot
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reach such agreement, by a qualified independent certified public
accounting firm, other than the accounting firm then engaged as
the Corporation's independent auditors.
(ii) Options and Convertible Securities. The consideration per
share received by the Corporation for Additional Shares of Common
Stock deemed to have been issued pursuant to paragraph (e) above,
relating to Options and Convertible Securities shall be determined by
dividing:
(A) the total amount, if any, received or receivable by
the Corporation as consideration for the issue of such Options or
Convertible Securities, plus the minimum aggregate amount of
additional consideration (as set forth in the instruments
relating thereto, without regard to any provision contained
therein designed to protect against dilution) payable to the
Corporation upon the exercise of such Options or the conversion
or exchange of such Convertible Securities, or in the case of
Options for Convertible Securities, the exercise of such Options
for Convertible Securities and the conversion or exchange of such
Convertible Securities, by
(B) the maximum number of shares of Common Stock (as set
forth in the instruments relating thereto, without regard to any
provision contained therein designed to protect against dilution)
issuable upon the exercise of such Options or conversion or
exchange of such Convertible Securities.
(g) Other Provisions Applicable to Adjustment Under this Section.
The following provisions shall be applicable to the adjustments in Conversion
Price as provided in this Section 7:
(i) Treasury Shares. The number of shares of Common Stock at
any time outstanding shall not include any shares thereof then
directly or indirectly owned or held by or for the account of the
Corporation.
(ii) Other Action Affecting Common Stock. If the Corporation
shall take any action affecting the outstanding number of shares of
Common Stock other than an action described in any of the foregoing
subsections 7(b) through 7(e) hereof, inclusive, which would have an
inequitable effect on the holders of Series D Stock, then the
Conversion Price shall be adjusted in such manner and at such time as
the Board on the advice of the Corporation's independent public
accountants may in good faith determine to be equitable in the
circumstances.
(iii) Minimum Adjustment. No adjustment of the Conversion Price
shall be made if the amount of any such adjustment would be an amount
less than
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one percent (1%) of the Conversion Price then in effect, but any such
amount shall be carried forward and an adjustment in respect thereof
shall be made at the time of and together with any subsequent
adjustment which, together with such amount and any other amount or
amounts so carried forward, shall aggregate an increase or decrease of
one percent (1%) or more.
(iv) Certain Adjustments. The Conversion Price shall not be
adjusted upward except in the event of a combination of the
outstanding shares of Common Stock into a smaller number of shares of
Common Stock or in the event of a readjustment of the Conversion Price
pursuant to Section 7(e)(ii) or (iii).
(h) Notices of Adjustments. Whenever the Conversion Price is adjusted
as herein provided, an officer of the Corporation shall compute the adjusted
Conversion Price in accordance with the foregoing provisions and shall prepare a
written certificate setting forth such adjusted Conversion Price and showing in
detail the facts upon which such adjustment is based, and such written
instrument shall promptly be delivered to the recordholders of the Series D
Stock.
8. Special Optional Redemption. If the Issuance is not approved after a
minimum of two duly called and properly held meetings of the stockholders of the
Corporation for the purpose of approving the Issuance, then the Corporation
shall submit a written offer (the "Offer") to each holder of Series D Stock to
purchase any and all of the Series D Stock owned by such holder at a redemption
price ("Redemption Price") per share, payable in cash, equal to the sum of (x)
the Series D Issue Price plus (y) all accrued and unpaid dividends on the shares
of Series D Stock to be so redeemed to the date of redemption (the "Redemption
Date") and (z) an amount such that the holder of Series D Stock will receive an
aggregate compounded rate of return of 10% from the Original Issue Date to the
Redemption Date. If the holder of Series D Stock desires to sell a number of his
shares of Series D Stock, then such holder shall communicate in writing his
election to sell such shares (an "Acceptance") to the Corporation within 30 days
of the date the Offer was made. The Corporation shall purchase all shares of
Series D Stock as to which an Acceptance was received by the Corporation within
30 days after the date of the Offer. Any Offer made by the Corporation shall
comply with the Securities Act of 1933, as amended (the "Securities Act"), and
the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and the
rules and regulations promulgated thereunder. The Redemption Price for the
shares of Series D Stock to be redeemed shall be paid on or after the Redemption
Date, upon surrender of the certificate or certificates evidencing such shares.
From and after the Redemption Date, unless there shall have been a default in
payment of the Redemption Price, all rights of the holders of shares of Series D
Stock as holders of Series D Stock (except the right to receive the Redemption
Price upon surrender of their certificate or certificates) shall cease as to
those shares of Series D Stock redeemed, and such shares shall not thereafter be
transferred on the books of the Corporation or be deemed to be outstanding for
any purpose whatsoever.
9. Voting Rights.
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(a) General. Holders of Series D Stock shall be entitled to notice of
all meetings of the Corporation's stockholders. Except as provided herein, in
addition to the rights otherwise provided for herein or by law, holders of the
Series D Stock shall be entitled to vote, together with the holders of the
Common Stock and any other class or series of stock then entitled to vote, as
one class on all matters submitted to a vote of stockholders of the Corporation,
in the same manner and with the same effect as the holders of the Common Stock
on an "as converted" basis. In addition, except for the vote of stockholders of
the Corporation with respect to the Issuance, holders of Series D Stock shall be
entitled to vote as a separate class on all matters submitted to a vote of
stockholders of the Corporation. In any such vote, and in any vote or action of
the holders of the Series D Stock voting together with the holders of the Common
Stock and any other class or series of stock then entitled to vote, each share
of issued and outstanding Series D Stock shall entitle the holder thereof to one
vote per share for each share of Common Stock (including fractional shares)
which would be obtained upon conversion of all of the outstanding shares of the
Series D Stock held by such holder, rounded up to the nearest one-tenth of a
share.
(b) Appointment of Board of Directors. Commencing on the first
anniversary of the Original Issue Date, the holders of Series D Stock shall have
the right to elect one third (_) of the members of the Board, and commencing on
the second anniversary of the Original Issue Date the holders of the Series D
Stock shall have the right to elect a majority of the members of the Board.
Subject to applicable law, the Series D Stock shall vote as a class to elect
such designees. The Corporation acting through its Board, shall (i)(A) increase
the size of its Board in accordance with the terms of this Section 9, (B) elect
the designees of the Series D Stock to the Board to the newly created
directorships to hold office until their respective successors are elected at a
special or annual meeting of the stockholders, and (C) in connection with any
subsequent election of directors, nominate, recommend and do all other acts and
things to cause (including, without limitation, voting all shares for which the
Corporation's management or Board holds proxies (including undesignated proxies)
unless otherwise provided by the stockholders submitting such proxies) the
persons referenced in the preceding clause (B) to be elected to the Board. In
the event the directors elected pursuant to this Section 8(b) shall cease to
serve as directors for any reason, the Corporation shall cause (subject to its
fiduciary duty and the provisions of the Certificate of Incorporation and the
Corporation's By-Laws and applicable law) the vacancies resulting thereby to be
filled as promptly as practicable by persons selected by the holders of Series D
Stock. Notwithstanding the foregoing, the rights of the holders of Series D
Stock in this Section 9(b) are in lieu of, and not in addition to, the right
that Stephen Gott possesses regarding the designation of directors contained in
Section 6.09 of the Merger Agreement.
(c) Protective Provisions. In addition to any other vote or consent
of stockholders provided by law or by the Certificate of Incorporation, the
Corporation shall not, without the approval by vote or written consent of the
holders of not less than 66_% of the then outstanding shares of Series D Stock,
voting as a separate class:
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<PAGE>
(i) amend, alter or repeal any of the provisions of the
Certificate of Incorporation or the Certificate of Designations
creating this Series D Stock which would alter or change the powers,
preferences or special rights of the shares of Series D Stock so as to
affect them adversely, including, but not limited to, increasing or
decreasing the par value of the Series D Stock; or
(ii) authorize, increase the number of or issue any Senior
Securities or reclassify any Junior Securities into Senior Securities
(the expressions "Junior Securities" and "Senior Securities" in this
clause (ii) to include securities convertible into or exchangeable for
options, warrants or other rights to acquire, Junior Securities or
Senior Securities, as the case may be).
10. Registration.
(a) Required Registration. If the Approval Date does not occur prior
to the one year anniversary of the Original Issue Date, then the Corporation
shall use its reasonable best efforts to prepare and file as soon as practicable
(but in no event more than 15 days after the first anniversary of the Original
Issue Date) with the Securities and Exchange Commission a registration statement
on Form S-3 (or such successor or other appropriate form) under the Securities
Act ("Registration Statement") with respect to the Series D Stock (the
"Registrable Shares") and to effect all such registrations, qualifications and
compliances (including, without limitation, obtaining appropriate qualifications
under applicable state securities or 'blue sky" laws and compliance with any
other applicable governmental requirements or regulations) as any holder of the
Series D Stock may reasonably request and that would permit or facilitate the
sale of Registrable Shares in the open market (provided, however, that the
Corporation shall not be required in connection therewith to qualify to do
business or to file a general consent to service of process in any such state or
jurisdiction), in each case so that such Registration Statement and all other
such registrations, qualifications and compliances may become effective.
Notwithstanding the foregoing, the Corporation shall not be obligated to effect
an underwritten Registration Statement.
(b) Effectiveness, Suspension Right.
(i) The Corporation will use its best efforts to maintain the
effectiveness of the Registration Statement and other applicable
registrations, qualifications and compliances until the second anniversary
of the effective date of the Registration Statement (the "Registration
Effective Period"), and from time to time will amend or supplement the
Registration Statement and the prospectus contained therein as and to the
extent necessary to comply with the Securities Act, the Exchange Act and
any applicable state securities statute or regulation, subject to the
following limitations and qualifications.
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<PAGE>
(ii) Following the date on which the Registration Statement is
first declared effective, the holders of the Registrable Shares will be
permitted (subject in all cases to Section 11 below) to offer and sell
Registrable Shares during the Registration Effective Period in the manner
described in the Registration Statement provided that the Registration
Statement remains effective and has not been suspended.
(iii) Notwithstanding any other provision of this Section 10 but
subject to Section 11, the Corporation shall have the right at any time to
require that all holders of Registrable Shares suspend further open market
offers and sales of Registrable Shares whenever, and for so long as, in the
reasonable judgment of the Corporation after consultation with counsel
there is or may be in existence material undisclosed information or events
with respect to the Corporation (the "Suspension Right"). In the event the
Corporation exercises the Suspension Right, such suspension will continue
for the period of time reasonably necessary for disclosure to occur at a
time that is not detrimental to the Corporation or its stockholders or
until such time as the information or event is no longer material, each as
determined in good faith by the Corporation after consultation with
counsel. The Corporation will give the holders of Registrable Shares notice
of any such suspension and will use all reasonable efforts to minimize the
length of the suspension.
(c) Expenses. The costs and expenses to be borne by the Corporation
for purposes of this Section 10 shall include, without limitation, printing
expenses (including a reasonable number of prospectuses for circulation by the
selling holders of Registrable Shares), legal fees and disbursements of counsel
for the Corporation, "blue sky'' expenses, accounting fees and filing fees, and
legal fees and disbursements of not more than one counsel for the holders of
Registrable Shares.
(d) Indemnification.
(i) To the extent permitted by law, the Corporation will
indemnify and hold harmless each holder of Registrable Shares, its
officers, directors, stockholders or partners and each person, if any, who
controls such holder of Registrable Shares within the meaning of the
Securities Act or the Exchange Act, against any losses, claims, damages or
liabilities (joint or several) to which they may become subject under the
Securities Act, the Exchange Act or other federal or state law, insofar as
such losses, claims, damages, or liabilities (or actions in respect
thereof) arise out of or are based upon any of the following statements,
omissions or violations (collectively a "Violation"): (A) any untrue
statement or alleged untrue statement of a material fact contained in the
Registration Statement, including any preliminary prospectus or final
prospectus contained therein or any amendments or supplements thereto, (B)
the omission or alleged omission to state therein a material fact required
to be stated therein, or necessary to make the statements therein not
misleading, or (C) any Violation or alleged Violation by the Corporation of
the Securities Act, the Exchange Act, any state securities law or any rule
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<PAGE>
or regulation promulgated under the Securities Act, the Exchange Act or any
state securities law; and the Corporation will pay to each such holder of
Registrable Shares (and its officers, directors, stockholders or partners)
or controlling person, any legal or other expenses reasonably incurred by
them in connection with investigating or defending any such loss, claim,
damage, liability, or action; provided, however, that the indemnity
agreement contained in this Section 10(d)(i) shall not apply to amounts
paid in settlement of any such loss, claim, damage, liability, or action if
such settlement is effected without the consent of the Corporation, nor
shall the Corporation be liable in any such case for any such loss, claim,
damage, liability, or action to the extent that it arises out of or is
based upon (a) a Violation which occurs in reliance upon and in conformity
with written information furnished expressly for use in the Registration
Statement by any such holder of Registrable Shares, or (b) a Violation that
would not have occurred if such holder of Registrable Shares had delivered
to the purchaser the version of the prospectus most recently provided by
the Corporation to the holder of Registrable Shares as of the date of such
sale.
(ii) To the extent permitted by law, each selling holder of
Registrable Shares will indemnify and hold harmless the Corporation, each
of its directors, each of its officers who has signed the Registration
Statement, each person, if any, who controls the Corporation within the
meaning of the Securities Act, any other holders of Registrable Shares
selling securities pursuant to the Registration Statement and any
controlling person of any other holders of Registrable Shares, against any
losses, claims, damages, or liabilities (joint or several) to which any of
the foregoing persons may become subject, under the Securities Act, the
Exchange Act or other federal or state law, insofar as such losses, claims,
damages, or liabilities (or actions in respect thereto) arise out of or are
based upon any Violation (which includes without limitation the failure of
the holders of Registrable Shares to comply with the prospectus delivery
requirements under the Securities Act, and the failure of the holders of
Registrable Shares to deliver the most current prospectus provided by the
Corporation prior to such sale), in each case to the extent (and only to
the extent) that such Violation occurs in reliance upon and in conformity
with written information furnished by such holders of Registrable Shares
expressly for use in the Registration Statement or such Violation is caused
by the holder's of Registrable Shares failure to deliver to the purchaser
of the Registrable Shares a prospectus (or amendment or supplement thereto)
that had been made available to the holders of Registrable Shares by the
Corporation; and each such holder of Registrable Shares will pay any legal
or other expenses reasonably incurred by any person intended to be
indemnified pursuant to this Section 10(d)(ii) in connection with
investigating or defending any such loss, claim, damage, liability, or
action; provided, however, that the indemnity agreement contained in this
Section 10(d)(ii) shall not apply to amounts paid in settlement of any such
loss, claim, damage, liability or action if such settlement is effected
without the consent of the holders of Registrable Shares, which consent
shall not be unreasonably withheld. The aggregate indemnification liability
of each holder of Registrable Shares under this Section 10(d)(ii) shall not
exceed the net proceeds received
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<PAGE>
by such holder of Registrable Shares in connection with sale of shares
pursuant to the Registration Statement.
(iii) Each person entitled to indemnification under this Section
10(d) (the "Indemnified Party'') shall give notice to the party
required to provide indemnification (the "Indemnifying Party")
promptly after such Indemnified Party has actual knowledge of any
claim as to which indemnity may be sought and shall permit the
Indemnifying Party to assume the defense of any such claim and any
litigation resulting therefrom, provided that counsel for the
Indemnifying Party who conducts the defense of such claim or any
litigation resulting therefrom shall be approved by the Indemnified
Party (whose approval shall not be unreasonably withheld), and the
Indemnified Party may participate in such defense at such party's
expense, and provided further that the failure of any Indemnified
Party to give notice as provided herein shall not relieve the
Indemnifying Party of its obligations under this Section 10 unless the
Indemnifying Party is materially prejudiced thereby. No Indemnifying
Party, in the defense of any such claim or litigation, shall (except
with the consent of each Indemnified Party) consent to entry of any
judgment or enter into any settlement that does not include as an
unconditional term thereof the giving by the claimant or plaintiff to
such Indemnified Party of a release from all liability in respect to
such claim or litigation. Each Indemnified Party shall furnish such
information regarding itself or the claim in question as an
Indemnifying Party may reasonably request in writing and as shall be
reasonably required in connection with the defense of such claim and
litigation resulting therefrom.
(iv) To the extent that the indemnification provided for in
this Section 10(d) is held by a court of competent jurisdiction to be
unavailable to an Indemnified Party with respect to any loss,
liability, claim, damage or expense referred to herein, then the
Indemnifying Party, in lieu of indemnifying such Indemnified Party
hereunder, shall contribute to the amount paid or payable by such
Indemnified Party as a result of such loss, liability, claim, damage
or expense in such proportion as is appropriate to reflect the
relative fault of the Indemnifying Party on the one hand and of the
Indemnified Party on the other in connection with the statements or
omissions which resulted in such loss, liability, claim, damage or
expense, as well as any other relevant equitable considerations. The
relative fault of the Indemnifying Party and of the Indemnified Party
shall be determined by reference to, among other things, whether the
untrue or alleged untrue statement of a material fact or the omission
or alleged omission to state a material fact relates to information
supplied by the Indemnifying Party or by the Indemnified Party and the
parties' relative intent, knowledge, access to information and
opportunity to correct or prevent such statement or omission. The
aggregate contribution liability of each holder of Registrable Shares
under this Section 10(d)(iv) shall not exceed the net proceeds
received by such holder of Registrable Shares in connection with sale
of shares pursuant to the Registration Statement.
11. Procedures for Sale of Shares under Registration Statement.
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<PAGE>
(a) Notice and Approval. If any holder of Registrable Shares shall
propose to sell any Registrable Shares pursuant to the Registration Statement,
it shall notify the Corporation of its intent to do so (including the proposed
manner and timing of all sales) at least 10 full business days prior to such
sale, and the provision of such notice to the Corporation shall conclusively be
deemed to reestablish and reconfirm an agreement by such holder of Registrable
Shares to comply with the registration provisions set forth in this Certificate
of Designations. Unless otherwise specified in such notice, such notice shall
be deemed to constitute a representation that any information previously
supplied by such holder of Registrable Shares expressly for inclusion in the
Registration Statement (as the same may have been superseded by subsequent such
information) is accurate as of the date of such notice. At any time within such
10 business day period, the Corporation may refuse to permit the holders of
Registrable Shares to resell any Registrable Shares pursuant to the Registration
Statement; provided, however, that in order to exercise this right, the
Corporation must deliver a certificate in writing to the holders of Registrable
Shares to the effect that a delay in such sale is necessary because a sale
pursuant to the Registration Statement in its then-current form without the
addition of material, non-public information about the Corporation, could
constitute a violation of the federal securities laws. Notwithstanding the
foregoing, the Corporation will ensure that in any event the holders of
Registrable Shares shall have at least 15 business days (prorated for partial
quarters) available to sell Registrable Shares during each calendar quarter (or
portion thereof) from the date the Registration Statement is declared effective
until the expiration of the Registration Effective Period.
(b) Delivery of Prospectus. For any offer or sale of any of the
Registrable Shares by a holder of Registrable Shares in a transaction that is
not exempt under the Securities Act, the holder of Registrable Shares, in
addition to complying with any other federal securities laws, shall deliver a
copy of the final prospectus (or amendment of or supplement to such prospectus)
of the Corporation covering the Registrable Shares in the form furnished to the
holder of Registrable Shares by the Corporation to the purchaser of any of the
Registrable Shares on or before the settlement date for the purchase of such
Registrable Shares.
(c) Copies of Prospectuses. Subject to the provisions of this
Section 11, when a holder of Registrable Shares is entitled to sell and gives
notice of its intent to sell Registrable Shares pursuant to the Registration
Statement, the Corporation shall, within 5 business days following the request,
furnish to such holder of Registrable Shares a reasonable number of copies of a
supplement to or an amendment of such prospectus as may be necessary so that, as
thereafter delivered to the purchasers of such Registrable Shares, such
prospectus shall not as of the date of delivery to the holder of Registrable
Shares include an untrue statement of a material fact or omit to state a
material fact required to be stated therein or necessary to make the statements
therein not misleading or incomplete in the light of the circumstances then
existing.
12 No Reissuance of Series D Stock. No share or shares of Series D Stock
acquired by the Corporation by reason of redemption, purchase, conversion or
otherwise shall be reissued,
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<PAGE>
and all such shares of Series D Stock shall be canceled, retired and eliminated
from the shares of Series D Stock which the Corporation shall be authorized to
issue. Any such shares of Series D Stock acquired by the Corporation shall have
the status of authorized and unissued shares of Preferred Stock issuable in
undesignated Series and may be redesignated and reissued in any series other
than as Series D Stock.
13 Exclusion of Other Rights. Except as may otherwise be required by
law, shares of Series D Stock shall not have any voting powers, designations,
preferences and rights, other than those specifically set forth herein (as may
be amended from time to time) and in the Certificate of Incorporation.
14 Registered Holders. A holder of Series D Stock registered on the
Corporation's stock transfer books as the owner of shares of Series D Stock
shall be treated as the owner of such shares for all purposes. All notices and
all payments required to be mailed to a holder of shares of Series D Stock shall
be mailed to such holder's registered address on the Corporation's stock
transfer books, and all dividend and redemption payments to a holder of shares
of Series D Stock made hereunder shall be deemed to be paid in compliance hereof
on the date such payments are deposited into the mail addressed to such holder
at his registered address on the Corporation's stock transfer books.
15 Headings of Subdivisions. The headings of the various subdivisions
hereof are for convenience of reference only and shall not affect the
interpretation of any of the provisions hereof.
16 Severability of Provisions. If any right, preference or limitation of
the Series D Stock set forth herein (as may be amended) from time to time is
invalid, unlawful or incapable of being enforced by reason of any rule of law or
public policy, such right, preference or limitation (including, without
limitation, the dividend rate) shall be enforced to the maximum extent permitted
by law and all other rights, preferences and limitations set forth herein (as so
amended) which can be given effect without the invalid, unlawful or
unenforceable right, preference or limitation shall, nevertheless, remain in
full force and effect, and no right, preference or limitation herein set forth
shall be deemed dependent upon any other such right, preference or limitation
unless so expressed herein.
[Remainder of page intentionally left blank.]
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<PAGE>
IN WITNESS WHEREOF, the undersigned has executed this Certificate of
Designations this 16 day of February, 1999.
7/TH/ LEVEL, INC.
By: /s/ DONALD SCHUPAK
--------------------------------
Donald Schupak
Chairman of the Board
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<PAGE>
EXHIBIT 10.45
EMPLOYMENT AGREEMENT
EMPLOYMENT AGREEMENT, dated as of February 16, 1999 (this "Agreement"), by
and between 7/TH/ LEVEL, INC., a Delaware corporation (the "Company"), and
STEPHEN GOTT ("Executive").
RECITALS
--------
WHEREAS, the Company is simultaneously entering into an Agreement and Plan
of Merger, by and among the Company, 7/th/ Level Merger Corporation, Street
Technologies, Inc. ("Street") and the stockholders of Street named therein (the
"Merger Agreement") pursuant to which the Company and Street shall merge (the
"Merger");
WHEREAS, Executive is the majority stockholder of Street and the current
Chief Executive Officer of Street; and
WHEREAS, the Company desires to employ Executive as Chief Executive Officer
of the Company on the terms and conditions hereinafter set forth and Executive
desires to accept such employment.
NOW, THEREFORE, in consideration of the premises and mutual covenants
contained herein, and for other good and valuable consideration, the receipt and
adequacy of which is hereby acknowledged, the parties agree as follows:
1. Employment.
----------
1.1 Subject to the terms and conditions of this Agreement, the
Company agrees to employ Executive during the Term (as defined in Section 2) as
Chief Executive Officer of the Company. Executive shall report to the Board of
Directors of the Company (the "Board"). As Chief Executive Officer of the
Company, Executive shall perform such duties and responsibilities as are
customarily performed by the chief executive officer of a company the size and
nature of the Company, and such other managerial duties and responsibilities
with the Company which are appropriate for his position at the Company as, from
time to time, may be assigned to him by the Board.
1.2 Subject to the terms and conditions of this Agreement,
Executive hereby accepts employment as Chief Executive Officer of the Company
and agrees to devote his full working time and efforts to the performance of
services, duties and responsibilities in connection therewith (other than during
periods of illness, disability or vacation). Nothing in this Agreement shall
preclude Executive, so long as, in the reasonable determination of the Board,
such activities do not materially interfere with his duties and responsibilities
hereunder, from
<PAGE>
engaging in charitable and community affairs, from managing any passive
investment made by him in real estate or other property (provided that no such
investment may exceed 2% of the equity securities of any entity, without the
prior approval of the Board), or from serving, subject to the prior approval of
the Board, as a member of boards of directors or as a trustee of any other
company, association or entity.
1.3 So long as the Executive shall serve as Chief Executive Officer
of the Company, the Company shall cause Executive to be a member of the Board.
2. Term of Employment. The term of this Agreement (the "Term") shall be
------------------
for a period commencing on the date hereof and continuing through the second
anniversary of the date hereof; subject to earlier termination in accordance
with the terms and conditions contained in Section 7 hereof.
3. Place of Employment. During the Term, Executive shall perform his
-------------------
services at the principal place of business of the Company which will be located
in 925 Westchester Avenue, White Plains, New York 10604. Executive shall be
furnished with office facilities and services suitable to his position and
suitable for the performance of his duties. Executive acknowledges and agrees
that in connection with his employment, however, he may be required to travel on
behalf of the Company.
4. Compensation.
------------
4.1 Salary. During the Term, the Company shall pay Executive a base
------
salary ("Base Salary") at the rate of Two Hundred Thousand Dollars ($200,000)
per annum (pro rated for the balance of fiscal 1999 ending December 31, 1999,
and for any partial year during the Term). The Base Salary shall be payable in
accordance with the ordinary payroll practices of the Company for its executive
officers but in no event less frequently than semi-monthly. The Base Salary
shall be reviewed annually by the Board on or before the last day of each fiscal
year, and may be increased in the sole discretion of the Board taking into
account corporate and individual performance, any increase in Executive's
responsibilities on account of acquisitions by, or the general growth of, the
Company and general business conditions.
4.2 Performance Bonus. Executive shall be entitled to receive an
-----------------
annual performance bonus (each, a "Performance Bonus") of not less than $50,000
for the fiscal year in which such bonus is earned. Subject to the immediately
preceding sentence, the amount of any such Performance Bonus shall be determined
by the Board, in its sole discretion, and shall be based on such quantitative
and qualitative initiatives as identified by the Board upon consultation with
Executive and upon approval of the budget for the respective fiscal year. Any
such Performance Bonus shall be paid to Executive within 120 days of the end of
the fiscal year to which it relates.
2
<PAGE>
4.3 Stock Options. (a) As an inducement to Executive to enter into
-------------
this Agreement, the Company has on the date hereof (the "Grant Date") granted to
Executive options (the "Options") to purchase 1,000,000 shares of common stock,
par value $.01 per share, of the Company ("Common Stock") exercisable at a price
equal to $3.25 per share of Common Stock. Pursuant to the terms of the grant,
vesting of such Options shall occur as follows:
333,000 Options shall vest on the first anniversary of the Grant Date;
333,000 Options shall vest on the second anniversary of the Grant Date;
334,000 Options shall vest on the third anniversary of the Grant Date.
(b) If Executive's employment is terminated by the Company without
Cause (as hereinafter defined) or if Executive terminates his employment with
the Company for Good Reason (as hereinafter defined), all Options shall fully
and immediately vest.
(c) If Executive terminates his employment with the Company other than
for Good Reason or if Executive's employment is terminated by the Company for
Cause (i) prior to the first anniversary of the Grant Date, then 333,000 Options
shall vest on such date of termination; (ii) after the first anniversary but
prior to the second anniversary of the Grant Date, then 333,000 Options shall
vest on such date of termination (in addition to the 333,000 Options which
vested on the first anniversary of the Grant Date); (iii) after the second
anniversary but prior to the third anniversary of the Grant Date, 334,000
Options shall vest on such date of termination (in addition to the 333,000
Options which vested on each of the first and second anniversary of the Grant
Date).
5. Employee Benefits.
-----------------
5.1 Employee Benefit Programs, Plans and Practices. The Company
----------------------------------------------
shall provide Executive during the Term, with coverage under all employee
benefit programs, plans and practices which the Company makes available from
time to time to its senior executives, with at least the same opportunity to
participate as the other senior executives of the Company including, without
limitation, retirement, pension, profit sharing, medical, dental,
hospitalization, life insurance, short and long term disability, accidental
death and dismemberment and travel accident coverage.
5.2 Vacation and Fringe Benefits.
----------------------------
(a) Executive shall be entitled to four (4) weeks paid vacation
in each year (pro rated as necessary for partial calendar years during the
Term). Executive may take his allotted vacation days at such times as are
mutually convenient for the Company and Executive, consistent with the Company's
vacation policy in effect from time to time with respect to its executive
officers.
3
<PAGE>
(b) Executive shall be entitled to the perquisites and fringe
benefits normally made available to other senior executives of the Company,
commensurate with his position with the Company.
5.3 Expenses. Executive is authorized to incur reasonable expenses
--------
in carrying out his duties and responsibilities under this Agreement, (in
accordance with the policies and procedures established from time to time by the
Company) including, without limitation, entertainment and travel expenses (and
the cost of living while away from home on business or at the request of, and in
the service of the Company), and similar items related to such duties and
responsibilities. The Company will reimburse Executive in full for all such
out-of-pocket expenses upon presentation by Executive from time to time of a
proper account of such expenditures in accordance with the policies and
procedures established by the Board and applicable to executive officers of the
Company.
5.4 Indemnification. Executive shall be entitled, at all times
---------------
(including after the termination of this Agreement for any reason), to the
benefit of the maximum indemnification and advancement of expenses available
from time to time under the Company's Restated Certificate of Incorporation and
By-laws, and if not set forth therein, to the maximum extent available under the
laws of the Company's state of incorporation.
6. Key-Person Insurance. Executive agrees that the Company may at any
--------------------
time and from time to time, and for the Company's own benefit, apply for and
take out term life, health, accident, and/or other insurance covering Executive
("Key-Person Insurance") in an amount to be determined in the sole discretion of
the Board in consultation with Executive. The Company shall own all rights in
any such Key-Person Insurance policies and proceeds thereof and Executive shall
not have any right, title or interest therein; except that if Executive is no
longer employed by the Company (other than as a result of his death or
Disability (as herein defined)) then the Company shall terminate such Key-Person
Insurance policies or, at the option of Executive, arrange for such Key-Person
Insurance policies to be assigned to Executive; provided, however, that said
policies permit such assignment and Executive is solely responsible for the
payment of any premiums after such assignment. Executive agrees to assist the
Company at the Company's expense in obtaining any such Key-Person Insurance by,
among other things, submitting to the customary examinations and correctly
preparing, signing and delivering such applications and other documents as may
be required by insurers.
7. Termination of Employment.
-------------------------
7.1 Good Reason. Executive shall be entitled to terminate his
-----------
employment for "Good Reason." For purposes of this Agreement, "Good Reason"
shall mean (without Executive's express prior written consent as a shareholder,
director or otherwise) (i) failure by the Company to pay any compensation when
due hereunder, (ii) any significant reduction by the Company of Executive's
authorities, powers, functions, duties or responsibilities in managing the
4
<PAGE>
Company's business or the assignment of duties to Executive by the Board
inconsistent with Executive's position (except in connection with termination of
Executive's employment for Cause (as defined in section 7.4), as a result of
Disability (as defined in Section 7.2), as a result of Executive's death or by
Executive other than for Good Reason) or (iii) any material breach by the
Company of any other material provision of this Agreement. If Executive desires
to terminate his employment with the Company for Good Reason, he shall first
give written notice of the facts and circumstances providing Good Reason to the
Company, and shall allow the Company no less than twenty (20) days to remedy,
cure or rectify the situation giving rise to Good Reason.
7.2 Disability. If Executive shall fail during the Term, because of
----------
illness, physical or mental disability or other incapacity, for a period of 90
consecutive days or any 120 days in any 365 consecutive days, to render the
services provided for by this Agreement or be adjudged an incompetent
("Disability"); provided that the date on which the Disability will be deemed to
occur shall be such 90th day or the date on which Executive is adjudged an
incompetent, as the case may be, the Company may terminate Executive's
employment on not less than two (2) weeks written notice thereof, setting forth
the facts and circumstances claimed to provide a basis for termination of
Executive's employment under this Section 7.2.
7.3 Death. Executive's employment hereunder will terminate
-----
automatically if he should die.
7.4 Termination for Cause. The Company shall have the right to
---------------------
terminate the employment of Executive with or without Cause (as hereinafter
defined). The term "Cause," as used herein, shall mean (i) Executive's
continuing, repeated and willful refusal and failure (other than during periods
of illness, disability or vacation) to perform his duties hereunder or under any
lawful directive of the Board (consistent with the terms of this Agreement),
(ii) Executive's willful misconduct or gross neglect in the performance of his
duties hereunder, (iii) the willful material breach of this Agreement by
Executive, (iv) the conviction, plea of guilty or nolo contendre of Executive in
respect of any felony, other than motor vehicle offenses, or for any misdemeanor
constituting theft or embezzlement from the Company; provided that an indictment
of Executive in such matters shall cause the Company to suspend Executive with
pay until such matters are, to the Company's satisfaction, clarified or
finalized , (v) other fraudulent action against the Company or (vi) any
violation by Executive, or conduct by Executive that poses a substantial threat
of causing the Company to violate, any statute, law, ordinance or regulation
promulgated or enforced by any entity with jurisdiction over the Company or
Executive, concerning employment discrimination or other employment-related
wrongs. For purposes of this Section 7.4, no act, or failure to act, on
Executive's part, will be considered "willful" unless done or omitted to be done
by him not in good faith or without a reasonable belief that his action or
omission was in furtherance of and in the best interests of the Company's
business. Termination by the Company for Cause may be effected by written
notice of the Company to Executive; provided, however, that if the Company
determines to terminate the Executive's employment pursuant to clause (i) or
(iii) hereof, the Company shall give the Executive written
5
<PAGE>
notice of the facts and circumstances providing Cause and shall allow Executive
no less than twenty (20) days in the case of a proposed termination pursuant to
clause (i) or (iii) above to remedy, cure or rectify the situation giving rise
to Cause.
7.5 Termination upon a Change of Control. In the event of a Change
------------------------------------
of Control, Executive shall become immediately and fully vested in all Options
held by Executive. For purposes of this Agreement, a "Change of Control" shall
mean that (i) any "person" (as such term is defined within the meaning of Rule
13(d)(3) of the Securities Exchange Act of 1934, as amended (the "1934 Act")),
other than any person who as of the date hereof beneficially owns (as defined in
Rule 13(d)(3) of the 1934 Act) directly or indirectly 5% or more of the
Company's outstanding Common Stock or as of the date hereof is on, or has
designated a member of, the Board, becomes a beneficial owner directly or
indirectly of securities of the Company representing in excess of fifty percent
(50%) of the Company's then outstanding securities having the right to vote for
the election of directors, (ii) the Company shall have consummated the sale of
all or substantially all of the assets of the Company, or (iii) the following
individuals cease for any reason to constitute a majority of the number of
directors then serving: individuals who, on the date hereof, constitute the
Board and any new director (other than a director whose initial assumption of
office is in connection with an actual or threatened election contest, including
but not limited to a consent solicitation, relating to the election of directors
of the Company) whose appointment or election by the Board or nomination for
election by the Company's stockholders was approved or recommended by a vote of
at least two-thirds (_) of the directors then still in office who either were
directors on the date hereof or whose appointment, election or nomination for
election was previously so approved or recommended.
8. Compensation Upon Termination.
-----------------------------
8.1 Constructive Termination; Termination by the Company without
------------------------------------------------------------
Cause; Termination by Executive for Good Reason. (i) If Executive terminates
- -----------------------------------------------
his employment pursuant to Section 7.1, or (ii) if Executive's employment is
terminated by the Company without Cause, or (iii) if the Company determines not
to extend the Term of this Agreement for a one year period, Executive shall be
entitled to (A) receive Executive's Base Salary, Performance Bonus and benefits
as set forth in Section 5 to which Executive is entitled up to and including the
effective date of Executive's termination of employment hereunder, (B) receive
Executive's Base Salary and minimum Performance Bonus as set forth in Section
4.2 paid consistent with the Company's payroll practices for one (1) year and
(C) become immediately and fully vested in all Options held by Executive.
Executive also shall be entitled to receive, during the period he is being paid
Base Salary under this Agreement, the benefits provided under Section 5.1;
except to the extent that such continued participation is not permitted under
the plan, program or practice or would cause the plan, program or practice to
cease to be qualified under any applicable law or regulation. Notwithstanding
the foregoing, nothing herein shall cause the Company to maintain Executive's
status as an employee of the Company after termination.
6
<PAGE>
8.2 Termination by Executive other than for Good Reason; Termination
----------------------------------------------------------------
by the Company for Cause. If Executive's employment is terminated by the
- ------------------------
Company for Cause or by Executive other than pursuant to Section 7.1, Executive
shall be entitled to (i) receive Executive's Base Salary, Performance Bonus and
benefits as set forth in Section 5 to which Executive is entitled up to and
including the effective date of Executive's termination of employment hereunder
and (ii) accelerated vesting of Options as described in Section 4.3. After such
termination of employment, the obligations of the Company under this Agreement
to make any further payments, or to provide any benefits specified herein, to
Executive shall thereupon cease and terminate.
8.3 No Substitution. Nothing contained in Section 8.1 shall be
---------------
construed to represent a substitution for compensation already paid to or earned
by Executive. In addition, Executive shall be entitled to receive all amounts
in respect of the period prior to the date of termination otherwise payable
herein (without double counting), including such payments provided for in
Sections 4 and 5.
9. Nondisclosure; Non-Competition and Non-Solicitation.
---------------------------------------------------
9.1 Nondisclosure. Executive shall not during the Term and
-------------
thereafter, without the prior written consent of the Company, divulge, disclose
or make accessible to any other person, firm, partnership, corporation or other
entity any Confidential Information (as herein defined) pertaining to the
business of the Company, except (i) while employed by the Company, in the
business of and for the benefit of the Company or (ii) when required to do so by
a court of competent jurisdiction, by any governmental agency having supervisory
authority over the business of the Company, or by any administrative body or
legislative body (including a committee thereof) with purported or apparent
jurisdiction to order Executive to divulge, disclose or make accessible such
information. For purposes of this Agreement, "Confidential Information" shall
mean non-public information concerning the Company's financial data, strategic
business plans, product development (or other proprietary product data),
customer information, discoveries, practices, processes, methods, marketing
plans and other material non-public, proprietary and confidential information of
the Company, that, in any case, is not otherwise generally available to the
public. In the event Executive's employment is terminated hereunder, he shall
immediately return to the Company all Confidential Information in his possession
other than information which Executive is entitled to receive in his capacity as
a shareholder of the Company. "Confidential Information" shall not include
information which becomes available to Executive on a non-confidential basis
from a source other than the Company or was available to Executive on a non-
confidential basis prior to its disclosure to Executive by the Company.
9.2 Prohibition on Competition. During the period of his employment
--------------------------
with the Company (other than on behalf of the Company) and for twenty four (24)
months after the date of termination of his employment with the Company (the
"Non-Competition Period"), Executive agrees that, without the prior written
consent of the Company: (i) he will not, directly
7
<PAGE>
or indirectly, either as principal, manager, agent, consultant, officer,
stockholder, partner, investor, lender or employee, or in any other capacity
(and wether or not for compensation) carry on, be engaged in or employed by or
be a consultant to or have any financial interest in, any business which is in
competition with the business of the Company (as defined in Section 9.3).
9.3 Non-Solicitation of Employees. During the Non-Competition
-----------------------------
Period, Executive will not:
(a) solicit or request any employee of or consultant to the
Company or its affiliates to (a) leave the employ or cease consulting
for the Company or its affiliates or (b) join the employ of or begin
consulting for any individual or entity that is in competition with
the business of the Company;
(b) solicit or request or suggest or otherwise abet any
individual or entity that is in competition with the business of the
Company to employ any employee of or consultant to the Company or its
affiliates; or
(c) employ, assist in employing or otherwise associate with any
employee, officer or agent of or consultant to the Company or its
affiliates in any business or venture which is in competition with the
business of the Company.
9.4 Non-Solicitation of Customers. During the Non-Competition
-----------------------------
Period, Executive will not, directly or indirectly, through brokers or
otherwise, solicit or attempt to solicit, or sell services or attempt to sell
services which are in competition with the business of the Company to any
Customer; for purposes hereof, "Customer" shall mean (A) all customers of the
Company (i) during the term of this Agreement, (ii) as of the date hereof and
(iii) within the two (2) year period preceding the date hereof and (B) all
potential customers of the Company who are being actively solicited by the
Company at the time of the termination of Executive's employment.
9.5 For purposes of this Section 9, a person or entity which is "in
competition with the business of the Company" shall mean an entity engaged in
the business of animation preparation and production software as presently
conducted or proposed to be conducted and any other business actually engaged in
during the term hereof, directly or indirectly, by the Company or its
subsidiaries including, but not limited to, community enrichment technology
solutions and web based education and training. Nothing in this Section 9 shall
be construed so as to preclude Executive from (i) investing in any publicly held
company provided Executive's beneficial ownership of any class of such company's
securities does not exceed 2% of the outstanding securities of such class, (ii)
owning memberships, or other similar rights or interests therein, of any United
States or foreign securities, commodities, options or similar exchange, board of
trade, contract market or terminal association (collectively "Exchanges") and
exercising the rights and privileges attendant to such ownership for his own
personal account or for the account of any spouse, child, parent or sibling or
any trust created for the benefit of Executive or any of the
8
<PAGE>
foregoing or for the account of any entity wholly owned by Executive or any of
the foregoing relatives or trusts or (iii) trading or dealing on any Exchanges
for Executive's own personal account or for the account of any relative or any
trust created for the benefit of any relative of Executive.
9.6 Executive and the Company agree that the covenants of non-
competition and non-solicitation are reasonable covenants under the
circumstances, and further agree that if in the opinion of any court of
competent jurisdiction such covenants are not reasonable in any respect, such
court shall have the right, power and authority to excise or modify such
provision or provisions of these covenants as to the court shall appear not
reasonable and to enforce the remainder of these covenants as so amended.
Executive agrees that any breach of the covenants contained herein would
irreparably injure the Company. Accordingly, Executive hereby agrees that, in
such event, the Company shall be entitled, without the necessity of proving
damages or posting a bond or security, and notwithstanding any election by the
Company to claim damages, to obtain a temporary and/or permanent injunction to
restrain any such breach or threatened breach or to obtain specific performance
of any such provisions, all without prejudice to any and all other remedies
which the Company may have at law or in equity.
10. Mitigation of Damages. Executive shall not be required to mitigate
---------------------
damages or the amount of any payment provided for under this Agreement by
seeking other employment (which may include self-employment) or otherwise, and,
after his termination of employment hereunder, any payments made by the Company
hereunder shall not be reduced by any amount Executive receives from any other
such employment.
11. Lock-up Agreement. Executive agrees not to sell, make any short sale
-----------------
of, pledge, grant any option for the purchase of or otherwise dispose of any
shares of Common Stock without the prior written consent of the Company until
the first anniversary of the date hereof. Notwithstanding the foregoing,
Executive shall be permitted to sell (i) such number of shares of Common Stock
as set forth in the Merger Agreement in Section 6.04(a) thereof, (ii) 1,000,000
shares of Common Stock pursuant to a private placement in accordance with
applicable securities laws; provided that the buyer of such shares shall have
one demand to cause the Company to file a registration statement registering the
offer and sale of such shares within 150 days of the closing of the private
placement and maintain its effectiveness for 90 days, (iii) a number of shares
agreed to be included by the managing underwriter in an underwritten public
offering.
12. Registration Rights.
-------------------
(a) After the first anniversary of the date hereof, Executive (i) may
make two (2) separate demands on the Company for the registration of the offer
and sale of his shares of Common Stock and (ii) shall have four (4)
opportunities to request that his shares of Common Stock be included on a
registration statement proposed to be filed under the Securities Act of
9
<PAGE>
1933, as amended, with respect to an offering by the Company for its own account
or for the account of any of its respective security holders.
10
<PAGE>
(b) Notwithstanding anything else herein contained to the contrary, if
Executive is terminated by the Company without Cause or if Executive terminates
his employment for Good Reason, then the Company shall, as soon as practicable,
file a registration statement covering the offer and sale of all of Executive's
Common Stock owned on such date of termination and shall maintain its
effectiveness for 180 days.
(c) The parties hereto agree to negotiate in good faith and execute a
registration rights agreement setting forth the details of the provisions of
Sections 11 and 12 hereof in accordance with the terms and conditions typically
included in similar registration rights agreements including, but not limited
to, underwriter's "cut-backs" and Company "blackouts".
13. Notices. Any notice, request, demand or other communication required
-------
or permitted hereunder shall be in writing and shall be deemed to have been duly
given when delivered by hand, electronic transmission (with a copy following by
hand or by overnight courier), by registered or certified mail, postage prepaid,
return receipt requested or by overnight courier addressed to the other party.
All notices shall be addressed as follows, or to such other address or addresses
as may be substituted by notice in writing:
To the Company:
7/th/ Level, Inc.
1201 Richardson Drive, Suite 277
Richardson, Texas 75080
Attention: Chairman of the Board
Fax No.: (972) 498-0111
with a copy to:
Swidler Berlin Shereff Friedman, LLP
919 Third Avenue
New York, New York 10022
Attention: Gerald Adler, Esq.
Fax No.: (212) 758-9526
To Executive:
Stephen Gott
c/o Street Technologies, Inc.
925 Westchester Avenue
White Plains, New York 10604
11
<PAGE>
with a copy to:
Proskauer Rose LLP
1585 Broadway
New York, New York 10036-8299
Attention: Stephen W. Rubin, Esq.
Fax No.: (212) 969-2900
Communications delivered by hand or by overnight courier shall be deemed
received on the date of delivery; communications sent by electronic means shall
be deemed received one (1) business day after the sending thereof, and
communications sent by registered or certified mail shall be deemed received
three (3) business days after the sending thereof.
14. Separability; Legal Fees. If any provision of this Agreement shall be
------------------------
declared to be invalid or unenforceable, in whole or in part, such invalidity or
unenforceability shall not affect the remaining provisions hereof which shall
remain in full force and effect. Each party shall bear the costs of any legal
fees and other fees and expenses which may be incurred in respect of enforcing
its respective rights under this Agreement.
15. Assignment. This contract shall be binding upon and inure to the
-----------
benefit of the heirs and representatives of Executive and the assigns and
successors of the Company. Neither this Agreement nor any rights hereunder
shall be assignable or otherwise subject to hypothecation by Executive (except
by will or by operation of the laws of intestate succession) or by the Company,
except that the Company may assign this Agreement to any successor (whether by
merger, acquisition of stock, purchase or otherwise) to all or substantially all
of the assets or business of the Company, if such successor expressly agrees in
writing to assume the obligations of the Company hereunder.
16. Amendment; Waiver. This Agreement may only be amended by written
-----------------
agreement signed by the parties hereto. A waiver by the Company or Executive of
a breach of any provision of this Agreement by the other party shall not operate
or be construed as a waiver of any subsequent breach by the other party.
17. Beneficiaries; References. Executive shall be entitled to select (and
-------------------------
change, to the extent permitted under any applicable law) a beneficiary or
beneficiaries to receive any compensation or benefit payable hereunder following
Executive's death, and may change such election, in either case by giving the
Company written notice thereof. In the event of Executive's death or a judicial
determination of his incompetence, reference in this Agreement to Executive
shall be deemed, where appropriate, to refer to his beneficiary, estate or other
legal representative. Any reference to the masculine gender in this Agreement
shall include, where appropriate, the feminine.
12
<PAGE>
18. Survivorship. The respective rights and obligations of the parties
------------
hereunder shall survive any termination of this Agreement to the extent
necessary to the intended preservation of such rights and obligations. The
provisions of this Section 18 are in addition to the survivorship provisions of
any other section of this Agreement.
19. Governing Law. This Agreement shall be construed, interpreted and
-------------
governed in accordance with the laws of the State of New York, without reference
to rules relating to conflicts of law.
20. Entire Agreement. This Agreement and the Merger Agreement contain the
----------------
entire understanding between Executive and the Company and supersede in all
respects any prior or other agreement or understanding between the Company and
Executive as to the matters set forth herein and therein. Except for the
obligations specifically set forth herein and therein, the Company does not owe
any obligations to Executive and Executive does not owe any obligations to the
Company with respect to the matters set forth herein and therein.
21. Withholding. The Company shall withhold from any payments due to
-----------
Executive hereunder, all taxes, FICA or other amounts required to be withheld
pursuant to any applicable law.
22. Headings. The section headings contained in this Agreement are for
--------
the convenience of reference only and shall not affect the construction of any
provision of this Agreement.
23. Counterparts. This Agreement may be executed in two or more
------------
counterparts, each of which will be deemed an original but all of which together
this shall constitute one and the same instrument.
[Remainder of page intentionally left blank.]
13
<PAGE>
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be
signed on the date and year first above written.
7TH LEVEL, INC.
By: /s/ DONALD SCHUPAK
----------------------------
Donald Schupak
Chairman of the Board
EXECUTIVE
/s/ STEPHEN GOTT
----------------------------
Stephen Gott
14
<PAGE>
EXHIBIT 23.1
INDEPENDENT AUDITORS' CONSENT
The Board of Directors
7/th/ Level, Inc.:
We consent to incorporation by reference in Registration Statements on Form S-8
(Nos. 333-10335, 333-10339, 333-65525, 033-87944 and 333-10341) and on Form S-3
(333-64365) of 7th Level, Inc. of our report dated January 30, 1998, related to
the consolidated balance sheet of 7/th/ Level, Inc. and subsidiaries as of
December 31, 1997, and the related consolidated statements of operations,
stockholders' equity, and cash flows and related schedule for each of the years
in the two year period ended December 31, 1997, which report appears in the
December 31, 1998 annual report on Form 10-K of 7th Level, Inc.
Our report dated January 30, 1998 contains an explanatory paragraph that states
that the Company has suffered recurring losses since inception and does not
currently have sufficient resources to meet its anticipated operating
requirements during 1998, which conditions raise substantial doubt about the
Company's ability to continue as a going concern. The consolidated financial
statements and financial statement schedule do not include any adjustments that
might result from the outcome of that uncertainty.
KPMG LLP
Dallas, Texas
March 29, 1999
<PAGE>
EXHIBIT 23.2
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
7/th/ Level, Inc.:
As independent public accountants, we hereby consent to the incorporation of our
report dated March 17, 1999, included in this Form 10-K, into the Company's
previously filed Registration Statements Files No. 333-65525, No. 333-10335,
No. 033-87944, No. 333-10341, No. 333-10339 filed on Forms S-8 and No. 333-64365
filed on Form S-3.
Arthur Andersen LLP
New York, New York
March 29, 1999
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<PERIOD-TYPE> YEAR YEAR
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1997
<PERIOD-START> JAN-01-1998 JAN-01-1997
<PERIOD-END> DEC-31-1998 DEC-31-1997
<CASH> 11,215,702 2,465,079
<SECURITIES> 0 0
<RECEIVABLES> 42,317 1,112,026
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<INVENTORY> 0 18,477
<CURRENT-ASSETS> 11,544,257 4,348,429
<PP&E> 1,399,652 4,960,560
<DEPRECIATION> 0 0
<TOTAL-ASSETS> 13,016,389 9,854,726
<CURRENT-LIABILITIES> 3,187,396 6,543,924
<BONDS> 0 0
0 0
628,800 0
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<OTHER-SE> 8,916,641 2,321,618
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<TOTAL-REVENUES> 1,571,398 10,499,021
<CGS> 233,454 4,541,960
<TOTAL-COSTS> 9,620,234 29,747,356
<OTHER-EXPENSES> 2,675,409 (1,332,617)
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<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (10,957,699) (22,457,678)
<EPS-PRIMARY> (1.03) (1.64)
<EPS-DILUTED> (1.03) (1.64)
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