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TDK Mediactive Inc – ‘SB-2/A’ on 5/9/96

As of:  Thursday, 5/9/96   ·   Accession #:  912057-96-8749   ·   File #:  33-80827

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  As Of                Filer                Filing    For·On·As Docs:Size              Issuer               Agent

 5/09/96  TDK Mediactive Inc                SB-2/A                26:1.1M                                   Merrill Corp/FA

Pre-Effective Amendment to Registration of Securities by a Small-Business Issuer   —   Form SB-2
Filing Table of Contents

Document/Exhibit                   Description                      Pages   Size 

 1: SB-2/A      Pre-Effective Amendment to Registration of           142    740K 
                          Securities by a Small-Business Issuer                  
 2: EX-1        Underwriting Agreement                                54    225K 
 3: EX-4.2      Instrument Defining the Rights of Security Holders    31    107K 
 4: EX-4.3      Instrument Defining the Rights of Security Holders    38    141K 
 5: EX-4.4      Instrument Defining the Rights of Security Holders     9     46K 
 6: EX-5        Opinion re: Legality                                   3     14K 
 7: EX-9.1      Voting Trust Agreement                                 6     27K 
 8: EX-9.2      Voting Trust Agreement                                 1     10K 
 9: EX-9.3      Voting Trust Agreement                                 1     10K 
10: EX-9.4      Voting Trust Agreement                                 1     10K 
11: EX-10.1     Material Contract                                     17     57K 
12: EX-10.2     Material Contract                                     16     57K 
13: EX-10.3     Material Contract                                     13     47K 
14: EX-10.35    Material Contract                                     12     55K 
15: EX-10.36    Material Contract                                     12     55K 
16: EX-10.37    Material Contract                                     12     55K 
17: EX-10.38    Material Contract                                     11     45K 
18: EX-10.39    Material Contract                                     10     40K 
19: EX-10.40    Material Contract                                      1     10K 
20: EX-10.41    Material Contract                                     23     81K 
21: EX-10.42    Material Contract                                      6     22K 
22: EX-10.43    Material Contract                                      5     23K 
23: EX-10.44    Material Contract                                      6     25K 
24: EX-10.45    Material Contract                                      7     30K 
25: EX-10.46    Material Contract                                      2     11K 
26: EX-23.1     Consent of Experts or Counsel                          1      8K 


SB-2/A   —   Pre-Effective Amendment to Registration of Securities by a Small-Business Issuer
Document Table of Contents

Page (sequential) | (alphabetic) Top
 
11st Page   -   Filing Submission
2Calculation of Registration Fee
4Sound Source Interactive, Inc
10Prospectus Summary
12The offering
13Common Stock
17Risk Factors
"Product Distribution
19Competition
21Fluctuations in Operating Results; Seasonality
23Limited Protection of Intellectual Property and Proprietary Rights
24Dependence on Net Proceeds of this Offering; Possible Need for Additional Financing
25Control of the Company by Officers and Directors
27Shares Eligible for Future Sale
28No Prior Market; Arbitrary Determination of Offering Price; Possible Volatility of Trading Prices for Securities
30No Dividends
32Use of Proceeds
33Dividend Policy
34Dilution
37Capitalization
38Selected Financial Data
40Management's Discussion and Analysis of Financial Condition and Results of Operations
42Development
43Quarterly Results of Operations
45Business
"General
46Business Strategy
48Products
53Sales and Marketing
54Operations
56Proprietary Rights and Licenses
57Legal Matters
58Management
"Directors and Executive Officers
60Executive Compensation
61Employment Agreements
631995 Stock Option Plan
661992 Stock Option Plan
"Limitation of Liability and Indemnification of Directors
69Principal and Selling Stockholders
70Resale of Outstanding Securities
"Certain Transactions
"1994 Acquisition
711994 Private Placement
"1995 Bridge Financing
721995 Private Placement
73Agreements With ASSI, Inc
74Description of Securities
"Redeemable Warrants
76Application of California GCL
79Underwriting
81Experts
"Additional Information
83Sound Source Interactive
"Index to Consolidated Financial Statements
"Consolidated Balance Sheets
"Consolidated Statements of Operations
"Consolidated Statements of Cash Flows
84Independent Auditors' Report
89Consolidated Statements of Stockholders' Deficit
96Notes to Consolidated Financial Statements
99Royalties
100Net loss per common share
114Registration Statement
"ASSI Warrants
115Options
118Table of Contents
122Selling Security Holders
125Plan of Distribution
127Item 24. Indemnification of Directors and Officers
128Item 25. Other Expenses of Issuance and Distribution
129Item 26. Recent Sales of Unregistered Securities
131Item 27. Exhibits and Financial Statement Schedules
135Item 28. Undertakings
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As filed with the Securities and Exchange Commission on May 9, 1996 Registration No. 33-80827 ------------------------------------------------------------------------------- ------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ----------------------- PRE-EFFECTIVE AMENDMENT NO. 1 TO FORM SB-2 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 -------------------------- SOUND SOURCE INTERACTIVE, INC. (Name of Small Business Issuer in its Charter) [Download Table] DELAWARE 7372 95-4264046 (State or Other Jurisdiction of (Primary Standard Industrial (I.R.S. Employer Incorporation or Organization) Classification Code Number) Identification No.) 2985 E. Hillcrest Drive, Suite A Westlake Village, California 91362 (805) 494-9996 (Address and Telephone Number of Principal Executive Offices) Vincent J. Bitetti Chief Executive Officer 2985 E. Hillcrest Drive, Suite A Westlake Village, California 91362 (805) 494-9996 (Name, Address and Telephone Number of Agent for Service) _____________________ Copies to: [Download Table] Sean P. McGuinness, Esq. Catherine DeBono Holmes, Esq. McDermott, Will & Emery Jeffer, Mangels, Butler & Marmaro LLP 1850 K Street, N.W. 2121 Avenue of the Stars Suite 500 10th Floor Washington, D.C. 20006 Los Angeles, California 90067 (202) 887-8000 (310) 203-8080 Fax: (202) 778-8087 Fax: (310) 203-0567 Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this Registration Statement. If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box: / x / __________________________ THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE. (Continued on next page)
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(Continued from previous page) CALCULATION OF REGISTRATION FEE [Enlarge/Download Table] ------------------------------------------------------------------------------------------------------------------------------------ ------------------------------------------------------------------------------------------------------------------------------------ Proposed Proposed Maximum Maximum Title of Each Class of Amount to Offering Price Aggregate Amount of Securities to be Registered be Registered Per Security(1) Offering Price(1) Registration Fee ----------------------------------------------------------------------------------------------------------------------------------- ----------------------------------------------------------------------------------------------------------------------------------- Common Stock, $.001 par value ("Common Stock")(2) . . . . . . . . . 2,867,500 (sh) $ 4.00 $11,470,000.00 $3,955.17 ----------------------------------------------------------------------------------------------------------------------------------- Common Stock Purchase Warrants (the "Redeemable Warrants")(3) . . . . 7,069,665 (wt) .25 1,767,416.25 609.45 ----------------------------------------------------------------------------------------------------------------------------------- Common Stock issuable upon exercise of Redeemable Warrants and ASSI Warrants(4) . . . . . . . . . . . 9,069,665 (sh) 4.40 39,906,526.00 13,760.87 ----------------------------------------------------------------------------------------------------------------------------------- Representative's Warrants. . . . . . . . 2 (wt) 50.00 50.00 .02 ----------------------------------------------------------------------------------------------------------------------------------- Common Stock issuable upon exercise of Representative's Warrants . 240,000 (sh) 4.80 1,152,000.00 397.24 ----------------------------------------------------------------------------------------------------------------------------------- Redeemable Warrants issuable upon exercise of Representative's Warrants 120,000 (wt) .30 36,000.00 12.41 ----------------------------------------------------------------------------------------------------------------------------------- Common Stock issuable upon exercise of Redeemable Warrants issuable upon exercise of Representative's Warrants 120,000 (sh) 4.80 576,000.00 198.62 ----------------------------------------------------------------------------------------------------------------------------------- Total Registration Fee . . . . . . . . . $18,933.78(5) ----------------------------------------------------------------------------------------------------------------------------------- ------------------------------------------------------------------------------------------------------------------------------------ (1) Estimated solely for the purpose of calculating the registration fee. (2) Includes: (i) 2,400,000 shares of Common Stock registered for the account of the Registrant, (ii) 340,000 shares of Common Stock registered for the account of the Registrant and 20,000 shares of Common Stock registered for the account of certain selling stockholders which the Underwriters have the option to purchase to cover over-allotments, if any, and (iii) 107,500 shares of Common Stock registered for the account of certain Selling Security Holders. (3) Includes: (i) 1,200,000 Redeemable Warrants registered for the account of the Registrant, (ii) 5,689,665 Redeemable Warrants registered for the account of certain Selling Security Holders, and (iii) 180,000 Redeemable Warrants registered for the account of the Registrant which the Underwriters have the option to purchase to cover over-allotments, if any. (4) Includes: (i) 1,200,000 shares of Common Stock issuable by the Registrant upon exercise of Redeemable Warrants which Redeemable Warrants are being registered for the account of the Registrant, (ii) 5,689,665 shares of Common Stock issuable by the Registrant upon exercise of Redeemable Warrants which Redeemable Warrants are being registered for the account of certain Selling Security Holders, (iii) 2,000,000 shares of Common Stock issuable by the Registrant upon issuance of warrants held by ASSI, Inc., and (iv) 180,000 shares of Common Stock issuable by the Registrant upon exercise of Redeemable Warrants which the Underwriters have the option to purchase to cover over-allotments, if any. (5) A registration fee of $23,318.76 was paid with the initial filing of this Registration Statement. Consequently, no registration fee is being paid with this filing. Pursuant to Rule 416, there are also being registered hereby such additional indeterminate number of shares of such Common Stock as may become issuable by reason of stock splits, stock dividends and similar adjustments as set forth in the provisions of the Redeemable Warrants and the Representative's Warrant.
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EXPLANATORY NOTE This Registration Statement contains two Prospectuses. The first Prospectus forming a part of this Registration Statement is to be used in connection with the underwritten public offering of: 2,760,000 shares of the Registrant's Common Stock (including 360,000 shares of Common Stock subject to the Underwriters' over-allotment option); and 1,380,000 of the Registrant's Redeemable Warrants (including 180,000 Redeemable Warrants subject to the Underwriters' over-allotment option), and immediately follows the Cross Reference Sheet. The second Prospectus forming a part of this Registration Statement is to be used in connection with the sale from time to time by the Company and certain nonaffiliated selling security holders of the Company of: 107,500 shares of Common Stock being sold by the nonaffiliated selling security holders; 5,689,665 Redeemable Warrants being sold by the nonaffiliated selling security holders; 5,689,665 shares of Common Stock underlying the nonaffiliated selling security holders' Redeemable Warrants issuable by the Company upon exercise of such Redeemable Warrants; 2,000,000 shares of Common Stock underlying the ASSI Warrants issuable by the Company upon exercise of such ASSI Warrants; and 1,380,000 shares of Common Stock underlying the Registrant's Redeemable Warrants issuable by the Company upon exercise of such Redeemable Warrants. The second Prospectus will consist of (i) the cover page and inside cover page of the second Prsospectus, (ii) pages 3 through 76 of the first Prospectus (other than the sections entitled "Resale of Outstanding Securities" and "Underwriting") and pages F-1 through F-32 of the first prospectus, (iii) pages SS-3 through SS-5 (which will appear in place of the section entitled "Resale of Outstanding Securities"), (iv) page SS-6 (which will appear in place of the section entitled "Underwriting") and (v) the back cover page, which is the last page of the second Prospectus.
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SOUND SOURCE INTERACTIVE, INC. Cross-Reference Sheet showing location in each Prospectus of Information Required by Items of Form SB-2 [Enlarge/Download Table] FORM SB-2 ITEM NUMBER AND CAPTION LOCATION IN PROSPECTUSES ---------------------------------- -------------------------- 1. Front of Registration Statement and Outside Front Cover of Prospectus . . . . . . . . . . . . . . . . Outside Front Cover Page 2. Inside Front and Outside Back Cover Pages of Prospectus . . . . . Inside Front Cover Page; Outside Back Cover Page 3. Summary Information and Risk Factors. . . . . . . . . . . . . . . Prospectus Summary; Risk Factors; Business 4. Use of Proceeds . . . . . . . . . . . . . . . . . . . . . . . . . Use of Proceeds 5. Determination of Offering Price . . . . . . . . . . . . . . . . . Outside Front Cover Page; Risk Factors; Underwriting 6. Dilution. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Dilution 7. Selling Security-Holders. . . . . . . . . . . . . . . . . . . . . Selling Security Holders 8. Plan of Distribution. . . . . . . . . . . . . . . . . . . . . . . Outside Front Cover Page; Risk Factors; Underwriting 9. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . Business -- Legal Matters 10. Directors, Executive Officers, Promoters and Control Persons. . . Business; Management -- Executive Officers and Directors 11. Security Ownership of Certain Beneficial Owners and Management. . . . . . . . . . . . . . . . . Principal Stockholders 12. Description of Securities . . . . . . . . . . . . . . . . . . . . Description of Securities 13. Interest of Named Experts and Counsel . . . . . . . . . . . . . . Experts 14. Disclosure of Commission Position on Indemnification for Securities Act Liabilities . . . . . . . . . Underwriting 15. Organization Within Last Five Years . . . . . . . . . . . . . . . Business 16. Description of Business . . . . . . . . . . . . . . . . . . . . . Business 17. Management's Discussion and Analysis or Plan of Operation . . . . Management's Discussion and Analysis of Financial Condition and Results of Operations 18. Description of Property . . . . . . . . . . . . . . . . . . . . . Business 19. Certain Relationships and Related Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . Management; Certain Transactions 20. Market for Common Equity and Related Stockholder Matters . . . . . . . . . . . . . . . . . . . . . . Risk Factors; Description of Securities; Underwriting; Management -- Executive Compensation 21. Executive Compensation. . . . . . . . . . . . . . . . . . . . . . Management -- Executive Compensation 22. Financial Statements. . . . . . . . . . . . . . . . . . . . . . . Financial Statements 23. Changes in and Disagreements With Accountants On Accounting and Financial Disclosure . . . . . . . . . . . . . Not Applicable
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INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE.
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SUBJECT TO COMPLETION, DATED MAY 9, 1996 PROSPECTUS [SOUND SOURCE INTERACTIVE, INC. LOGO] 2,400,000 SHARES OF COMMON STOCK AND 1,200,000 REDEEMABLE WARRANTS ------------------ Sound Source Interactive, Inc. (the "Company") hereby offers 2,400,000 shares (the "Shares") of common stock, par value $.001 per share (the "Common Stock"), and 1,200,000 redeemable warrants (the "Redeemable Warrants") (the Shares and the Redeemable Warrants offered hereby by the Company are sometimes collectively referred to herein as the "Securities"). The Shares and the Redeemable Warrants will be separately tradeable immediately upon issuance and may be purchased separately. It is currently anticipated that the initial public offering price will be $4.00 per share of Common Stock and $.25 per Redeemable Warrant. Each Redeemable Warrant entitles the holder thereof to purchase one share of Common Stock at a purchase price equal to 110 percent of the initial public offering price per share, subject to adjustment, at any time during the 54-month period commencing one year after the date of this Prospectus, and is redeemable by the Company at a redemption price of $.25 per Redeemable Warrant, commencing one year after the date of this Prospectus, provided that the average closing bid price of the Common Stock equals or exceeds 140 percent of the initial public offering price per share for any 20 trading days within a period of 30 consecutive trading days ending on the fifth trading day prior to the date of the notice of redemption. See "Description Securities -- Redeemable Warrants." ------------------------ THESE SECURITIES INVOLVE A HIGH DEGREE OF RISK AND IMMEDIATE SUBSTANTIAL DILUTION. SEE "RISK FACTORS" AND "DILUTION" COMMENCING ON PAGES 10 AND 26, RESPECTIVELY. --------------------- THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. [Download Table] UNDERWRITING PROCEEDS TO PRICE TO PUBLIC DISCOUNTS (1) COMPANY (2) Per Share....................... $4.00 $.400 $3.600 Per Redeemable Warrant.......... .25 .025 .125 Total (3)....................... 9,900,000.00 990,000.000 8,910,000.000 (1) Does not include additional compensation to the Representatives in the form of a nonaccountable expense allowance equal to three percent of the gross offering proceeds. For indemnification arrangements with, and additional compensation payable to, the Underwriters, see "Underwriting." (2) Before deducting expenses of this offering payable by the Company, estimated at approximately $600,000 in the aggregate, including the Representatives' nonaccountable expense allowance. (3) For the purpose of covering over-allotments, if any, the Company and certain affiliated selling stockholders have granted to the Underwriters an option, exercisable within 45 days from the date of this Prospectus, to purchase up to 360,000 additional shares of Common Stock and/or up to 180,000 additional Redeemable Warrants. If such over-allotment option is exercised in full, the total Price to Public, Underwriting Discounts and Proceeds to Company will be $11,385,000.00 and $1,138,500.00 and $10,246,500.00, respectively. See "Underwriting." The Securities are offered by the Underwriters, when, as and if delivered to and accepted and subject to their right to withdraw, cancel or modify this offering and to reject any orders in whole or in part. It is expected that delivery of the Securities will be made on or about , 1996. ------------------------ THE BOSTON GROUP, L.P. JOSEPH STEVENS & COMPANY, L.P. The date of this Prospectus is , 1996
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[COVER ART] Prior to this offering, there has been no public market for the Securities and there can be no assurance that a market for the Securities will develop or, if a market develops, that it will be sustained. The Common Stock and Redeemable Warrants have been approved for quotation on the Nasdaq SmallCap Market under the symbols SSII and SSIIW for the Common Stock and Redeemable Warrants, respectively. The initial public offering prices for the Common Stock and Redeemable Warrants and the exercise price of the Redeemable Warrants have been determined by negotiation between the Company and The Boston Group, L.P. and Joseph Stevens & Company, L.P., as representatives (the "Representatives") of the several Underwriters, and are not necessarily related to the Company's asset value, net worth or other established criteria of value. See "Risk Factors" and "Underwriting." IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK AND/OR THE REDEEMABLE WARRANTS AT LEVELS ABOVE THOSE WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME. The Company intends to furnish its stockholders with annual reports containing audited financial statements, with a report thereof by its independent certified public accountant, and such other periodic reports as the Company may determine to be appropriate or as may be required by law.
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[SOUND SOURCE LOGO] From the silver screen to the computer, our Interactive MovieBooks-TM- combine the fun of movies with the educational value of a book. Designed for young children, these CD-ROMs make reading fun with movie clips, pictures, sound effects, animation and other surprises. Our "Talking Utilities" give your PC personality. Audio clips of your favorite heroes and villains-plus authentic sound effects-can be assigned to computer functions and application events. From startup to shutdown, and a ton of places in between, AudioClips are the only way to have fun while you work (and get away with it). Each package is a collector's item, desktop diversion and functional utility all in one! Our unique line of Entertainment Utilities features something for every fan of pop culture: Babylon 5-TM-, Star Wars-Registered Trademark- Trilogy, Saturday Night Live-Registered Trademark-, The Twilight Zone-TM- and Terminator 2-TM-: Judgment Day. Combining original animation, stylized stills and authentic AudioClips, our CHILDREN'S EDUCATION/ENTERTAINMENT [GRAPHICS] AUDIOCLIPS [GRAPHICS]
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entertainment utilities put the FUN in functional. In summer of 1996, the company will introduce its first Creativity Centers for children based on popular franchises and major motion pictures. The company targets the growing audience of home PC users who value high quality, fully-featured, fun and easy to use software for themselves and their children. Sound Source interactive products are available at thousands of retail outlets, selling for $15.00 to $30.00. ENTERTAINMENT UTILITIES AND SCREEN SAVERS [GRAPHICS]
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PROSPECTUS SUMMARY THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY, AND MUST BE READ IN CONJUNCTION WITH, THE MORE DETAILED INFORMATION AND FINANCIAL STATEMENTS APPEARING ELSEWHERE IN THIS PROSPECTUS. THE COMPANY Sound Source Interactive, Inc. (the "Company") is engaged primarily in developing, publishing and marketing educational, interactive computer software for children. MOVIEBOOKS-TM-, which combine text, photos, sound clips and actual film footage of well recognized family films and cartoon series, are the Company's major software products. MOVIEBOOKS-TM- are developed and published by the Company on compact disk-read only memory ("CD-ROM") for multimedia personal computers ("Multimedia PCs") as entertaining, interactive reading tools for young children. The Company also produces a variety of entertainment computer software utilities which incorporate screen savers, sound clips known as AUDIOCLIPS-REGISTERED TRADEMARK- and other content based on entertainment properties. The new entertainment utilities are marketed as limited edition serialized collector editions. The Company is currently developing another line of products which it refers to as creativity centers. This product line combines learning activities such as painting, drawing, matching, puzzles and mazes within a framework of three distinct skill levels. The Company's products are based on licensed content of major motion pictures and television shows under agreement with major entertainment studios including Viacom Consumer Products (as agent for Paramount Pictures Corp.), Lucasfilm Ltd., Warner Bros. Consumer Products, CBS Entertainment, MCA/Universal Merchandising, Inc., Carolco Pictures, Inc., DC Comics, MGM/UA Merchandising, Inc. and others. The Company's license agreements for existing products include BABE-TM-, LASSIE-TM-, THE LITTLE RASCALS-TM-, BLACK BEAUTY-TM-, THE ADVENTURES OF BATMAN AND ROBIN-TM-, TERMINATOR 2: JUDGMENT DAY-TM-, the STAR WARS-TM- trilogy, FREE WILLY 2-TM-, THE SECRET GARDEN-TM-, STAR TREK-TM-, SATURDAY NIGHT LIVE-TM-, THE TWILIGHT ZONE-TM-, TOTAL RECALL-TM- and other popular titles. The Company also holds licenses for new products currently being developed for release in 1996 on ALL DOGS GO TO HEAVEN II-TM-, THE LAND BEFORE TIME-TM-, DRAGON HEART-TM- and I LOVE LUCY-TM-. The Company is continuing the negotiation of additional licenses for its MOVIEBOOKS-TM-, AUDIOCLIPS-REGISTERED TRADEMARK-, entertainment utilities, creativity centers and screen savers. Management believes the Company is capable of continuing to obtain new licenses for major motion pictures and television shows and developing new, high quality software products using content from these entertainment properties. The powerful capabilities and declining price of Multimedia PCs have enabled it to draw acceptance as an all purpose, functional educational and entertainment product for home and school use. Industry sources state that the installed base of Multimedia PCs exceeds 9,000,000 units. The technological capabilities of the Multimedia PC itself have allowed the Company to produce interactive software that is "user friendly" while maintaining what management believes are high standards in design, sound quality, three-dimensional sound effects and quality duplication of motion picture footage. Management believes that the Company is well positioned to participate in this market not only through expansion of its existing software products but through development opportunities in other media formats, such as interactive television, virtual reality and the Internet. The Company believes that as of March 31, 1996, its products were in distribution to approximately 6,000 retail outlets. Retailers currently selling the Company's products include Target, Tower Records, Sears, Wal-Mart, Price/Costco, CompUSA, Best Buy, BJ's, Computer City, Egghead, -3-
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Electronics Boutique, Babbages, Software, Etc., Kmart, Barnes & Noble, Sam Goody, Sam's Club, QVC, Musicland, Circuit City, Blockbuster Video and others. The Company's strategy is to focus primarily on developing nonviolent, family-oriented products with educational and entertainment value, which are based on popular movies, television series and comic book characters and are easy to use and install. The Company plans to develop a broad line of products, to upgrade successful products and to develop product line extensions and complementary products. Among other products the Company intends to develop games based on licensed content. The Company intends to keep development costs as low as possible by utilizing existing technologies and externally developed programming, which will enable the Company to maintain prices which appeal to the mass market. The Company's objective is to be a leading publisher of high quality, value priced, family oriented software. To achieve this objective, the Company intends to (i) focus primarily on developing nonviolent products with educational and entertainment value which are based on popular movies, television series and comic book characters and are easy to use and install, (ii) develop a broad line of products, upgrade successful products and develop product line extensions and complementary products, (iii) leverage studio relationships to develop cross-marketing promotional programs, (iv) promote tradename recognition, (v) utilize existing technologies and externally developed programming which the Company believes will enable it to maintain prices which appeal to the mass market, (vi) leverage its licensed content to develop products intended for the game market, (vii) pursue strategic alliances and acquisitions. The Company is located at 2985 East Hillcrest Drive, Suite A, Westlake Village, California 91362. Its telephone number is (805) 494-9996. Its facsimile number is (805) 379-3446. -4-
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THE OFFERING Securities Offered by the Company. . . . . . . . . . . 2,400,000 shares of Common Stock and 1,200,000 Redeemable Warrants. Each Redeemable Warrant entitles the holder thereof to purchase one share of Common Stock. The Common Stock and Redeemable Warrants will be purchased and traded separately commencing on the date of this Prospectus. See "Description of Securities." Terms of the Redeemable Warrants . . . . . . . . Each Redeemable Warrant will entitle the holder to purchase one share of Common Stock at a price of 110 percent of the initial public offering price per share, subject to adjustment, during the 54-month period commencing one year after the date of this Prospectus. In the event that the Redeemable Warrants are called for redemption, they will be exercisable for 30 days preceding the applicable redemption date. Redemption of the Redeemable Warrants . . . . . . . . Commencing one year after the date this Prospectus, the Redeemable Warrants will be subject to redemption at $.25 per Redeemable Warrant if the average closing bid price of the Common Stock equals or exceeds 140 percent of the initial public offering price per share for any 20 trading days within a period of 30 consecutive trading days ending on the fifth trading day prior to the date of the notice of redemption. See "Description of Securities -- Redeemable Warrants." Shares of Common Stock Outstanding: Prior to the offering . . . . . . . 1,808,291 shares. After the offering . . . . . . . . 4,208,291 shares, or 4,558,291 shares if the Underwriters' over- allotment option is exercised. Of the 360,000 shares subject to the Underwriters' over-allotment option, 340,000 are being offered by the Company and 20,000 are being offered by two affiliated stockholders. Of the 20,000 shares being offered by two affiliated stockholders, 10,000 shares are currently issued and outstanding and 10,000 are subject to a presently exercisable stock option. See "Principal and Selling Stockholders." Up to 10,110,183 additional shares may be issued in the future under the Redeemable Warrants offered hereby and options and warrants that are outstanding or agreed to be issued. -5-
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Use of Proceeds. . . . . . . . . . . . . The Company intends to use the net proceeds of this offering to repay notes issued to investors in the Company's 1995 Private Placement (as defined below) in the aggregate principal amount of $4,987,500 (plus accrued interest estimated at $242,500 as of March 31, 1996), to obtain additional licenses, to pay sales and marketing costs, to make capital expenditures and for working capital. See "Use of Proceeds" and "Certain Transactions -- 1995 Private Placement." Nasdaq Symbols: Common Stock. . . . . . . . . . . . SSII Redeemable Warrants . . . . . . . . SSIIW Risk Factors . . . . . . . . . . . . . . An investment in the Common Stock and Redeemable Warrants involves a high degree of risk and immediate substantial dilution. See "Risk Factors" and "Dilution." Consulting Arrangement . . . . . . . . . On April 30, 1996, the Company entered into a consulting agreement with ASSI, Inc., which also is a creditor of the Company. Pursuant to that agreement, ASSI, Inc. has agreed to provide certain financial and personnel consulting services to the Company, in consideration for which the Company has issued to ASSI, Inc. warrants (the "ASSI Warrants") to purchase 2,000,000 shares of Common Stock at an exercise price of $4.40 per share, which will become exercisable September 1, 1996. See "Certain Transactions -- Agreements With ASSI, Inc." -6-
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Resale of Outstanding Securities; Issuance of Common Stock Underlying Redeemable Warrants . . . . . A separate Prospectus is being filed with the Registration Statement of which this Prospectus is a part which relates to the registration by the Company, at its expense, for the account of certain security holders (the "Selling Security Holders") and for the account of the Company, of (i) 107,500 shares of Common Stock and 5,689,665 warrants (unless otherwise indicated, such warrants and the Redeemable Warrants offered hereby by the Company are collectively referred to as "Redeemable Warrants") previously issued by the Company to the Selling Security Holders, (ii) 7,069,665 shares of Common Stock issuable by the Company upon the exercise of the Redeemable Warrants, and (iii) 2,000,000 shares of Common Stock issuable by the Company upon the exercise of the ASSI Warrants. The 107,500 shares of Common Stock, 5,689,665 Redeemable Warrants and 9,069,665 shares of Common Stock issuable upon the exercise of the Redeemable Warrants and ASSI Warrants being so offered for sale by the Selling Security Holders are sometimes collectively referred to as the "Selling Security Holders' Securities." The Selling Security Holders' Securities are not being underwritten in this offering and the Company will not receive any proceeds from the sale of the Selling Security Holders' Securities. The Common Stock and Redeemable Warrants being registered for the account of the Selling Security Holders may be sold by the Selling Security Holders or their transferees commencing on the third business day from the date of this Prospectus. See "Risk Factors -- Sale of Certain Outstanding Securities," "Certain Transactions" and "Resale of Outstanding Securities." -7-
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SUMMARY FINANCIAL INFORMATION The following table of summary financial information is derived from and should be read in conjunction with the Company's financial statements and the footnotes thereto included elsewhere in this Prospectus. [Enlarge/Download Table] Six Months Ended Year Ended June 30, December 31, ------------------------ -------------------------- Statement of Operations Data 1994 1995 1994 1995 --------------------------------------------- --------- --------- --------- ---------- Retail software sales. . . . . . . . . . . . 1,313,890 1,255,230 1,006,849 1,077,547 OEM sales . . . . . . . . . . . . . . . . . 5,500 479,675 389,979 21,466 Development agreement revenues . . . . . . . . . . . . . . . 112,520 343,250 127,250 0 Royalties . . . . . . . . . . . . . . . . . 253,961 76,771 76,253 21,678 Net sales from continuing operations. . . . . . . . . . . . . . . 1,685,871 2,154,926 1,600,331 1,120,691 Gross profit . . . . . . . . . . . . . . . . 505,068 1,082,235 643,963 438,181 Noncash compensation expense recorded in connection with Common Stock and Common Stock options issued for services . . . . . . 2,992,862 733,165 193,332 0 Other expenses . . . . . . . . . . . . . . . 1,374,052 1,940,124 886,272 2,448,553 Loss from continuing operations. . . . . . . (3,861,846) (1,591,054) (435,641) (2,010,372) Loss from discontinued operations. . . . . . (115,887) (143,106) (13,376) 0 Net loss . . . . . . . . . . . . . . . . . (3,977,733) (1,734,160) (449,017) (2,010,372) Loss per common share from continuing operations . . . . . . . . . (2.38) (0.85) (0.23) (1.08) Loss per common share from discontinued operations . . . . . . . . (0.07) (0.08) (0.01) 0 Net loss per common share. . . . . . . . . . (2.45) (0.93) (0.24) (1.08) Weighted average number of common shares outstanding(1). . . . . . 1,626,107 1,862,908 1,869,998 1,868,145 [Download Table] As of December 31, 1995 ----------------------------- Balance Sheet Data Actual As Adjusted(1) ------------------------------------------- ------------ -------------- Working Capital. . . . . . . . . . . . . . . (2,913,040) 4,666,092 Total assets . . . . . . . . . . . . . . . . 4,165,858 6,533,154 Current liabilities. . . . . . . . . . . . . 6,873,471 1,661,635 Long term debt . . . . . . . . . . . . . . . 25,601 25,601 Stockholder equity (deficit) . . . . . . . . (2,733,214) 4,845,918 --------------------------------- (1) Unless otherwise indicated, all share and per share information in this Prospectus gives effect to a 9.25-for-1 stock split effected in May 1994 and a 1-for-5.976 reverse stock split effected in September 1995. Unless otherwise indicated, such share and per share information does not give effect to: (i) the exercise of the Underwriters' over-allotment option to purchase up to 360,000 shares of Common Stock and 180,000 Redeemable Warrants; (ii) the issuance of 1,200,000 shares of Common Stock underlying the Redeemable Warrants being offered by the Company; (iii) the issuance of 5,689,665 shares of Common Stock underlying the Redeemable Warrants and 2,000,000 shares of Common Stock underlying the ASSI Warrants being offered by the Selling Security Holders; (iv) the issuance of 180,000 shares of Common Stock underlying the Redeemable Warrants included in the Underwriters' over-allotment option; (v) the -8-
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exercise of a warrant granted to the Representative (the "Representative's Warrant") to purchase up to 240,000 shares of Common Stock and/or 120,000 Redeemable Warrants; (vi) the issuance upon exercise of the Representative's Warrant of 240,000 shares of Common Stock, 120,000 Redeemable Warrants or 120,000 shares of Common Stock issuable upon exercise of such Redeemable Warrants; (vii) the issuance of 384,070 shares of Common Stock underlying options granted pursuant to the Company's 1992 Stock Option Plan; (viii) 500,000 shares of Common Stock reserved for issuance pursuant to the Company's 1995 Stock Option Plan, as to which the Company has granted no options and has agreed to grant 13,610 options; or (ix) the issuance of 292,838 shares of Common Stock underlying options held by the Company's President. (2) As adjusted to reflect the issuance of 2,400,000 shares of Common Stock at an assumed initial public offering price of $4.00 per share and 1,200,000 Redeemable Warrants at an assumed initial public offering price of $.25 per Redeemable Warrant, net of the expenses of the offering (estimated at $990,000 for the Underwriter's discount and $600,000 for expenses, including the Representatives' three percent nonaccountable expense allowance) and repayment of all of the Company's funded indebtedness (estimated at $5,105,676 at December 31, 1995) with a portion of such proceeds. The as adjusted amounts do not reflect the issuance of up to 340,000 shares of Common Stock and 180,000 Redeemable Warrants by the Company to cover over-allotments, if any, the exercise of the Representative's Warrant to purchase up to 240,000 shares of Common Stock and/or 120,000 Redeemable Warrants, or the exercise of any other outstanding (or agreed to be issued) options or warrants to purchase up to an additional 10,120,183 shares of Common Stock. -9-
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RISK FACTORS AN INVESTMENT IN THE SECURITIES OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK AND IMMEDIATE SUBSTANTIAL DILUTION. IN ADDITION TO THE OTHER INFORMATION CONTAINED IN THE PROSPECTUS, PROSPECTIVE INVESTORS SHOULD CAREFULLY CONSIDER THE FOLLOWING RISK FACTORS BEFORE MAKING AN INVESTMENT. PRODUCT DISTRIBUTION In June 1995, the Company entered into a Sales and Distribution Agreement with Acclaim Distribution, Inc., a subsidiary of Acclaim Entertainment, Inc. (collectively, "Acclaim"), a distributor of entertainment software and related products. The Company had no sales to or through Acclaim during its fiscal year ended June 30, 1995. During the six-month period ended December 31, 1995, of the Company's total revenues from retail software sales of $1,120,691, a total of $819,619 (73 percent) were generated by Acclaim. Under the terms of this agreement, Acclaim was the exclusive distributor of the Company's products on a worldwide basis, subject to certain limited exceptions. The Company was not satisfied with the distribution of its products through Acclaim, and determined to terminate the Acclaim distribution agreement in March 1996. The Company and Acclaim have terminated the distribution agreement as of April 30, 1996. On or before June 30, 1996, Acclaim will render a final accounting to the Company together with payment of the balance of any amounts due to the Company under the distribution agreement. Acclaim has notified its accounts that it will not accept returns of any of the Company's software products after June 30, 1996. The Company, however, will remain liable for all such returns regardless of when received by Acclaim. The Company believes it has the ability to distribute its products through nonexclusive software distributors and by means of direct sales to major computer and software retailers. The Company further believes that it could generate sales sufficient to allow it to operate profitability without a major exclusive distribution relationship similar to its past relationship with Acclaim. Nevertheless, the Company believes that it is possible to generate higher sales to mass marketers through an exclusive affiliate distributor, and that the attendant risk of collection of accounts can be mitigated. Therefore, the Company is currently in the process of negotiating distribution agreements with potential new exclusive distributors. There can be no assurance, however, that the Company will be successful in entering into any such distribution agreements, or that the terms of any such distribution agreement will be favorable to the Company. If the Company fails to enter into satisfactory distribution agreements, there also can be no assurance as to its ability to market its products directly. Moreover, even if the Company does enter into one or more such distribution agreements, there can be no assurance that any new distributor will successfully market the Company's products. The Company may experience a loss of sales momentum as a result of the termination of the Acclaim distribution agreement, even if the Company enters into agreements with new distributors. See "Business -- Product Distribution." PRODUCT RETURNS; COLLECTION OF ACCOUNTS RECEIVABLE; CREDIT RISK Under the Acclaim distribution agreement, Acclaim was required to make payments to the Company for all products shipped to retailers within 120 days of their shipment, net of commissions earned by Acclaim. Thereafter, all risks associated with collection of accounts receivable with respect to all products sold by the Company through Acclaim were solely the responsibility of Acclaim. In the event of any product returns by retailers, the Company was responsible for return of payments made for the products to the retailers, whereas the risk of product returns remained with the Company. On product sales made directly by the Company, which included all sales by means of direct mail, -10-
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"infomercials," television home shopping and "bundling" agreements with original equipment manufacturers, all risks of both collections and product returns were retained by the Company. After the termination of the Acclaim distribution agreement, and until such time as the Company enters into a new exclusive distribution agreement (which cannot be assured), the Company will bear all the risks of collection of accounts receivable and acceptance of product returns on all of its sales. The Company expects to remain responsible for product returns from retail outlets for all products sold by it following the termination of the Acclaim Distribution Agreement. The Company has maintained and will continue to maintain a reserve for product returns equal to a percentage of all sales booked based upon historical and current sell through information. It is difficult for the Company to ascertain current demand for its existing products and anticipated demand for newly introduced products. Accordingly, the Company will be exposed to the risk of product returns from retailers and distributors. There can be no assurance that actual returns and uncollectible receivables will not exceed the Company's reserves. Any significant increase in product returns or uncollected accounts receivable beyond reserves could have a material adverse effect on the Company's business, results of operations and financial condition. See "Business -- Sales and Marketing." PAST OPERATING LOSSES; GOING CONCERN QUALIFICATION The Company sustained net losses of $3,977,733 and $1,734,160 for the fiscal years ended June 30, 1994 and 1995, respectively, and a net loss of $2,010,372 for the six months ended December 31, 1995. The Company's losses include noncash charges attributable to Common Stock and options for the purchase of Common Stock issued for services rendered of $2,992,862 and $733,165 for the fiscal years ended June 30, 1994 and 1995, respectively. See generally "Management's Discussion and Analysis of Financial Condition and Results of Operations." The Company will continue to sustain losses unless it can further increase product sales. In their report respecting the Company's results of operations for its fiscal year ended June 30, 1995, the Company's auditors state that the Company's recurring losses from operations, its excess of current liabilities over current assets and its stockholders' deficit raise substantial doubt about its ability to continue as a going concern. See "Independent Auditors' Report." LIMITED HISTORY OF BUSINESS OPERATIONS The Company has limited operating history. The Company conducted substantially no business prior to its acquisition of the Subsidiary (as hereinafter defined) in 1994. The Subsidiary itself commenced operations originally as a nonincorporated entity in 1988. The Subsidiary's revenues originally were derived from the sale of sound patches for music synthesizers. Since 1993, revenues and income have been predominately derived from entertainment utilities software for Macintosh and IBM-compatible computers incorporating content licensed from major motion picture studios. NEW BUSINESS RISKS FOR THE LICENSED SOFTWARE PRODUCTS The business of creating and marketing licensed software derived from motion pictures is a new and evolving industry, which will be subject to a number of risks, including trends in personal computer sales, changes in available technology and changes in the competition for licenses to develop software derived from motion pictures. Changes in these factors could have a material adverse effect on the Company's revenues and potential profitability. In 1994, the Company entered the multimedia interactive educational software market. As a result, the Company believes that period-to-period -11-
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comparisons of its results of operations are not necessarily meaningful and should not be relied upon as an indication of its future performance. COMPETITION The market for the Company's consumer software products is intensely and increasingly competitive. Existing consumer software companies may broaden their product lines to compete with the Company's products, and potential new competitors, including computer hardware or software manufacturers, diversified media companies and book publishing companies, may enter or increase their focus on the consumer software market, resulting in even greater competition for the Company. Many of the companies with which the Company currently competes or may compete in the future have greater financial, technical, marketing, sales and customer support resources, as well as greater name recognition and better access to consumers, than the Company. The competition for retail shelf space is also likely to increase due to the continued proliferation of consumer software products and companies. In addition, to the extent that competitors achieve performance, price or other selling advantages, the Company could be materially adversely affected. There can be no assurance that the Company will have the resources required to respond effectively to market or technological changes or to compete successfully in the future. In addition, increasing competition in the consumer software market may cause prices to fall, which may materially adversely affect the Company's business, operating results and financial condition. The Company has entered into license agreements with Viacom Consumer Products (as agent for Paramount Pictures Corp.), Lucasfilm Ltd., Warner Bros. Consumer Products, CBS Entertainment, MCA/Universal Merchandising, Inc., Carolco Pictures Inc., DC Comics, MGM/UA Merchandising, Inc. and others. Several of these major motion picture studios now have captive software divisions. As these types of software products become better known in the marketplace, these profit centers may begin to vie for their studio's products. Management believes that Disney, Lucasfilm and Paramount/Viacom are currently the most active studios in publishing their own product to create software packages. Fox, Universal Pictures, Sony Pictures and Warner Bros. each have announced the formation of their own interactive computer software divisions to publish software products using their own licensed content, which could have a material adverse effect on the Company's ability to renew existing licenses or obtain new licenses for additional movie titles. The establishment of these divisions may limit the Company's ability to obtain licenses from the studios involved, which in turn could reduce the Company's potential product offerings. To date, the Company has had ample product licensing opportunities, and management believes that even if some sources are lost due to the establishment of interactive software divisions by some motion picture studios, there will continue to be multiple sources of licensing for the Company's new products. There can be no assurance, however, that the Company will have sufficient product licensing opportunities in the future. See "Business -- Competition." DEPENDENCE ON KEY PERSONNEL; SUBSTANTIAL MANAGEMENT COMPENSATION The Company's success depends to a significant extent on the performance and continued service of its senior management and certain key employees. In particular, the loss of the services of Vincent J. Bitetti, Chairman of the Board and Chief Executive Officer, could have a material adverse effect on the Company. Mr. Bitetti has agreed to work full-time for the Company and has signed an employment agreement for the period ending September 15, 1998. Competition for highly skilled employees with technical, management, marketing, sales, creative product development and other specialized training is intense, and there can be no assurance that the Company will be successful in attracting and retaining such personnel. In addition, there can be no assurance that employees will not leave the Company or compete against the Company. The Company's failure to attract additional qualified employees or to retain the services of key personnel could have a material adverse effect on -12-
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the Company's business, operating results and financial condition. The Company is the beneficiary of a $1,000,000 life insurance policy on Vincent J. Bitetti, Chairman of the Board and Chief Executive Officer, a $2,000,000 life insurance policy on Eric H. Winston, President and Chief Operating Officer, and a $500,000 life insurance policy on Ulrich Gottschling, Chief Financial Officer, but does not currently maintain life insurance on any of its other employees. See "Management -- Directors and Executive Officers" and "-- Employment Agreements." Following this offering, the Company intends to obtain an additional $4,000,000 of life insurance coverage on Vincent J. Bitetti. The Company's Chairman of the Board and Chief Executive Officer currently receives annual base compensation of $200,000, and its President and Chief Operating Officer currently receives annual base compensation of $175,000. Such base compensation, however, will be reduced by 20 percent on the date of this Prospectus until such time as the Company generates net sales of $1,500,000 or more for any three consecutive month period. In addition, each is entitled to receive cash bonuses based upon the Company's performance. For fiscal 1995, each received a salary of $150,000 and a bonus of $75,000. The Company's President and Chief Operating Officer also has received options to purchase a total of 392,838 shares of Common Stock at nominal cost since April 1994 (including options to purchase 292,838 shares granted by the Company and options to purchase 100,000 shares granted by the Chairman of the Board and Chief Executive Officer). See "Management -- Executive Compensation." Such compensation may be considered excessive in view of the Company's size and history of operating losses. After the closing of this offering, the Company intends to hire a new Chief Executive Officer upon terms to be negotiated. When the new Chief Executive Officer is hired, Mr. Bitetti will resign as Chief Executive Officer and will continue to serve as Chairman of the Board and retain his current salary, bonuses and benefits, provided that his salary will be adjusted to an amount not less than that of the new Chief Executive Officer, up to a maximum of $300,000. NO OUTSIDE DIRECTORS The Company currently has no independent directors. Consequently, the Company's management is in a position to control the operations of the Company and is not subject to independent review. Following this offering, the Company intends to increase the size of its Board of Directors from three to five, to include one director nominated by ASSI, Inc. and two other independent directors. The Company has agreed to grant to each of The Boston Group, L.P., Joseph Stevens & Company, L.P. and ASSI, Inc., the right to nominate from time to time one director of the Company or to have an individual designated thereby attend all meetings of the Board of Directors of the Company as a nonvoting advisor. Upon such expansion, it is anticipated that the Board will include three independent directors. See "Management -- Directors and Executive Officers," "Underwriting" and "Certain Transactions -- Agreements with ASSI, Inc." LIMITATION ON DIRECTORS' LIABILITY; INDEMNIFICATION The Company's Certificate of Incorporation provides that a director of the Company, to the maximum extent now or hereafter permitted by Section 102(b)(7) of the Delaware General Corporation Law (the "Delaware GCL"), will have no personal liability to the Company or its stockholders for monetary damages for breach of fiduciary duty as a director. The Company's Bylaws generally require the Company to indemnify and advance expenses to its directors, officers, employees and other agents to the fullest extent permitted by Delaware law. The Company also has entered into indemnification agreements with each of its directors whereby the Company will indemnify each such person against certain claims arising out of certain past, present or future acts, omissions or breaches of duty -13-
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committed by an indemnitee while serving as a Company director. See "Management -- Limitation of Liability and Indemnification of Directors." CHANGES IN TECHNOLOGY AND INDUSTRY STANDARDS The consumer software industry is undergoing rapid changes, including evolving industry standards, frequent new product introductions and changes in consumer requirements and preferences. The introduction of new technologies, including operating systems and media formats, could render the Company's existing products obsolete or unmarketable. In 1993, for example, there was a significant shift in consumer demand from DOS-based software to Microsoft- Registered Trademark--Windows-Registered Trademark--based software. More recently, consumer demand has been shifting from disk-based software to software on CD-ROM. In addition, the recent introduction of the new Windows '95- Registered Trademark- operating system may affect consumer preferences and the demand for new consumer software in ways which cannot be foreseen. In the future, there could be radical changes in software delivery systems, replacing CD-ROM with on-line or other methods of distribution. There can be no assurance that the current demand for the Company's Windows-Registered Trademark- and CD-ROM products will continue or that the mix of the Company's future product offerings will keep pace with technological changes or satisfy evolving consumer preferences. The success of the Company will be dependent upon its ability to develop, introduce and market products which respond to such changes in a timely fashion. The Company intends to maintain its products in accordance with industry standards. The development cycle for products utilizing new operating systems or formats may be significantly longer than the Company's current development cycle for products on existing operating systems and formats and may require the Company to invest resources in products that may not become profitable. Although the Company's software is Windows '95-Registered Trademark- compatible, there can be no assurance that the Company will be successful in developing and marketing products for certain advanced and emerging operating systems and formats that may arise in the future. Failure to develop and introduce new products and product enhancements in a timely fashion could result in significant product returns and inventory obsolescence and could impair the Company's business, operating results and financial condition. See "Business -- Products" and "-- Development." UNCERTAINTY OF MARKET ACCEPTANCE; SHORT PRODUCT LIFE CYCLES Consumer preferences for software products are difficult to predict, and few consumer software products achieve sustained market acceptance. The Company believes that the highest sales of each of its products will occur during the six- to nine-month periods following their introduction, and that thereafter sales will diminish and pricing will be reduced. Therefore, the Company's success is dependent upon the market acceptance of its existing products and the continued development and introduction of new products which achieve market acceptance. There can be no assurance that the Company's existing products will continue to realize market acceptance, or that new products introduced by the Company will achieve any significant degree of market acceptance or sustain any such acceptance for any significant period of time. Failure of the Company's new and existing products to achieve and sustain market acceptance will have a material adverse effect on the Company's business, operating results and financial condition. See "Business -- Products" and "-- Development." FLUCTUATIONS IN OPERATING RESULTS; SEASONALITY The Company has experienced, and may continue to experience, fluctuations in operating results due to a variety of factors, including the size and rate of growth of the consumer software market, market acceptance of the Company's products and those of its competitors, development and promotional expenses relating to the introduction of new products or new versions of existing -14-
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products, ability to add new distribution channels, product returns, changes in pricing policies by the Company and its competitors, the accuracy of retailers' forecasts of consumer demand, the timing of the receipt of orders from major customers, and account cancellations or delays in shipment. In response to competitive pressures for new product introductions, the Company may take certain pricing or marketing actions that could materially and adversely affect the Company's business, operating results and financial condition. The Company's expense levels are based, in part, on its expectations as to future sales. Therefore, operating results could be disproportionately affected by a reduction in sales or a failure to meet the Company's sales expectations. The Company may be required to pay in advance or to guarantee royalties, which may be substantial, to obtain licenses of intellectual properties from third parties before such properties have been introduced or achieved market acceptance. Defective products may result in higher customer support costs and product returns. Additionally, the consumer software business traditionally has been seasonal. Typically, net sales are highest during the fourth calendar quarter and decline sequentially in the first and second calendar quarters. The seasonal pattern is due primarily to the increased demand for consumer software during the year-end holiday buying season. The Company expects its net sales and operating results to continue to reflect seasonality. There can be no assurance that the Company will achieve consistent profitability on a quarterly or annual basis. Nevertheless, management believes that in the future its results may be less subject to seasonal fluctuations because its products will be marketed in conjunction with the releases of major motion pictures and home videos, which occur throughout the year. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Quarterly Results of Operations." DEPENDENCE ON RETAILERS The Company's retail customers include computer stores, office supply stores, warehouse clubs, consumer electronics stores, bookstores, video stores and alternative channels. The Company's customers are not contractually required to make future purchases of the Company's products and therefore could discontinue carrying the Company's products in favor of a competitor's product or for any other reason. Retailers compete in a volatile industry that is subject to rapid change, consolidation, financial difficulty and increasing competition from new distribution channels. Due to increased competition for limited shelf space, retailers are increasingly in a better position to negotiate favorable terms of sales, including price discounts and product return policies. Retailers often require software publishers to pay fees in exchange for preferred shelf space. Retailers may give higher priority to products other than the Company's, thus reducing their efforts to sell the Company's products. There can be no assurance that the Company will be able to increase or sustain its current amount of retail shelf space or promotional resources, and as a result, the Company's operating results could be materially adversely affected. In addition, other types of retail outlets and methods of product distribution may become important in the future, such as on-line services. It is critical to the success of the Company that as these changes occur, the Company gains access to those channels of distribution. See "Business -- Sales and Marketing." DEPENDENCE ON OUTSIDE SUPPLIERS The Company contracts with third party suppliers to provide programming and manufacturing of its products, which the Company believes allows it to control effectively its costs of production. The Company relies upon the ability of such suppliers to provide products which are free of defects. To the extent that any supplier produced defective product which was not discovered until the product was shipped, it could result in liability of the Company for returned merchandise and a loss of its reputation for high quality products. Although the Company would attempt to recoup any expenses -15-
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caused to it for defective products, there can be no assurance that it would be fully compensated for any losses that resulted. RISK OF INABILITY TO MANAGE RAPID GROWTH The Company is currently experiencing a period of rapid growth that has placed, and could continue to place, a significant strain on the Company's financial, management and other resources. The Company's ability to manage its growth effectively will require it to continue to improve its operational, financial and management information systems, and to attract, train, motivate, manage and retain key employees. The Company may make additional investments in capital equipment to expand into new product lines. No assurances can be given that these new systems will be implemented successfully, and the failure to do so could have a material adverse effect on the Company's business, operating results and financial condition. If the Company's management becomes unable to manage growth effectively, the Company's business, operating results and financial condition could be materially adversely affected. See "Business -- Operations" and "Management -- Directors and Executive Officers." RISKS ASSOCIATED WITH ACQUISITIONS As part of its strategy to enhance revenue growth and market presence, the Company continually evaluates acquisitions of entertainment software companies and selected titles within existing or new product categories. In considering an acquisition, the Company may compete with other potential acquirors, many of which may have greater financial and operational resources. Further, the evaluation, negotiation and integration of such acquisitions may divert significant time and resources of the Company, particularly management. There can be no assurance that suitable acquisition candidates will be identified, that any acquisitions can be consummated, or that any acquired businesses or products can be successfully integrated into the Company's operations. In addition, there can be no assurance that future acquisitions will not have a material adverse effect upon the Company's business, operating results and financial condition, particularly in the fiscal quarters immediately following the consummation of such transactions due to unexpected expenses which may be associated with integrating such acquisitions. See "Business -- Strategy -- Acquisitions." LIMITED PROTECTION OF INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS The Company regards its software as proprietary and relies primarily on a combination of trademark, copyright and trade secret laws, employee and third party nondisclosure agreements and other methods to protect its proprietary rights. All of the Company's new products are CD-ROM based, and hence are difficult to copy. However, unauthorized copying occurs within the software industry, and if a significant amount of unauthorized copying of the Company's products were to occur, the Company's business, operating results and financial condition could be materially adversely affected. Also, as the number of software products in the industry increases and the functionality of these products further overlaps, software developers and publishers may increasingly become subject to infringement claims. There can be no assurance that third parties will not assert infringement claims against the Company in the future with respect to current or future products. The Company's licenses and other intellectual property may not be transferred to third parties without the consent of the licensors. Under the terms of certain such licenses, transfer of ownership of stated percentages of the Common Stock could constitute a prohibited transfer of the licenses. The licensors under such licenses have agreed that neither the sale by the Company of the Common Stock pursuant to this offering nor the issuance by the Company of the Common Stock underlying the Redeemable Warrants and the Representative's Warrant will cause a termination of such licenses. Certain other licenses provide that a change in "management" will be deemed an unauthorized -16-
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assignment of the license. It is not clear under what circumstances the Company might be deemed to have a change in management which could result in the termination of licenses containing this provision. Any future change in ownership or control of the Company could result in the termination of the licenses referred to above. The potential terminability of such licenses could have the effect of delaying, deferring or preventing a change in control of the Company, may discourage bids for the Common Stock at a premium over the market price of the Common Stock and may materially adversely affect the market price of the Common Stock. Although the Company has not been the subject of any actual, pending or threatened intellectual property litigation, there has been substantial litigation regarding copyright, trademark and other intellectual property rights involving computer software companies. In the future, litigation may be necessary to enforce the Company's proprietary rights, to protect copyrights, trademarks and trade secrets and other intellectual property rights owned by the Company or its licensors, to defend the Company against claimed infringements of the rights of others and to determine the scope and validity of the proprietary rights of the Company and others. Any such litigation, with or without merit, could be costly and result in a diversion of management's attention, which could have a material adverse effect on the Company's business, operating results and financial condition. Adverse determinations in such litigation could result in the loss of the Company's proprietary rights, subject the Company to significant liabilities, require the Company to seek licenses from third parties or prevent the Company from selling its products, any of which could have a material adverse effect on the Company's business, operating results and financial condition. LIMITED TIME PERIOD OF LICENSES The Company's products are based upon licensed content of major motion pictures and television shows under license and/or development agreements with major entertainment studios. See "Business -- General" and "-- Licensed Property." All of such license and development agreements to which the Company currently is a party are for fixed terms which will expire over the next one to five years. Although no licensor is required to extend any license, the Company anticipates that the licensor under each agreement will extend its terms, provided that the Company is in compliance with all requirements of each license, including most significantly that the Company has satisfied the applicable minimum royalty guarantees. In the event that any licensor fails to renew its license agreement, then the subject license will terminate and the Company will no longer be entitled to sell the licensed product. The loss of one or more of the licenses could have a material adverse effect on the Company's revenues and operating results. There can be no assurance that the Company will satisfy its performance obligations under any license or development agreement or that even if such requirements are satisfied, all material licenses will be renewed. See "Business -- Proprietary Rights and Licenses." DEPENDENCE ON NET PROCEEDS OF THIS OFFERING; POSSIBLE NEED FOR ADDITIONAL FINANCING The Company is dependent on the net proceeds of this offering or other financing to repay the aggregate principal amount of $4,987,500 in Private Notes issued to investors in the Company's 1995 Private Placement, plus accrued interest estimated at $242,500 as of March 31, 1996. As of the date of this Prospectus, the Company has been dependent on the net proceeds of approximately $4,023,000 from its 1995 Private Placement, the net proceeds of approximately $278,000 from its 1995 Bridge Financing (which was repaid out of the net proceeds of the Company's 1995 Private Placement), $263,300 of proceeds from the Private Warrants and the net proceeds of approximately $1,371,000 from its 1994 Private Placement, to fund its working capital requirements. The Company believes that the proceeds of this offering, together with its cash on hand, and anticipated net cash -17-
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flow from operations, will be sufficient to fund the Company's contemplated cash requirements for at least the next 12 months. However, there can be no assurance that additional unanticipated expenses will not arise which would require additional financing. See "Use of Proceeds" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." BROAD DISCRETION IN USE OF PROCEEDS The net proceeds to the Company from the sale of the Securities offered hereby, after deducting underwriting discounts and the estimated expenses of this offering of $600,000 (including the Representatives' three percent nonaccountable expense allowance), are estimated to be approximately $8,313,000 (assuming the Underwriters' over-allotment option is not exercised), assuming a public offering price of $4.00 per share and $.25 per Redeemable Warrant. The Company estimates that of such net proceeds, $2,183,000 will be allocated to working capital. If the Underwriters exercise their over-allotment in full, the Company will realize additional net proceeds of approximately $1,183,200, all of which will be allocated to working capital. The Company will have broad discretion in the use of funds allocated to working capital. See "Use of Proceeds." RISK OF LIMITATION OF USE OF NET OPERATING LOSS CARRYFORWARDS As of June 30, 1995, the Company had net operating loss carryforwards of approximately $2,513,000 for federal income tax purposes, which may be utilized from 1996 to 2011 (subject to certain limitations). It is possible that the consummation of this offering, including the issuance of the Securities offered hereby and the Representative's Warrant, will result in an "ownership change" as defined in Section 382 of the Internal Revenue Code of 1986, as amended (the "Code"), and the Treasury Regulations promulgated thereunder, or that the issuance of warrants to investors in the Company's 1995 Bridge Financing and 1995 Private Placement and the reverse stock split effected by the Company in September 1995 may have resulted in an ownership change under the Code and said Treasury Regulations. As a result, the Company's use of its net operating loss carryforwards to offset taxable income in any post-change period may be subject to certain specified annual limitations. If there is any ownership change, there can be no assurance as to the specific amount of net operating loss carryforwards available in any post-change year since the calculation is based upon a fact-dependent formula. CONTROL OF THE COMPANY BY OFFICERS AND DIRECTORS Upon the consummation of this offering, the current officers and directors of the Company including the current controlling stockholder, will, in the aggregate, beneficially own approximately 42.0 percent of the Common Stock (16.2 percent assuming exercise in full of the Redeemable Warrants and all other outstanding warrants and options, but excluding issuance of any Common Stock and Redeemable Warrants pursuant to the over-allotment option). As a result, it is anticipated that these individuals will be in a position to influence materially, if not control, the outcome of all matters requiring stockholder approval, including the election of directors. See "Management," "Principal Stockholders," "Description of Securities -- Common Stock" and "Underwriting." Such influence and control is likely to continue for the foreseeable future. The Company is, and upon consummation of this offering will be, a QUASI- California corporation subject to certain provisions of the California General Corporation Law (the "California GCL"). See "Description of Securities -- Application of California GCL." Among other consequences of the Company's status as a QUASI-California corporation, at the request of any stockholder, the election of the Company's directors will be determined by cumulative voting procedures. Consequently, following this offering the Company's stockholders other than its current officers and directors will have sufficient votes, if cumulative voting is exercised, to elect two of its three directors (or three of its five -18-
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directors, upon expansion of the Board following this offering as planned) assuming no exercise of the Redeemable Warrants and two of its three (or four of its five, as applicable) directors assuming exercise of the Redeemable Warrants in full. The Company has agreed to allow each of The Boston Group, L.P., Joseph Stevens & Company, L.P. and ASSI, Inc. to nominate one director following this offering. In addition, Vincent J. Bitetti, the Chairman of the Board and Chief Executive Officer, and Eric H. Winston, the President and Chief Operating Officer, have entered into voting agreements with each of The Boston Group, L.P., Joseph Stevens & Company, L.P. and ASSI, Inc. Pursuant to these agreements, Messrs. Bitetti and Winston have agreed to vote their Common Stock for the three director nominees of The Boston Group, L.P., Joseph Stevens & Company, L.P. and ASSI, Inc. In addition, ASSI, Inc. has agreed to vote its shares of Common Stock for two directors nominated by Mr. Bitetti for as long as he holds 20 percent or more of the issued and outstanding Common Stock, and for one director nominated by Mr. Bitetti for as long as he holds at least ten perent but less than 20 percent of the issued and outstanding Common Stock. The voting agreements with ASSI, Inc. will terminate when Messrs. Bitetti and Winston together cease to own at least ten percent of the issued and outstanding Common Stock. See "Management -- Directors and Executive Officers." IMMEDIATE SUBSTANTIAL DILUTION This offering involves an immediate and substantial dilution to investors in this offering of $2.91 per share of Common Stock (73 percent) between the pro forma net tangible book value per share after this offering and the initial public offering price of the shares of Common Stock. See "Dilution." RECENTLY FORMED REPRESENTATIVES Both of the Representatives are recently formed, and neither has extensive experience as an underwriter of securities. The Boston Group, L.P., which was formed in March 1995, has acted as the managing underwriter for three public offerings and has not acted as a member of an underwriting syndicate. Joseph Stevens & Company, L.P., which was formed in May 1994, has acted as the managing underwriter for four public offerings and as a member of an underwriting syndicate on approximately seven occasions. The Representatives are relatively small firms. No assurance can be given that either will be able to participate as a market maker in the Securities, or that any other broker-dealer will do so. See "Underwriting." REPRESENTATIVES' POTENTIAL INFLUENCE ON THE MARKET It is anticipated that a significant amount of the shares of Common Stock and substantially all of the Redeemable Warrants being offered hereby will be sold to customers of the Representatives. Although the Representatives have advised the Company that they intend to make a market in the Securities following this offering, they will have no legal obligation to do so. The Representatives, if they become market makers, could be a dominating influence in the market, if one develops. The prices and the liquidity of the Common Stock and the Redeemable Warrants may be significantly affected by the degree, if any, of the Representatives' participation in the market. No assurance can be given that any market making activities of the Representatives, if commenced, will be continued. See "Underwriting." -19-
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CURRENT PROSPECTUS AND STATE REGISTRATION TO EXERCISE WARRANTS The Redeemable Warrants are not exercisable unless, at the time of the exercise, the Company has a current prospectus covering the shares of Common Stock issuable upon exercise of the Redeemable Warrants and such shares have been registered, qualified or deemed to be exempt under the securities or "blue sky" laws of the jurisdiction of residence of the exercising holder of the Redeemable Warrants. In addition, in the event that any holder of the Redeemable Warrants attempts to exercise any Redeemable Warrants at any time after nine months from the date of this Prospectus, the Company may be required to file a post-effective amendment and deliver a current prospectus before the Redeemable Warrants may be exercised. Although the Company has undertaken to use its best efforts to have all the shares of Common Stock issuable upon exercise of the Redeemable Warrants registered or qualified on or before the exercise date and to maintain a current prospectus relating thereto until the expiration of the Redeemable Warrants, there is no assurance that it will be able to do so. The value of the Redeemable Warrants may be greatly reduced if a current prospectus covering the Common Stock issuable upon the exercise of the Redeemable Warrants is not kept effective or if such Common Stock is not qualified or exempt from qualification in the jurisdictions in which the holders of the Redeemable Warrants then reside. The Redeemable Warrants will be separately tradeable immediately upon issuance and may be purchased separately from the Common Stock. Although the Securities will not knowingly be sold to purchasers in jurisdictions in which the Securities are not registered or otherwise qualified for sale, investors may purchase the Redeemable Warrants in the secondary market or may move to jurisdictions in which the shares underlying the Redeemable Warrants are not registered or qualified during the period that the Redeemable Warrants are exercisable. In such event, the Company would be unable to issue shares to those persons desiring to exercise their Redeemable Warrants unless and until the shares could be qualified for sale in jurisdictions in which such purchasers reside, or an exemption from such qualification exists in such jurisdictions, and holders of the Redeemable Warrants would have no choice but to attempt to sell the Redeemable Warrants in a jurisdiction where such sale is permissible or allow them to expire unexercised. See "Description of Securities -- Redeemable Warrants." ADVERSE EFFECT TO HOLDERS OF POSSIBLE REDEMPTION OF REDEEMABLE WARRANTS The Redeemable Warrants are subject to redemption by the Company, at any time, commencing one year after the date of this Prospectus, at a price of $.25 per Redeemable Warrant if the average closing bid price for the Common Stock equals or exceeds 140 percent of the initial public offering price per share for any 20 trading days within a period of 30 consecutive trading days ending on the fifth trading day prior to the date of the notice of redemption. If the Redeemable Warrants are redeemed prior to their exercise, the holders thereof would lose their right to exercise Redeemable Warrants except during such period of notice of redemption and the benefit of the difference between the market price of the underlying Common Stock as of such date and the exercise price of such Redeemable Warrants, as well as any possible future price appreciation in the Common Stock. Upon the receipt of a notice of redemption of the Redeemable Warrants, the holders thereof would be required to: (i) exercise the Redeemable Warrants and pay the exercise price at a time when it may be disadvantageous for them to do so; (ii) sell the Redeemable Warrants at the market price, if any, when they might otherwise wish to hold the Redeemable Warrants; or (iii) accept the redemption price, which is likely to be substantially less than the market value of the Redeemable Warrants at the time of redemption. See "Description of Securities -- Redeemable Warrants" and "Underwriting." SHARES ELIGIBLE FOR FUTURE SALE A total of 4,208,291 shares of Common Stock will be issued and outstanding upon the consummation of this offering, assuming no exercise of the Underwriters' over-allotment option -20-
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and assuming that the Representative's Warrants and all other options and warrants then to be outstanding are not exercised. Of such shares, the 2,400,000 shares offered by the Company and the 107,500 shares offered by the Selling Security Holders will be freely tradeable without further registration under the Securities Act, except for any such shares of Common Stock purchased by an "affiliate" of the Company. Of the remaining 1,700,791 outstanding shares, 183,723 shares are freely tradeable and the remainder are "restricted shares" as defined in Rule 144 under the Securities Act and may not be sold without registration under the Securities Act unless pursuant to an applicable exemption therefrom. See generally "Shares Eligible for Future Sale." SALE OF CERTAIN SECURITIES A separate Prospectus is being filed with the Registration Statement of which this Prospectus is a part which relates to the registration for the account of the Selling Security Holders of 107,500 shares of Common Stock and 5,689,665 Redeemable Warrants and to the registration for the account of the Company of 9,069,665 shares of Common Stock issuable upon exercise of the Redeemable Warrants and ASSI Warrants. The Selling Security Holders' Securities may be sold by the Selling Security Holders or their transferees commencing on the date of this Prospectus. Sales by the Selling Security Holders or their transferees of the Selling Security Holders' Securities may depress the price of the Common Stock or the Redeemable Warrants in any market therefor that may develop. See "Certain Transactions" and "Resale of Outstanding Securities." In addition, the Company has issued warrants for 2,000,000 shares of Common Stock to ASSI, Inc., a consultant to and creditor of the Company. The Common Stock underlying the ASSI Warrants is being registered pursuant to the Registration Statement of which this Prospectus is a part. Sales of the Common Stock underlying the ASSI Warrants may depress the market for the Common Stock. See "Certain Transactions -- Agreements With ASSI, Inc." NO PRIOR MARKET; ARBITRARY DETERMINATION OF OFFERING PRICE; POSSIBLE VOLATILITY OF TRADING PRICES FOR SECURITIES Prior to this offering, there has been no public market for the Common Stock or the Redeemable Warrants, and there can be no assurance that a public market for the Securities will develop or, if developed, that it will be sustained after the offering. The initial public offering prices of the Common Stock and Redeemable Warrants and the terms of the Redeemable Warrants were determined arbitrarily by, among other things, negotiations between the Company and the Representative and bear no relationship to the Company's assets, net worth, results of operations or other established criteria of value. See "Underwriting." Pursuant to a separate Prospectus filed as a part of the Registration Statement of which this Prospectus is a part, 107,500 shares of Common Stock and 5,689,665 Redeemable Warrants previously issued by the Company are being registered for the account of the Selling Security Holders. See "Certain Transactions -- 1995 Bridge Financing" and "-- 1995 Private Placement" and "Selling Security Holders." Such Common Stock and Redeemable Warrants are expected to become freely tradeable on or about the third business day after the date of this Prospectus. In addition, the 9,069,665 shares of Common Stock issuable upon exercise of the 5,689,665 Redeemable Warrants being registered for the account of the Selling Security Holders, the 2,000,000 ASSI Warrants and the 1,380,000 Redeemable Warrants being issued by the Company pursuant to this offering (assuming exercise of the Underwriters' over-allotment option) all will become freely tradeable on the date of their issuance pursuant to the exercise of such Redeemable Warrants and ASSI Warrants. Sales of the Common Stock and Redeemable Warrants being registered for the account of the Selling Security Holders will likely have an adverse effect on the market price of the shares of Common Stock and the Redeemable Warrants being issued by the Company pursuant to this offering, and such adverse effect may be material. In addition, the Common Stock underlying the Redeemable Warrants being issued by the Company pursuant to this offering and being separately -21-
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registered for the account of the Selling Security Holders and the ASSI Warrants also are expected to become freely tradeable on the issuance thereof pursuant to conversion of the related Redeemable Warrants or ASSI Warrants, as applicable. Sales of such Common Stock also will likely have an adverse effect on the market price of the Common Stock and such adverse effect may be material. The trading prices of the Securities could be subject to wide fluctuations in respect to the Company's operating results announcements by the Company or others of developments affecting the Company or its competitors or customers and other events or factors. In addition, the stock market has experienced extreme price and volume fluctuations in recent years, particularly in the securities of small development companies. The fluctuations have had a substantial effect on the market prices of many companies, often unrelated to the operating performances of the specific companies, and similar events in the future may materially adversely affect the market prices of the Securities. See "Description of Securities" and "Selling Security Holders." ADVERSE EFFECT ON COMMON STOCK FROM EXERCISE OF WARRANTS AND OPTIONS The Company's Certificate of Incorporation authorizes the issuance of 20,000,000 shares of Common Stock. A total of 4,208,291 shares of Common Stock will be outstanding after the completion of this offering, assuming exercise of the Underwriters' over-allotment option and assuming that the Representative's Warrant and all other stock options and warrants then to be outstanding are not exercised. A total of 8,889,665 shares of Common Stock are reserved for issuance pursuant to the Redeemable Warrants being issued by the Company pursuant to this offering and being registered for the account of the Selling Security Holders (and assuming no exercise of the Underwriters' over-allotment option) and the ASSI Warrants. An additional 1,536,908 shares of Common Stock are reserved for issuance pursuant to the Representative's Warrant (360,000 shares, including Common Stock issuable pursuant to the Redeemable Warrants issuable pursuant to the Representative's Warrant), options previously granted by the Company to the President and Chief Operating Officer (292,838 shares) and under the 1992 Stock Option Plan (384,000 shares) and options that may be granted under the 1995 Stock Option Plan (500,000). Thus, an additional 5,365,136 shares of Common Stock remain available for issuance at the discretion of the Board of Directors. The potential issuance of such authorized and unissued Common Stock may have the effect of delaying, deferring or preventing a change in control of the Company, may discourage bids for the Common Stock at a premium over the market price of the Common Stock and may materially adversely affect the market price of, and the voting and other rights of the holders of the Common Stock. Although the Company has no present intention to issue any such shares of its authorized and unissued Common Stock there can be no assurance the Company will not do so in the future. See "Description of Securities -- Common Stock." NO PREEMPTIVE RIGHTS; POSSIBLE DILUTIVE EVENT The holders of Common Stock do not have any subscription, redemption or conversion rights, nor do they have any preemptive or other rights to acquire or subscribe for additional, unissued or treasury shares. Accordingly, if the Company were to elect to sell additional shares of Common Stock, or securities convertible into or exercisable to purchase shares of Common Stock, following this offering, persons acquiring Common Stock in this offering would have no right to purchase additional shares, and as a result, their percentage equity interest in the Company would be diluted. See "Description of Securities -- Common Stock." -22-
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NO DIVIDENDS As of the date of this Prospectus, the Company has not paid any cash dividends on its Common Stock and does not intend to declare any such dividends in the foreseeable future. The Company's ability to pay dividends is subject to limitations imposed by Delaware law and, as a QUASI-California corporation, to the more restrictive provisions of California law. The sole source of funds available to the Company for the payment of dividends is dividends or loans advanced to it by the Subsidiary which is itself a California corporation and therefore subject to the dividend payment provisions of the California GCL. Under Delaware law, dividends may be paid out of a corporation's capital surplus, or if there is no surplus, out of the corporation's net profits for the fiscal year in which the dividend is declared or the preceding fiscal year. California law generally prohibits a corporation from paying dividends unless the retained earnings of the corporation immediately prior to the distribution exceed the amount of the distribution. Alternatively, a corporation may pay dividends if (i) the assets of the corporation exceed 1-1/4 times its liabilities; and (ii) the current assets of the corporation equal or exceed its current liabilities, but if the average pre-tax earnings of the corporation before interest expense for the two years preceding the distribution was less than the average interest expense of the corporation for those years, the current assets of the corporation must exceed 1-1/4 times its current liabilities. Under the foregoing requirements, the Company will not be able to pay dividends for the foreseeable future. See "Dividend Policy" and "Description of Securities." QUALIFICATION REQUIREMENTS FOR NASDAQ SECURITIES; RISK OF LOW PRICED SECURITIES Certain qualification requirements are established for the initial and continued listing of securities on Nasdaq. The Common Stock and the Redeemable Warrants will be eligible for initial listing on the Nasdaq SmallCap Market under these rules upon consummation of this offering. Under the rules for initial listing, a company must, among other things, have at least $4,000,000 in total assets, at least $2,000,000 in total capital and surplus, and a minimum bid price of $3.00 per share. For continued listing, a company must, among other things, maintain at least $2,000,000 in total assets, at least $1,000,000 in total capital and surplus, and a minimum bid price of $1.00 per share. The Company has qualified for initial listing on the Nasdaq SmallCap Market and expects to maintain its listing on Nasdaq; however, if the Company experiences losses from operations or material adverse trading conditions, it may be unable to maintain the standards for continued listing and the Securities could be subject to delisting from Nasdaq. It is anticipated that if the Securities are delisted from Nasdaq, trading, if any, in the Securities would be conducted in the over-the-counter market on the NASD OTC Electronic Bulletin Board established for securities that do not meet the Nasdaq listing requirements or quoted in what are commonly referred to as the "pink sheets." In such event, an investor may find it more difficult to dispose of, or to obtain accurate price quotations and volume information concerning, the Securities. In addition, if the Securities are delisted from Nasdaq, they might be subject to the low priced security or so-called "penny stock" rules that impose additional sales practice requirements on broker-dealers who sell such securities to persons other than established customers and accredited investors (generally defined as investors with a net worth in excess of $1,000,000 or annual income exceeding $200,000, or $300,000 together with a spouse). For any transaction involving a penny stock, unless exempt, the rules require, among other things, the delivery, prior to the transaction, of a disclosure schedule required by the Securities and Exchange Commission relating to the penny stock market. The broker-dealer also must disclose the commissions payable to both the broker-dealer and the registered representative, current quotations for the securities and, if the broker-dealer is the sole market-maker, the broker-dealer must disclose this fact and the broker-dealer's presumed control over -23-
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the market. Finally, monthly statements must be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stocks. Although the Company believes that the Securities will not be defined as a penny stock due to their anticipated continued listing on Nasdaq, in the event the Securities subsequently become characterized as a penny stock, the market liquidity for the Securities could be severely affected. In such an event, the regulations relating to penny stocks could limit the ability of broker-dealers to sell the Securities and, thus, the ability of purchasers in this offering to sell their Securities in the secondary market. -24-
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USE OF PROCEEDS The net proceeds to the Company from the sale of the Securities offered hereby, after deducting underwriting discounts of $990,000 and $600,000 for expenses, including the Representatives' three percent nonaccountable expense allowance, are estimated to be approximately $8,310,000 ($9,496,200 if the Underwriters' over-allotment option is exercised in full), assuming a public offering price of $4.00 per share and $.25 per Redeemable Warrant. The Company anticipates that the estimated net proceeds of this offering initially will be allocated substantially as follows: APPROXIMATE PERCENTAGE OF APPLICATION OF NET PROCEEDS DOLLAR AMOUNT NET PROCEEDS ------------------------------------------- ------------- ------------- Repayment of Notes(1). . . . . . . . . . $5,230,000 62.9% Marketing Expenses(2). . . . . . . . . . 400,000 4.8 Licenses and Royalties(3). . . . . . . . 450,000 5.4 Capital Expenditures(4) . . . . . . . . 50,000 .6 Working capital(5) . . . . . . . . . . . 2,180,000 26.3 --------- ---- Total. . . . . . . . . . . . . . . . . . $8,310,000 100.0% ------------------------ (1) Represents repayment of all of the Company's outstanding Private Notes in the aggregate principal amount of $4,987,500, plus accrued interest of approximately $242,500 as of March 31, 1996. The Private Notes were issued in connection with the Company's 1995 Private Placement (as defined below), bear interest at the rate of ten percent per annum and are due on the earlier of (i) September 1, 1996 or (ii) the completion of any initial public offering by the Company. See "Certain Transactions -- 1995 Private Placement." (2) Represents amounts expected to be expended in connection with product marketing activities, including print and co-operative advertising, promotions and contests, coupon inserts and in-store displays. (3) Represents amounts expected to be paid to licensors in connection with the obtaining of new licenses, and to licensors under the terms of existing licenses. (4) Represents amounts expected to be expended for purchases of equipment for use in the Company's business. (5) Working capital will be used, among other things, to fund operating expenses, including rent and salaries. If the Underwriters exercise their over-allotment option in full, the Company will realize additional net proceeds of approximately $1,183,200 which will be added to the Company's working capital. In addition, all net proceeds received by the Company upon the exercise, if any, of the Redeemable Warrants and the Representative's Warrant will be added to working capital. The Company anticipates that the net proceeds of this offering, together with its cash on hand and anticipated net cash flow from operations, will be sufficient to fund the Company's contemplated cash requirements for at least the next 12 months. See "Risk Factors -- Dependence on Net Proceeds of this Offering; Possible Need for Additional Financing." While the initial allocation of the net proceeds of this offering, as set forth above, represents the Company's best estimates of its future financing needs, the amounts actually expended for each purpose may vary significantly from the specific allocation of the net proceeds set forth above, depending on numerous factors. The Company, -25-
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therefore, reserves the right to reallocate the net proceeds of this offering among the various categories set forth above as it, in its sole discretion, deems necessary or advisable. In the event that the Company requires additional financing prior to the completion of this offering, the Company reserves the right to borrow up to $500,000. It is anticipated that any such loan will be made at an interest rate not to exceed ten percent per annum. Any such loan would be repaid out of the proceeds of this offering. The Company, however, may allow the lender to convert the outstanding balance of the loan into warrants having terms substantially the same as those of the Redeemable Warrants. Part of the Company's strategy is to expand through acquisitions. After this offering, the Company intends to seek to make such acquisitions, but it is not currently a party to any discussion, agreement, arrangement or understanding in connection with any such acquisition. See "Business -- Business Strategy -- Acquisitions and Affiliate Label Arrangements." Pending application, the net proceeds of this offering will be invested principally in U.S. government securities, short-term certificates of deposit, money market funds or other similar short-term interest-bearing investments. DIVIDEND POLICY The Company has not declared or paid any cash dividends on its Common Stock since its inception. It is the current policy of the Company that it will retain its earnings, if any, for expansion of its operations and other corporate purposes, and that it will not pay any dividends in respect of the Common Stock in the foreseeable future. The payment of dividends, if any, is within the discretion of the Board of Directors and will depend upon the Company's earnings, if any, its capital requirements and financial condition and such other factors as the Board of Directors may consider. The Company's ability to pay dividends is subject to the applicable provisions of the General Corporation Law of Delaware, which is the Company's jurisdiction of incorporation. As a QUASI-California corporation, the Company also is subject to the relatively more restrictive provisions of the California GCL. The sole source of funds available to the Company for the payment of dividends is dividends and loans advanced to it by the Subsidiary, which is itself a California corporation and therefore subject to the dividend payment provisions of the California GCL. Under Delaware law, dividends may be paid out of a corporation's capital surplus, or if there is no surplus, out of the corporation's net profits for the fiscal year in which the dividend is declared or the preceding fiscal year. California law generally prohibits a corporation from paying dividends unless the retained earnings of the corporation immediately prior to the distribution exceed the amount of the distribution. Alternatively, a corporation may pay dividends if the assets of the corporation exceed 1-1/4 times its liabilities; and (ii) the current assets of the corporation equal or exceed its current liabilities, but if the average pre-tax earnings of the corporation before interest expense for the two years preceding the distribution was less than the average interest expense of the corporation for those years, the current assets of the corporation must exceed 1-1/4 times its current liabilities. Under the foregoing requirements, the Company will not be able to pay dividends until it achieves positive retained earnings, which management does not anticipate will occur for the foreseeable future. See "Risk Factors - No Dividends." -26-
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DILUTION At December 31, 1995, the Company had 1,808,291 shares of Common Stock outstanding and at such date the net tangible book value of the Company was $(2,733,214) or approximately ($1.51) per share of Common Stock. "Net tangible book value per share" represents the total tangible assets of the Company, less total liabilities, divided by the number of shares of Common Stock outstanding. After giving effect to the receipt of the net proceeds (estimated to be approximately $8,049,000 after deducting the Underwriters' discount of $990,000 and $600,000 for expenses, including the Representatives' three percent nonaccountable expense allowance), from the sale of the 2,400,000 shares of Common Stock offered by the Company at an assumed public offering price of $4.00 per share (without giving any effect to the net proceeds from the sale of the Redeemable Warrants), the pro forma net tangible book value of the Company at December 31, 1995 would have been $4,584,918, or approximately $1.09 per share of Common Stock. This represents an immediate increase in net tangible book value of $2.60 per share of Common Stock to existing stockholders and an immediate dilution to new investors of approximately $2.91 per share of Common Stock. Dilution per share represents the difference between the offering price per share of Common Stock and the net tangible book value per share after giving effect to this offering. The following table illustrates the per share dilution to be incurred by the purchasers of Common Stock of this offering from the assumed initial public offering price of $4.00 per share: [Enlarge/Download Table] DESCRIPTION AMOUNT AMOUNT ------------------------------------------------------------------------ ---------- ---------- Assumed initial public offering price per share of Common Stock(1) . . $4.00 Net tangible book value per share of Common stock before offering . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1.51) Increase in net tangible book value per share of Common Stock attributable to the sale of the Common Stock offered by the Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.60 ---- Pro forma net tangible book value per share of Common Stock after offering . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.09 ---- Dilution per share of Common Stock to public investors(2)(3) . . . . . 2.91 ---- ---- -------------------------- (1) Before deducting underwriting discounts and other expenses of this offering. (2) If the net proceeds of $261,000 from the sale of the Redeemable Warrants offered by the Company (after deducting the Underwriters' discount and the Representative's nonaccountable expense allowance, but attributing no other costs of this offering to the Redeemable Warrants) had been attributed to the net tangible book value of the shares of Common Stock after this offering, it would increase the pro forma net tangible book value after this offering by $.06 per share of Common Stock and decrease the dilution to new public investors by approximately $.06 per share of Common Stock. (3) In the event that the Underwriters exercise their over-allotment option to purchase 340,000 shares of Common Stock from the Company, the pro forma net tangible book value of the Company after this offering (after deducting the underwriters' discount and the Representative's nonaccountable expense allowance but no other costs of this offering) would be approximately $6,029,118 (including the net proceeds of $261,000 from the sale of the Redeemable Warrants) or $1.33 per share of Common Stock, which would result in immediate dilution in net tangible book value to the public investors of approximately $2.67 per share of Common Stock. In the event of the further exercise of all 484,037 -27-
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presently exercisable Common Stock purchase options at the average exercise price of $.75 per share, and the sale and exercise in full of the Representative's Warrant including the sale and exercise in full of the Redeemable Warrants and the ASSI Warrants, and after giving effect to all of the aforementioned transactions, the pro forma net tangible book value of the Company would be approximately $49,666,063 or $3.43 per share, which would result in immediate dilution in net tangible book value to the public investors of approximately $.57 per share of Common Stock. The following table illustrates the per share dilution to be incurred by the purchasers of Common Stock in this offering upon exercise of the Redeemable Warrants and ASSI Warrants from the assumed exercise price of $4.00 per share: [Enlarge/Download Table] DESCRIPTION AMOUNT AMOUNT ----------------------------------------------------------------------- ---------- -------- Assumed initial public offering price per share of Common Stock(1) . . $4.00 Pro forma net tangible book value per share of Common stock before exercise of Redeemable Warrants and ASSI Warrants. . . . . $1.33 Increase in net tangible book value per share of Common Stock attributable to the sale of the Common Stock upon exercise of all Redeemable Warrants and ASSI Warrants . . . . . . . . . . . . . 2.10 ---- Pro forma net tangible book value per share of Common Stock after exercise of all Redeemable Warrants and ASSI Warrants . . . . . 3.43 ---- Dilution per share of Common Stock to investors exercising Redeemable Warrants and ASSI Warrants . . . . . . . . . . . . . . . . . . . . . . .57 ---- ---- ---------------------------------- (1) Before deducting warrant exercise fee payable to the Representative upon exercise of the Redeemable Warrants and ASSI Warrants. See "Underwriting." The following table sets forth, as of December 31, 1995, the number and percentage of shares of Common Stock purchased by, and the amount and percentage of consideration paid by, the existing stockholders, by public investors in this offering and the average price per share of Common Stock. [Enlarge/Download Table] SHARES PURCHASED TOTAL CONSIDERATION ----------------------------- ----------------------------------------------- AVERAGE PRICE NUMBER PERCENTAGE AMOUNT PERCENTAGE PER SHARE ------------ ---------- ----------- ---------- ------------- Current stockholders(1) 1,808,291 43.0% $6,128,007 39.0% $3.39 Public investors(2). . . . . . 2,400,000 57.0 9,600,000 61.0% 4.00 --------- ----- --------- ----- Total. . . . . . . . . . . 4,208,291 100.0% $15,728,007 100.0% (1) Includes: (i) $263,300 paid by the investors in the Company's 1995 Private Placement and 1995 Bridge Financing for warrants to purchase 5,268,747 shares of Common Stock issued by the Company in such private placements; and (ii) the nominal consideration of $50 paid by Financial West Group, Inc. for the -28-
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warrants to purchase up to 420,918 shares of Common Stock issued to it in connection with such private placements as part of the total consideration paid by existing stockholders. See "Certain Transactions." (2) Does not include the $600,000 to be paid by public investors for the 1,200,000 Redeemable Warrants being offered by the Company. To the extent that any of the Redeemable Warrants are exercised, there will be no further dilution to the public investors. The foregoing computations assume the exercise of no stock options after December 31, 1995. As of December 31, 1995, 292,838 shares of Common Stock were subject to presently exercisable options granted to the Company's President and Chief Operating Officer at an exercise price of $.06 per share. As of December 31, 1995, additional options to purchase a total of 184,070 shares of Common Stock were issued pursuant to the 1992 Stock Option Plan; options to purchase a total of 200,000 additional shares of Common Stock were subsequently issued pursuant to the 1992 Stock Option Plan. All of such options are non- qualified stock options having an exercise price of $.06 per share. Of the 384,070 options that have been granted pursuant to the 1992 Stock Option Plan, 191,199 are presently exercisable, 45,840 will become exercisable in fiscal 1997 and the balance will become exercisable in fiscal 1998. No further options may be granted pursuant to the Company's 1992 Stock Option Plan. An additional 500,000 shares of Common Stock are available for issuance under the Company's 1995 Stock Option Plan, of which the Company has agreed to issue 13,610 options to its nonexecutive employees. See "Management -- Executive Compensation," "-- 1995 Stock Option Plan" and "-- 1992 Stock Option Plan." The Representative's Warrant entitles the Representative to purchase 240,000 shares of Common Stock and/or 120,000 Redeemable Warrants at 120 percent of the offering price of the Common Stock or Redeemable Warrants, as applicable, in this offering, and will become exercisable one year after the date of this Prospectus. See "Underwriting." -29-
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CAPITALIZATION The following table sets forth, as of December 31, 1995, the short-term debt and capitalization of the Company on an actual basis and as adjusted to reflect the issuance and sale of the 2,400,000 shares of Common Stock and the 1,200,000 Redeemable Warrants offered by the Company and the initial application of the estimated net proceeds therefrom. The table should be read in conjunction with the financial statements and the notes to the financial statements which are contained elsewhere in this Prospectus. [Enlarge/Download Table] DECEMBER 31, 1995 ------------------------------------- ACTUAL AS ADJUSTED(1) -------------- --------------- Notes payable. . . . . . . . . . . . . . . . . . . . . . . . . . $ 4,987,500 $ 0 Stockholders' equity (deficit) Common Stock, $.001 par value; 20,000,000 shares authorized; 1,808,291 shares issued and outstanding (actual); 4,208,291 shares issued and outstanding (as adjusted) . . . . . . . . 1,808 4,208 Warrants . . . . . . . . . . . . . . . . . . . . . . . 263,350 524,350 Additional paid-in capital . . . . . . . . . . . . . . . . . . . 5,124,576 13,171,176 Accumulated deficit. . . . . . . . . . . . . . . . . . . . . . . (8,122,948) (8,853,816) Total stockholders' equity (deficiency). . . . . . . . . . . . . (2,733,214) 4,845,918 Total capitalization . . . . . . . . . . . . . . . . . 2,254,286 4,845,918 (1) As adjusted to reflect the issuance of 2,400,000 shares of Common Stock at an assumed initial public offering price of $4.00 per share and 1,200,000 Redeemable Warrants at an assumed initial public offering price of $.25 per Redeemable Warrant, net of anticipated expenses of the offering (estimated at $990,000 for the Underwriters' discount and $600,000 for expenses, including the Representatives' three percent nonaccountable expense allowance) and repayment of all of the Company's funded indebtedness (estimated at $5,105,676 at December 31, 1995) with a portion of such proceeds. The as adjusted amounts do not reflect the issuance of up to 340,000 shares of Common Stock and 180,000 Redeemable Warrants by the Company to cover over-allotments, if any, or the exercise of the Representative's Warrant to purchase up to 240,000 shares of Common Stock and/or 120,000 Redeemable Warrants, or the exercise of any other outstanding (or agreed to be issued) options or warrants to purchase up to an additional 10,120,183 shares of Common Stock. -30-
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SELECTED FINANCIAL DATA The following table of summary financial information is derived from and should be read in conjunction with the Company's financial statements and the footnotes thereto included elsewhere in this Prospectus. The financial data for the fiscal years ended June 30, 1994 and 1995 has been derived from audited financial statements prepared by Corbin & Wertz, certified public accountants, who are the Company's independent auditors. The Company's losses for fiscal 1994 and 1995 include noncash charges of $2,992,862 and $733,165, respectively, associated with the granting of certain compensatory stock options. The financial data for the six-month periods ended December 31, 1994 and 1995 are derived from unaudited financial statements of the Company. The unaudited financial statements include all adjustments consisting of normal recurring accruals which the Company considers necessary for a fair presentation of the financial position and the results of operations. Operating results for the six-month period are not necessarily indicative of the results that may be expected for the entire year ending June 30, 1996. See "Risk Factors -- Fluctuations in Operating Results; Seasonality" and "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Quarterly Results of Operations." [Enlarge/Download Table] Six Months Ended Year Ended June 30, December 31, ------------------------ ------------------------- Statement of Operations Data 1994 1995 1994 1995 ---------------------------------------- --------- ---------- --------- ---------- Retail software sales. . . . . . . . . . 1,313,890 1,255,230 1,006,849 1,077,547 OEM sales. . . . . . . . . . . . . . . . 5,500 479,675 389,979 21,466 Development agreement revenues. . . . . . . . . . . . . . 112,520 343,250 127,250 0 Royalties. . . . . . . . . . . . . . . . 253,961 76,771 76,253 21,678 Net sales from continuing operations. . . . . . . . . . . . . 1,685,871 2,154,926 1,600,331 1,120,691 Gross profit . . . . . . . . . . . . . . 505,068 1,082,235 643,963 438,181 Noncash compensation expense recorded in connection with Common Stock and Common Stock options issued for services . . . 2,992,862 733,165 193,332 0 Other expenses . . . . . . . . . . . . . 1,374,052 1,940,124 886,272 2,448,553 Loss from continuing operations. . . . . (3,861,846) (1,591,054) (435,641) (2,010,372) Loss from discontinued operations. . . . (115,887) (143,106) (13,376) 0 Net loss . . . . . . . . . . . . . . . . (3,977,733) (1,734,160) (449,017) (2,010,372) Loss per common share from continuing operations . . . . . . . (2.38) (0.85) (0.23) (1.08) Loss per common share from discontinued operations . . . . . (0.07) (0.08) (0.01) 0 Net loss per common share. . . . . . . . (2.45) (0.93) (0.24) (1.08) Weighted average number of common shares outstanding(1). . . . 1,626,107 1,862,908 1,869,998 1,868,145 [Download Table] As of December 31, 1995 ---------------------------- Balance Sheet Data Actual As Adjusted(1) ---------------------------------------- ------------ -------------- Working Capital. . . . . . . . . . . . . (2,913,040) 4,666,092 Total assets . . . . . . . . . . . . . . 4,165,858 6,533,154 Current liabilities. . . . . . . . . . . 6,873,471 1,661,635 Long term debt . . . . . . . . . . . . . 25,601 25,601 Stockholder equity (deficit) . . . . . . (2,733,214) 4,845,918 -31-
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---------------- (1) Unless otherwise indicated, all share and per share information in this Prospectus gives effect to a 9.25-for-1 stock split effected in May 1994 and a 1-for-5.976 reverse stock split effected in September 1995. Unless otherwise indicated, such share and per share information does not give effect to: (i) the exercise of the Underwriters' over-allotment option to purchase up to 360,000 shares of Common Stock and 180,000 Redeemable Warrants; (ii) the issuance of 1,200,000 shares of Common Stock underlying the Redeemable Warrants being offered by the Company; (iii) the issuance of 5,689,665 shares of Common Stock underlying the Redeemable Warrants and 2,000,000 shares of Common Stock underlying the ASSI Warrants being offered by the Selling Security Holders; (iv) the issuance of 180,000 shares of Common Stock underlying the Redeemable Warrants included in the Underwriters' over-allotment option; (v) the exercise of a warrant granted to the Representative (the "Representative's Warrant") to purchase up to 240,000 shares of Common Stock and/or 120,000 Redeemable Warrants; (vi) the issuance upon exercise of the Representative's Warrant of 240,000 shares of Common Stock, 120,000 Redeemable Warrants or 120,000 shares of Common Stock issuable upon exercise of such Redeemable Warrants; (vii) the issuance of 384,070 shares of Common Stock underlying options granted pursuant to the Company's 1992 Stock Option Plan; (viii) 500,000 shares of Common Stock reserved for issuance pursuant to the Company's 1995 Stock Option Plan, as to which the Company has granted no options and has agreed to grant 13,610 options; or (ix) the issuance of 292,838 shares of Common Stock underlying options held by the Company's President. (2) As adjusted to reflect the issuance of 2,400,000 shares of Common Stock at an assumed initial public offering price of $4.00 per share and 1,200,000 Redeemable Warrants at an assumed initial public offering price of $.25 per Redeemable Warrant, net of the expenses of the offering (estimated at $990,000 for the Underwriters' discount and $600,000 for expenses, including the Representatives' three percent nonaccountable expense allowance) and repayment of all of the Company's funded indebtedness (estimated at $5,105,676 at December 31, 1995) with a portion of such proceeds. The as adjusted amounts do not reflect the issuance of up to 340,000 shares of Common Stock and 180,000 Redeemable Warrants by the Company to cover over-allotments, if any, or the exercise of the Representative's Warrant to purchase up to 240,000 shares of Common Stock and/or 120,000 Redeemable Warrants, or the exercise of any other outstanding (or agreed to be issued) options or warrants to purchase up to an additional 10,120,183 shares of CommonStock. -32-
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW The Company derives substantially all of its revenues from sales of its retail consumer software and original equipment manufacturer ("OEM") versions of its retail consumer software. The Company designs, develops, markets and supports a broad line of consumer software products. The Company focuses primarily on nonviolent, family-oriented products with educational and entertainment value, which are easy to use and install, using popular movies, television series and comic book characters. See generally "Business." In June 1995, the Company entered into a Sales and Distribution Agreement with Acclaim Distribution, Inc., a subsidiary of Acclaim Entertainment, Inc. (collectively, "Acclaim," as previously defined), a distributor of entertainment software and related products. The Company had no sales to or through Acclaim during its fiscal year ended June 30, 1995. During the six-month period ended December 31, 1995, of the Company's net sales of $1,120,691, a total of $819,619 (73 percent) were generated by Acclaim. Under the terms of this agreement, Acclaim was the exclusive distributor of the Company's products on a worldwide basis, subject to certain limited exceptions. The Company was not satisfied with the distribution of its products through Acclaim, and determined to terminate the Acclaim distribution agreement in March 1996. The Company and Acclaim have terminated the distribution agreement as of April 30, 1996. On or before June 30, 1996, Acclaim will render a final accounting to the Company together with payment of the balance of any amounts due to the Company under the distribution agreement. Acclaim has notified its accounts that it will not accept returns of any of the Company's software products after June 30, 1996. The Company, however, will remain liable for all such returns regardless of when received by Acclaim. Net sales consist of gross sales net of allowances for returns, credit losses and other adjustments. The Company adjusts its allowance for returns as it deems appropriate. The Company could be forced to accept substantial product returns or other concessions to maintain its relationships with retailers and distributors and its access to distributor channels. The Company is also exposed to the risk of returns of defective, shelf-worn and damaged products from retailers and distributors. Costs of sales consist primarily of product cost, freight charges, royalties to outside programmers and content providers, and an inventory provision for damaged and obsolete products. Product costs consist of the costs to purchase the underlying materials and print both boxes and manuals, media costs (disks and CD-ROMs) and fulfillment (assembly and shipping). From the Company's inception through October 24, 1995, the Company sold synthesizer sound libraries. In July 1995, the Company's Board of Directors approved a formal plan to license the proprietary assets related to such revenues in exchange for royalties. The Results of Operations discussion and analysis which follows includes only the continuing operations of the Company, which is primarily comprised of software sales. The Company sustained losses from these discontinued synthesizer operations of $143,106 in fiscal 1995 and $115,887 in fiscal 1994. -33-
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RESULTS OF OPERATIONS SIX MONTHS ENDED DECEMBER 31, 1994 COMPARED TO SIX MONTHS ENDED DECEMBER 31, 1995 NET SALES. Net sales from continuing operations decreased by 30 percent from $1,600,331 for the six months ended December 31, 1994 to $1,120,691 for the six months ended December 31, 1995. In 1995, the Company determined to concentrate its focus on development of its educational interactive CD-ROM software and to reduce its development work for third parties. Consequently, total retail sales of the Company's software products increased from $1,006,849 during the six months ended December 31, 1994 to $1,197,718 during the six months ended December 31, 1995, but the Company had no development revenues in the period, compared with $127,250 for the prior period. Revenues from OEM sales declined from $389,979 to $21,466, reflecting a one-time agreement with Acer in 1994 that did not produce significant revenues in 1995. In addition, the Company's royalty fees declined from $76,253 to $21,678 during the corresponding periods. The higher royalty revenues for the six months ended December 31, 1994 resulted primarily from introductions of products incorporating content sublicensed by the Company that were not repeated in the six months ended December 31, 1995. This decline in royalty revenues also reflected the Company's current strategy of focusing on developing all product licenses itself rather than sublicensing them to third parties. During the six months ended December 31, 1995, of the Company's net sales of $1,120,691, a total of $819,619 (73 percent) were generated by Acclaim. None of the Company's net sales of $1,006,840 during the six months ended December 31, 1994 were generated by Acclaim. As noted above, because of its disappointment with the level of sales generated by Acclaim, the Company has terminated its distribution agreement with Acclaim effective April 30, 1996. COST OF SALES. Cost of sales decreased by 29 percent from $956,368 for the six months ended December 31, 1994 to $682,510 for the six months ended December 31, 1995, representing 60 percent and 61 percent of net sales, respectively. This decrease is primarily attributable to diminished inventory and reduced production costs resulting from the Company's switch from floppy disk to CD-ROM media for the majority of its products. MARKETING AND SALES. Marketing and sales expenses increased by 96 percent from $291,805 for the six months ended December 31, 1994 to $572,778 for the six months ended December 31, 1995, and increased as a percentage of net sales from 18 percent to 51 percent, respectively. These increases were primarily due to increased marketing activities to promote the Company's products and brand name among retail purchasers, and increased personnel costs. The Company intends to continue to launch new and innovative marketing promotions and to hire additional personnel. GENERAL AND ADMINISTRATIVE. General and administrative expenses increased by 75 percent from $688,974 for the six months ended December 31, 1994 to $1,208,838 for the six months ended December 31, 1995, and increased as a percentage of net sales from 43 percent to 108 percent, respectively. The increase is primarily attributable to costs incurred by the Company during the six months ended December 31, 1995 related to the 1995 Bridge Financing and a $422,310 bad debt reserve relating to the Company's receivable from Acclaim, offset by decreased executive salaries and noncash compensation incurred in connection with the issuance of Common Stock and Common Stock options. A total of $193,332 of the general and administrative expenses for the six months ended December 31, 1994 relates to a noncash charge to earnings in connection with the vesting of stock options granted to employees, determined as the difference between the fair market value on the date of grant and the exercise price. No such charge was incurred during the six months ended December 31, 1995. -34-
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DEVELOPMENT. Development expenses increased by 247 percent from $76,725 six months ended December 31, 1994 to $266,153 for the six months ended December 31, 1995, and increased as a percentage of net sales from 5 percent to 24 percent, respectively. These increases were primarily attributable to costs relating to product upgrade and new product development activities. The Company believes that development expenses will increase in dollar amount and as a percentage of net sales in the future as the Company expands its development activities. TAX PROVISION. The current period income tax provision is comprised of minimum state franchise taxes of $1,200. There is no provision for Federal income taxes as the Company has a loss in the six month periods ended December 31, 1994 and 1995, respectively. OTHER. Other income (expense) increased from $20,900 for the six months ended December 31, 1994 to $399,584 for the six months ended December 31, 1995, and increased as a percentage of net sales from one percent to 36 percent, respectively. This increase is primarily comprised of amortization of deferred loan costs of $262,732, and interest expense of $118,176, during the six months ended December 31, 1995, all of which costs related to the Company's 1995 Private Placement. FISCAL YEAR ENDED JUNE 30, 1994 COMPARED TO FISCAL YEAR ENDED JUNE 30, 1995 NET SALES. Net sales from continuing operations increased by 28 percent from $1,685,871 for fiscal 1994 to $2,154,296 for fiscal 1995. Retail software sales decreased by 5 percent from $1,313,890 for 1994 to $1,255,230 for 1995 due principally to discounting and pricing declines for the Company's software products. Development revenues increased by 205 percent from $112,520 for 1994 to $343,250 for 1995, primarily as a result of an agreement to develop MOVIEBOOKS-TM- under a contract with a motion picture studio. OEM sales increased by 13.3 percent from $5,500 for 1994 to $479,675 for 1995. This increase in OEM sales resulted principally from sales pursuant to a software bundling agreement with a PC manufacturer. Royalty fees decreased by 69 percent from $253,961 for 1994 to $76,771 for 1995. The decline in royalty revenues reflected the Company's strategy of focusing on developing all product licenses itself rather than sublicensing them to third parties. The Company established a reserve for returns that it believes to be adequate based upon historical return data and its analysis of current customer inventory levels and sell through rates. COST OF SALES. Costs of sales decreased by 9.1 percent from $1,180,803 for fiscal 1994 to $1,072,691 for fiscal 1995, and decreased as a percentage of net sales from 70.0 percent to 50 percent, respectively. This percentage decrease was principally attributable to the substantially lower costs associated with the sale of the single "golden master" for certain of the Company's products sold to a PC manufacturer to install under an OEM bundling agreement in the first six months of fiscal 1995, partially offset by a change in the product mix to higher priced items and a decrease in OEM costs. MARKETING AND SALES. Marketing and sales expenses increased by 45.2 percent from $356,381 for fiscal 1994 to $516,886 for fiscal 1995, and increased as a percentage of net sales from 21.1 percent to 24 percent, respectively. These increases were primarily due to increased marketing activities to promote the Company's product and brand name, and an increase in personnel. The Company intends to continue to launch new and innovative marketing promotions and to hire additional personnel. GENERAL AND ADMINISTRATIVE. General and administrative expenses decreased by 53 percent from $3,821,728 for fiscal 1994 to $1,783,023 for fiscal 1995, and decreased as a percentage of net sales -35-
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from 227 percent to 83 percent, respectively. The decrease was primarily due to a decrease in noncash compensation in connection with Common Stock issued for services provided, partially offset by increased staffing and associated overhead expenses necessary to manage and support the Company's growth. A total of $2,992,862 of the 1994 general and administrative expenses and $733,165 of the 1995 general and administrative expenses relates to noncash charges to earnings in connection with the vesting of stock options granted to employees, determined as the difference between the fair market value on the date of grant and the exercise price. DEVELOPMENT. Development expenses increased by 223.1 percent from $116,559 for fiscal 1994 to $378,471 for fiscal 1995, and increased as a percentage of net sales from 7 percent to 18 percent, respectively. These increases were primarily attributable to costs relating to product upgrade and new product development activities. The Company developed its first four MOVIEBOOKS-TM- in fiscal 1995, and to date has developed four MOVIEBOOKS-TM- in fiscal 1996. The Company believes that development expenses will increase in dollar amount and as a percentage of net sales in the future as the Company expands its development activities. TAX PROVISION. The income tax provision for 1994 and 1995 is comprised of minimum State of California Franchise Taxes of $1,600. There is no provision for Federal income taxes as the Company has a current year loss and has a $2,513,000 net operating loss carryforward. Depending upon future changes in ownership of the Company, the use of this carryforward may be limited in the future. QUARTERLY RESULTS OF OPERATIONS The Company has experienced, and may continue to experience, fluctuations in operating results due to a variety of factors, including the size and rate of growth of the consumer software market, market acceptance of the Company's products and those of its competitors, development and promotional expenses relating to the introduction of new products or new versions of existing products, product returns, changes in pricing policies by the Company and its competitors, the accuracy of retailers' forecasts of consumer demand, the timing of the receipt of orders from major customers, and account cancellations or delays in shipment. The Company's expense levels are based, in part, on its expectations as to future sales and, as a result, operating results could be disproportionately affected by a reduction in sales or a failure to meet the Company's sales expectations. SEASONALITY The consumer software business traditionally has been seasonal. Typically, net sales are the highest during the fourth calendar quarter and decline sequentially in the first and second calendar quarters. The seasonal pattern is due primarily to the increased demand for consumer software during the year-end holiday buying season. The Company expects its net sales and operating results to continue to reflect seasonality. Nevertheless, management believes that in the future its results may be less subject to seasonal fluctuations because its products will be marketed in connection with the releases of major motion pictures and home videos, which occur throughout the year. See "Risk Factors -- Fluctuations in Operating Results; Seasonality." LIQUIDITY AND CAPITAL RESOURCES Since its formation, the Company has financed its operations and capital expenditures primarily with cash provided by operating activities, securities issuances and financing arrangements. As of December 31, 1995, the Company had negative working capital of $2,490,730 and cash equivalents of $1,492,507. To date, the Company has not invested in derivative securities or any other financial -36-
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instruments that involve a high degree of complexity or risk, and management does not intend to invest in these types of securities or financial instruments in the future. The Company invested approximately $46,000 during fiscal year 1995 and currently anticipates investing approximately $100,000 during fiscal 1996 for capital equipment to expand into new product lines and to address potential capacity constraints created by the Company's growing unit sales volumes. From time to time, the Company evaluates acquisitions of products, businesses and technologies that are complementary to the Company's business. Presently, however, the Company does not have any understandings, commitments or agreements with respect to any such acquisitions. The Company is dependent on the net proceeds of this offering or other financing to repay the aggregate principal amount of $4,987,500 in Private Notes issued to investors in the Company's 1995 Private Placement, plus accrued interest. The Company believes that the net proceeds from the offering, together with its cash on hand, and anticipated net cash flow from operations, will be sufficient to fund the Company's contemplated cash requirements for at least the next 12 months. The Company currently plans to develop four to five MOVIEBOOKS-TM- and at least one activity center per year, which management estimates will cost approximately $150,000 per title, plus a licensing fee of approximately $25,000 to $150,000 per title. If the Company can generate sales of at least 40,000 units per title, management believes the Company will be able to finance its business operations from net sales revenue. If the Company is unable to generate the necessary volume of sales on its existing products through March 31, 1997, the Company will be required to seek additional financing to continue the development of new products for the next fiscal year. There can be no assurance that the Company will achieve the necessary sales to fund its future operations or that, if additional financing is necessary, such financing will be available. See "Risk Factors -- Dependence on Net Proceeds of this Offering; Possible Need for Additional Financing." Management expects that in the future, cash in excess of current requirements will be invested in investment-grade, interest-bearing securities. NEW ACCOUNTING STANDARDS In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123"). SFAS No. 123 establishes a method of accounting for stock compensation plans based on fair value of grants made under such plans on the date of grant using certain option-pricing models. SFAS No. 123 allows companies to continue to account for their stock option plans in accordance with APB opinion 25 "Accounting for Stock Issued to Employees," which provides for an intrinsic valuation model that recognizes only the difference between the fair market value of a company's stock and the price paid to acquire the stock under the stock compensation plan. However, SFAS No. 123 encourages the adoption of the fair value accounting method. Companies electing not to follow the new fair value based method are required to provide expanded footnote disclosures, including pro forma net income and earnings per share, determined as if the company had applied the new method. SFAS No. 123 is required to be adopted prospectively beginning January 1, 1996. The Company plans to use the intrinsic valuation model and provide footnote disclosure with respect to the fair value of options for fiscal years beginning after January 1, 1996. -37-
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BUSINESS GENERAL The Company is engaged primarily in developing, publishing and marketing educational, interactive computer software products for children. MOVIEBOOKS-TM-, which combine text, photos, soundclips and actual film footage of well recognized family films and cartoon series, are the Company's major software products. MOVIEBOOKS-TM- are developed and published by the Company on CD-ROM for Multimedia PCs as entertaining, interactive reading tools for young children. The Company also produces a variety of entertainment computer software utilities such as screen savers and sound clips known as AUDIOCLIPS-Registered Trademark-. The Company is currently developing another line of products which it refers to as creativity centers. This product line combines learning activities such as painting, drawing, matching, puzzles and mazes within a framework of three distinct skill levels. The Company's products are based on licensed content of major motion pictures and television shows under agreement with major entertainment studios including Viacom Consumer Products (as agent for Paramount Pictures Corp.), Lucasfilm Ltd., Warner Bros. Consumer Products, CBS Entertainment, MCA/Universal Merchandising, Inc., Carolco Pictures, Inc., DC Comics, MGM/UA Merchandising, Inc. and others. The Company's license agreements include for existing products BABE-TM-, LASSIE-TM-, THE LITTLE RASCALS-TM-, BLACK BEAUTY-TM-, THE ADVENTURES OF BATMAN AND ROBIN-TM-, TERMINATOR 2: JUDGMENT DAY-TM-, the STAR WARS-TM- trilogy, FREE WILLY 2-TM-, THE SECRET GARDEN-TM-, STAR TREK-TM-, SATURDAY NIGHT LIVE-TM-, THE TWILIGHT ZONE-TM-, TOTAL RECALL-TM-, and other popular titles. The Company also holds licenses for new products being developed for release in 1996 on ALL DOGS GO TO HEAVEN II-TM-, THE LAND BEFORE TIME-TM-,DRAGON HEART-TM-, and I LOVE LUCY-TM-. The Company is continuing the negotiation of additional licenses for all of its product line offerings. Management believes the Company is capable of continuing to obtain new licenses for major motion pictures and television shows and developing new, high quality software products using content from these entertainment properties. The Company believes that as of March 31, 1996, its products were in distribution to approximately 6,000 retail outlets. Retailers currently selling the Company's products include Target, Tower Records, Sears, Wal-Mart, Price/Costco, CompUSA, Best Buy, BJ's, Computer City, Egghead, Electronics Boutique, Babbages, Software, Etc., Kmart, Barnes & Noble, Sam Goody, Sam's Club, QVC, Musicland, Circuit City and others. INDUSTRY BACKGROUND In recent years, the installed base of Multimedia PCs in households has grown substantially as prices have declined significantly and as improvements in computing power and capability have been achieved. There are a number of factors driving the increased demand and use of Multimedia PCs in U.S. and foreign households beyond the general impact of falling prices and increased performance. Enabling technologies and standards, such as graphical user interfaces and the Microsoft-Registered Trademark- Windows-Registered Trademark- operating system, and the recent release of the Windows '95-Registered Trademark- operating system, have made Multimedia PCs easier to use for a broad range of applications, resulting in the transformation of Multimedia PCs into general-purpose tools. In addition, today's Multimedia PCs feature high-speed microprocessors, large amounts of memory, high-resolution monitors and enhanced sound and speaker and graphics capabilities. These advanced capabilities, along with the introduction of CD-ROM multimedia technology, have allowed software developers to produce more engaging software with advanced three-dimensional graphics, realistic sound and full motion video. The Company believes that CD- ROM multimedia technology will continue to impact the growth of the consumer software market as software developers take advantage of the multimedia capabilities of this more advanced hardware technology. -38-
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The resulting increased penetration of Multimedia PCs into domestic households has created a large and growing mass market for consumer software as consumers wish to maximize the utility of their Multimedia PCs. The distribution of consumer software has also expanded beyond traditional software retailers and computer stores to include general mass merchandisers. In response to these developments, increasing numbers of consumer software products are being developed to address a broad range of consumer interests and everyday tasks. The Company believes that consumers are more frequently purchasing software on impulse in the same way that they often buy books, music compact discs ("CDs") and motion picture videos. With the increasing consumerization of the software market, the Company believes that the prices for consumer software products may fall. If this occurs, the distribution channels for consumer software could continue to expand to include book and music stores, video outlets and, possibly, supermarkets. As consumer software becomes more of a mass market product, the Company believes it will become increasingly important for consumer software companies to have direct relationships with retailers and to effectively market their products to consumers. Competition for retail shelf space is also likely to increase due to the proliferation of consumer software products and companies. As a result, the Company believes that in order to be successful, consumer software companies must have a consumer-driven focus, a broad offering of category-leading products, close relationships with retailers, a recognized brand name and a cost-efficient business model. BUSINESS STRATEGY The Company's objective is to be a leading publisher of high quality, value priced family oriented consumer software. The Company seeks to develop a broad line of products in categories in which a substantial market share can be attained. The Company also seeks to expand product franchises by upgrading successful products and developing product line extensions and complementary products. The Company believes that it may achieve its objectives utilizing the following strategies: - MAINTAIN CONSUMER-DRIVEN FOCUS. The Company develops what it believes are creative and innovative products with mass market appeal, targeting families who are familiar with the Company's licensed movie titles, television series and comic book characters. The Company believes that these consumers base their software purchasing decisions largely on quality, value, ease of use, recognition and personal affinity for recognizable motion picture and television productions upon which the Company's products are based. As a result, the Company is committed to providing products that are high quality, value priced and which require minimal computer experience to operate. The Company's consumer-oriented marketing strategy combines attractive and informative shrink-wrap packaging with high-impact promotional campaigns to encourage impulse purchases. To enhance customer satisfaction, the Company also provides technical support for all of its products. In addition, the Company revises products in response to consumer feedback and upgrades products to utilize new technologies as those technologies gain broader acceptance in the consumer market. The Company receives consumer feedback primarily from comments on product registration cards submitted to it by customers. - DEVELOP DIVERSIFIED TITLES WITH STRONG FRANCHISE VALUE. The Company seeks to develop a broad line of products in sustainable categories in which a substantial market share can be achieved. The Company currently has 21 software products available for sale in stores in the education and entertainment categories. Hollywood content such as motion pictures and television shows will continue to be the foundation on which the products are based. The Company seeks to build franchise value through its merchandising programs and seeks -39-
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to create franchises by upgrading products and developing product line extensions and complementary products. Several of the Company's licenses permit it to produce multiple software titles using the same proprietary subject matter. The Company also seeks to create "evergreen" titles with extended lifecycles by upgrading successful products to incorporate new features and to adapt to new technologies. - LEVERAGE STUDIO RELATIONSHIPS. The Company is developing a variety of cross-marketing promotional programs with its movie studio licensors and other licensees of movie titles licensed by the Company for its software products. For example, the Company has worked with the MCA Home Video Division to include discount coupons for the Company's BABE-TM- MOVIEBOOK-TM- in video cassettes of BABE-TM-. The Company is further working with MCA Home Video Division to include trailers for MCA movie titles in the Company's software products. In addition, the Company is working with the manufacturers of toy action figures to include rebate coupons for the Company's products with the related action figures. The Company has also developed a screen saver for Universal Studios Florida in return for trip packages to be used for promotional contests. The Company's goal is to run one special promotion, such as a contest, every two to three months. Based on currently pending negotiations with its movie studio licensors, management believes the Company will have the opportunity to develop a variety of new cross-promotional programs that may significantly enhance the Company's marketing efforts. - PROMOTE TRADENAME RECOGNITION. The Company promotes its licensed properties in conjunction with its brand name "Sound Source Interactive" in order to encourage customer loyalty and repeat purchases. The Company believes that its brand name products are recognized by consumers as high quality, fully featured software that consistently exceed consumer expectations. Drawing upon established consumer marketing techniques, the Company uses its brand name and consistent packaging style which emphasize high-impact design and recognizable motion picture and television titles. The Company includes a mail-in order form with each product it sells, which includes a list of the Company's other available products to encourage repeat purchases. The Company believes that by promoting a recognizable brand name and consistent packaging, satisfied consumers are more likely to purchase additional Company-produced products when faced with multiple options in a software category. The Company also has an established public relations effort which seeks to broaden consumer awareness and acceptance of its tradename. As the consumer software industry becomes more of a mass market, the Company believes that tradename recognition will become an increasingly important means of product differentiation among retailers and consumers. - MANAGE DEVELOPMENT PROCESS TO MAINTAIN QUALITY AND VALUE PRICING. The Company manages its development process in an attempt to provide consistent product quality, shorter and more predictable delivery schedules, and lower overall development costs. The Company works closely with each licensor to carefully select appropriate product development opportunities. The Company's internal development efforts are focused primarily on product design and features, consistent user interfaces and product quality and consistency. The Company supplements its internal product development resources by utilizing existing technologies and externally developed programming. This process allows the Company to maintain internal control over the creative and market-driven aspects of its product development efforts, while using outside resources to lessen its development risks and control costs. This allows the Company to offer value pricing of its products. As consumer software becomes more of a mass market driven by consumer demand and lower price points, the Company believes that its ability to develop, produce, market and support value-priced products provides it with a competitive advantage. -40-
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- DEVELOP GAME PRODUCTS. The Company intends to develop products intended for the game market in the future. The Company believes that its access to motion picture and related content will enable it to produce games that can be successfully marketed. The Company intends to market its game products in concert with studio releases and events. - ACQUISITIONS. The Company intends to pursue acquisitions of entertainment software companies and selected titles within existing or new product categories. The Company believes that acquisitions may provide diversification of revenues and enhanced revenues growth. The Company is not currently a party to any discussion, agreement, arrangement or understanding in connection with any such acquisition. PRODUCTS INTERACTIVE CD-ROM The Company has created MOVIEBOOKS-TM- for children, which are electronic storybooks with full motion video based on the licensed property. MOVIEBOOKS- TM- are marketed as reading aids for young children. Research studies involving literacy have shown that children learn to read by repetitive reading -- usually with the aid of a parent or teacher. This learning process begins at about 18 months of age and continues through the first and second grades for many children. The targeted ages for MOVIEBOOKS-TM- are three through ten. The Company has released five of its MOVIEBOOKS-TM- on CD-ROM. This product provides options for automatic reading by the computer, user reading, a dictionary invoked by "clicking" on a dictionary book icon, actual full motion video taken from the motion picture that coincides with the text pages, high- quality sound, art and animation as well as a quiz consisting of multiple choice questions on a related topic to the story, reinforcement through a "jigsaw" puzzle which can be printed, and a "bookmark" so the adventure can be stopped, put away and restarted at the same point at a later date. More elaborate activities in the MOVIEBOOK-TM- have been included in BABE-TM-, THE LITTLE RASCALS-TM-, FREE WILLY 2-TM-, EXOSQUAD-TM- and THE ADVENTURES OF BATMAN AND ROBIN-TM-, will be further incorporated in the next generation of products. The Company first introduced its MOVIEBOOK-TM- product line into the marketplace in August 1994 with the release of Warner Bros.' THE SECRET GARDEN- TM-. The Company released Warner Bros.' BLACK BEAUTY-TM- in November 1994, Broadway Video's LASSIE-TM-," a Paramount Pictures release, in December 1994 and Universal Pictures' LITTLE RASCALS-TM- in June 1995. The Company released Warner Bros.' FREE WILLY 2-TM- in July 1995. During November 1995, three new MOVIEBOOKS-TM- were completed and released: BABE-TM- (Universal Pictures), EXOSQUAD-TM- (Universal Pictures) and THE ADVENTURES OF BATMAN & ROBIN-TM- (DC Comics). These three products, however, did not receive widespread distribution until the first calendar quarter of 1996. All products are currently Windows '95-Registered Trademark- compatible. Currently, the products are sold at a suggested retail price of up to $30 each, a price point intended to generate impulse purchases among consumers at the retail level. The Company intends to introduce four to five new MOVIEBOOKS-TM- annually in the future. Each is expected to experience its highest sales prices and volumes within the 12 months following its introduction. Although the products may continue to be sold after 12 months, they typically will be sold on a discounted basis. The following is a listing of the Company's MOVIEBOOK-TM- products which are currently existing or planned for release, all of which are on CD-ROM: -41-
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[Enlarge/Download Table] MOVIEBOOK-TM-TITLE LICENSOR RELEASE DATE CURRENT PLATFORM ---------------------------- ---------------- -------------- ------------------ The Secret Garden-TM- Warner Bros. August 1994 Windows-Registered Trademark- and Windows '95-Registered Trademark- Black Beauty-TM- Warner Bros. November 1994 Windows-Registered Trademark- and Windows '95-Registered Trademark- Lassie-TM- Broadway Video December 1994 Windows-Registered Trademark- and Windows '95-Registered Trademark- The Little Rascals-TM- Universal Pictures June 1995 Windows-Registered Trademark- and Windows '95-Registered Trademark- Free Willy 2-TM- Warner Bros. July 1995 Windows-Registered Trademark- and Windows '95-Registered Trademark- Babe-TM- Universal Pictures November 1995 Windows-Registered Trademark- and Windows '95-Registered Trademark- ExoSquad-TM- Universal Pictures November 1995 Windows-Registered Trademark- and Windows '95-Registered Trademark- The Adventures of DC Comics November 1995 Windows-Registered Trademark- and Batman and Robin-TM- Windows '95-Registered Trademark- Land Before Time-TM- UniversalPictures July 1996 Windows-Registered Trademark- and Windows '95-Registered Trademark- All Dogs Go to Heaven II-TM- MGM October 1996 Windows-Registered Trademark- and Windows '95-Registered Trademark- Batman and Robin II-TM- DC Comics March 1997 Windows-Registered Trademark- and Windows '95-Registered Trademark- The Company is currently developing another line of interactive CD-ROM based products which it refers to as creativity centers. This product line combines learning activities such as painting, drawing, matching, puzzles and images within a framework of three distinct skill levels. The Company intends to introduce its first creativity center product in June 1996, and to introduce one or two new creativity centers annually thereafter. The following creativity center products which are planned for release in 1996. [Enlarge/Download Table] CREATIVITY CENTER TITLE LICENSOR RELEASE DATE CURRENT PLATFORM ------------------------ -------- ------------- --------------------- DRAGONHEART-TM- Universal June 1996 Macintosh-Registered Trademark-, Pictures Windows-Registered Trademark- and Windows '95-Registered Trademark- LAND BEFORE TIME-TM- Universal October 1996 Macintosh-Registered Trademark-, Pictures Windows-Registered Trademark- and Windows '95-Registered Trademark- ENTERTAINMENT UTILITIES The Company was one of the first to license motion picture studio properties to create entertainment utility software. The first product was Star Trek AUDIOCLIPS-Registered Trademark- and the second was a sub-license for a STAR TREK-TM- Screen Saver. The Company followed its STAR TREK-TM- products with STAR WARS-TM-, THE WIZARD OF OZ-TM-, TERMINATOR 2: JUDGMENT DAY-TM- and others. The Company's screen saver line-up now includes TERMINATOR 2: JUDGMENT DAY-TM-, THE TWILIGHT ZONE-TM- and SATURDAY NIGHT LIVE-TM-. Additionally, the sub-license for Star Trek AUDIOCLIPS-Registered Trademark- now extends to STAR TREK: THE NEXT GENERATION-TM-, STAR TREK: THE MOTION PICTURES-TM- and a Stardate Desktop Calendar. -42-
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Entertainment utility products may include AUDIOCLIPS-Registered Trademark-, screen savers based on animation, video and still images, and wallpaper, VISUALCLIPS-Registered Trademark- and jigsaw puzzles. - LIMITED EDITION ENTERTAINMENT UTILITIES. The Company's new entertainment computer software utilities incorporate screen savers, AUDIOCLIPS-Registered Trademark- and other content based on entertainment properties. The new entertainment utilities are marketed as limited issue, serialized collector editions. For Christmas 1995, the Company released a Limited Edition BABYLON 5-TM- (Warner Bros.) Entertainment Utility which contains screen savers and AUDIOCLIPS-Registered Trademark-. Limited edition products are serialized and retail at approximately $30 each. The Company expects the limited edition products to replace stand alone screen savers and AUDIOCLIPS-Registered Trademark- by Christmas of 1996. The Company currently sells the following limited edition entertainment utilities: [Enlarge/Download Table] TITLE LICENSOR RELEASE DATE CURRENT PLATFORM -------------------------- ------------------- -------------------- ---------------------------------- STAR WARS TRILOGY-TM- Lucasfilm, Ltd. July 1985 Macintosh-Registered Trademark-, Windows-Registered Trademark- and Windows '95-Registered Trademark- BABYLON 5-TM- Warner Bros. November 1995 Windows-Registered Trademark- and Windows '95-Registered Trademark- TERMINATOR 2; Carolco Pictures July 1996 Windows-Registered Trademark- and JUDGMENT DAY-TM- Windows '95-Registered Trademark- STAR TREK DEEP SPACE Paramount/ August 1996 Windows-Registered Trademark- and NINE-TM- Viacom Windows '95-Registered Trademark- STAR TREK VOYAGER-TM- Paramount/ November 1996 Windows-Registered Trademark- and Viacom Windows '95-Registered Trademark- I LOVE LUCY-TM- CBS November 1996 Windows-Registered Trademark- and Windows '95-Registered Trademark- - AUDIOCLIPS-Registered Trademark-. The Company's AUDIOCLIPS-Registered Trademark- Desktop Diversion Utilities are audio computer software utilities which utilize segments of dialogue, music or sound effects from original soundtracks of major motion pictures and hit television shows to provide complementary audio "cues" for certain computer system functions. The AUDIOCLIPS-Registered Trademark- utilities are packaged with default assignments via the playing "engine" to enable consumers to personalize their computing environment. Thus, although AUDIOCLIPS-Registered Trademark- are pre-programmed for use by the computer novice, the technology enables the user to assign other sounds to the computer function of their choice. AUDIOCLIPS- Registered Trademark- products were first introduced into the marketplace in December 1991. Currently, the products are sold at a suggested retail price of approximately $15 each, a price point intended to generate impulse purchases among consumers at the retail level. The Company currently sells the following AUDIOCLIPS- Registered Trademark- products: [Enlarge/Download Table] AUDIOCLIPS Registered Trademark- TITLE LICENSOR RELEASE DATE CURRENT PLATFORM --------------------------- ------------------- ---------------- --------------------------------- TERMINATOR 2: Carolco Pictures January 1993 Windows-Registered Trademark- and JUDGMENT DAY-TM- Windows '95-Registered Trademark- TOTAL RECALL-TM- Carolco Pictures February 1993 Windows-Registered Trademark- and Windows '95-Registered Trademark- STAR WARS-TM- Lucasfilm, Ltd. October 1992 Macintosh-Registered Trademark- STAR WARS-TM- Lucasfilm, Ltd. August 1993 Windows-Registered Trademark- and Windows '95-Registered Trademark- THE EMPIRE STRIKES BACK-TM- Lucasfilm, Ltd. August 1994 Windows-Registered Trademark- and Windows '95-Registered Trademark- -43-
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[Enlarge/Download Table] AUDIOCLIPS Registered Trademark- TITLE LICENSOR RELEASE DATE CURRENT PLATFORM --------------------------- ------------------- ---------------- --------------------------------- RETURN OF THE JEDI-TM- Lucasfilm, Ltd. October 1994 Windows-Registered Trademark- and Windows '95-Registered Trademark- STAR TREK-TM- Paramount March 1995 Windows-Registered Trademark- and (original TV show) /Viacom Windows '95-Registered Trademark- STAR TREK: Paramount March 1995 Windows-Registered Trademark- and THE NEXT GENERATION-TM- /Viacom Windows '95-Registered Trademark- STAR TREK: Paramount October 1994 Windows-Registered Trademark- and THE MOTION PICTURES-TM- /Viacom Windows '95-Registered Trademark- STAR WARS TRILOGY-TM- (limited Lucasfilm, Ltd. July 1995 Macintosh-Registered Trademark-, edition of AUDIOCLIPS- Windows-Registered Trademark- and Registered Trademark- Windows '95-Registered Trademark- and VISUALCLIPS- Registered Trademark-) - SCREEN SAVERS. Originally developed as a utility to protect computer monitors from image "burn-in," screen saver utilities have evolved into desktop entertainment software. Market observers estimate the screen saver market currently to exceed $80 million per annum. The Company first introduced its screen saver product line into the marketplace in August 1993 with the release of its TERMINATOR 2: JUDGMENT DAY-TM- screen saver. In November 1994, the Company released its THE TWILIGHT ZONE-TM- screen saver and SATURDAY NIGHT LIVE-TM- screen saver. Currently, the stand alone screen saver products are sold at a suggested retail price of approximately $20 each, a price point intended to generate impulse purchases among consumers at the retail level. The Company currently sells the following screen saver products: [Enlarge/Download Table] SCREEN SAVERS TITLE LICENSOR RELEASE DATE CURRENT PLATFORM ------------------- ------------------ ---------------- ---------------------------------- TERMINATOR 2: Carolco Pictures August 1993 Windows-Registered Trademark- and JUDGMENT DAY-TM- Windows '95-Registered Trademark- THE TWILIGHT ZONE-TM- CBS Television November 1994 Windows-Registered Trademark- and Windows '95-Registered Trademark- SATURDAY NIGHT LIVE-TM- Broadway Video November 1994 Windows-Registered Trademark- and Windows '95-Registered Trademark- MUSIC INDUSTRY PRODUCTS The Company's original products were sound libraries for professional musicians sold to musical instrument manufacturers, music stores and directly to end users. Although sales of the hardware that utilize the products continue today, software sales remain flat due to the limited consumer population. The Company recently discontinued its music industry products operations in order to focus entirely on the computer software market. The Company will continue to utilize its sound laboratory facilities and its sound library as it exists today for incorporation into multimedia products as necessary. Using its own sound library, the Company is capable of providing all of its own music and sound effects for its software products, and creating new sounds as required for each project. The Company believes that the discontinuance of its music industry business will not materially affect its future earnings. DEVELOPMENT AGREEMENTS The Company has entered into development agreements with MTV Music Television, NBC Television and Fox Interactive, pursuant to which the Company is entitled to receive fees for its -44-
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development services and/or royalties on the products sold by the contracting parties. The Company has developed or is in current development with the following entities for the following titles: [Enlarge/Download Table] CLIENT CONTENT CATEGORY STATUS -------------------------- --------------------- ------------------ -------------------- MTV Music Television DEAD AT 21-TM- Screen Saver Completed NBC Television HISTORIC PEACOCK-TM- Screen Saver Completed Fox Interactive EEK! THE CAT-TM- MOVIEBOOK-TM- In Final Approval Fox Interactive THE TICK-TM- MOVIEBOOK-TM- In Final Approval Fox Interactive BOBBY'S WORLD-TM- MOVIEBOOK-TM- In Development Fox Interactive LIFE WITH LOUIE-TM- MOVIEBOOK-TM- In Development The Company currently does not intend to enter into additional development agreements in the foreseeable future, because it intends to emphasize the development of its own products. PRODUCT DISTRIBUTION In June 1995, the Company entered into a Sales and Distribution Agreement with Acclaim Distribution, Inc., a subsidiary of Acclaim Entertainment, Inc. (collectively, "Acclaim," as previously defined), a distributor of entertainment software. The Company had no sales to or through Acclaim during its fiscal year ended June 30, 1995. During the six-month period ended December 31, 1995, of the Company's total revenues from retail software sales of $1,120,691, a total of $819,619 (73 percent) were generated by Acclaim. Under the terms of this agreement, Acclaim was the exclusive distributor of the Company's products on a worldwide basis to retail accounts, resellers and distributors except with respect to distribution in North America by direct mail, "infomercials," television home shopping channels or through "bundling" agreements with OEMs. As a result of the foregoing, the Company was substantially dependent upon Acclaim for the distribution and sale of its products through March 31, 1996. See "Business -- Relationship With Acclaim." The Company was not satisfied with the distribution of its products through Acclaim and determined to terminate the Acclaim distribution agreement in March 1996. The Company and Acclaim have terminated the distribution agreement as of April 30, 1996. On or before June 30, 1996, Acclaim will render a final accounting to the Company together with payment of the balance of any amounts due to the Company under the distribution agreement. Acclaim has notified its accounts that it will not accept returns of any of the Company's software products after June 30, 1996. The Company, however, will remain liable for all such returns regardless of when received by Acclaim. The Company believes that it has the ability to distribute its products through nonexclusive software distributors and by means of direct sales to major computer and software retailers. The Company further believes that it could generate sales sufficient to allow it to operate profitability without a major exclusive distribution relationship similar to its past relationship with Acclaim. Nevertheless, the Company believes that it is possible to generate higher sales to mass marketers through an exclusive affiliate distributor, and that the attendant risk of collection of accounts can be mitigated. Therefore, the Company is currently in the process of negotiating distribution agreements with potential new exclusive distributors. There can be no assurance, however, that the Company will be successful in entering into any such distribution agreements, or that the terms of any such distribution agreement will be favorable to the Company. Moreover, even if the Company does enter into one or more such distribution agreements, there can be no assurance that the distributors in question will successfully market the Company's products. The Company may experience a loss of sales momentum as a result of the termination of the Acclaim distribution agreement, even if the Company enters into agreements with new distributors. -45-
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The Company believes that its products currently are in distribution to approximately 6,000 retail outlets. Retailers currently selling the Company's products include Target, Tower Records, Sears, Wal-Mart, Price/Costco, CompUSA, Best Buy, BJ's, Computer City, Egghead, Electronics Boutique, Babbages, Software Etc., Kmart, Barnes & Noble, Sam Goody, Sam's Club, QVC, Musicland, Circuit City, Blockbuster Video and others. In fiscal 1994, the Company had four customers who collectively represented 29 percent of the Company's sales, including two distributors, Cameo Interactive and Good Times Interactive, each of which accounted for ten percent or more of the Company's sales. As a result of the Company's broader distribution to retail customers during fiscal 1995, only one customer, Comp USA, accounted for 18 percent of the Company's gross sales, and no other customer accounted for ten percent or more of the Company's gross sales. The Company believes that mass market retailers will increasingly be significant outlets for consumer software. SALES AND MARKETING The Company intends to tailor marketing efforts, promotions and merchandising displays to fit the needs of specific retailers. This strategy enables the Company to identify and react to trends in the retail consumer market and to help build incremental sales. The Company believes that its attention to detail at the retail level and careful execution will be key factors in successful marketing programs. As the number of consumer software titles continues to grow and as the competition for retail shelf space increases, the Company believes that this marketing strategy, combined with the strength of its licensed titles, will give it a competitive advantage. Offering a wide variety of products, the Company can provide retailers with an assortment of titles in categories of interest to consumers. The Company also supports its retailers by setting up special displays, end caps and kiosks, executing targeted promotions and analyzing sales trends to help build incremental sales. The Company is currently developing a variety of cross- marketing promotional programs with its movie studio licensors and other licensees of movie titles licensed by the Company for its software products. These promotional programs will include discount coupons for products in video cassettes, rebate coupons with action figures, movie trailers in the Company's software products, and promotional contests with various motion picture studios. Drawing upon established consumer marketing techniques, the Company's marketing department creates and executes high-impact merchandising programs with the goal of maximizing each product's retail exposure. The Company believes that its consumer-driven marketing, the relatively high perceived value and low price points of its products, and easily identifiable packaging which emphasizes high-impact design and concise, nontechnical product information lead to higher visibility and impulse purchases of its products in retail stores. The Company provides technical support by telephone at no additional charge. The Company has installed a telephone system and a call handling center to facilitate its response to customer inquiries. Customer feedback is shared among other support representatives and made available to product managers for development of product enhancements and upgrades. DEVELOPMENT The Company seeks to develop a broad line of products in sustainable market categories in which a leading market share can be obtained. The Company depends on a flow of creative ideas to develop high-quality, value-priced products. The Company believes that its efficient development model has certain key advantages including consistent product quality, reliable delivery schedules, cost containment and low investment risk. -46-
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The Company's product managers oversee the development of various products from conception through completion, and control the products' content, design, scope and development schedule. New product ideas are evaluated with each studio partner based upon upcoming theatrical releases, detailed market research on the subject matter, the type and demographics of the target consumer, and the existence and characteristics of competitive products. The Company seeks to design new products which incorporate all of the important functions and features of the leading competitive products. Once a product is approved for development, a detailed design specification is created that includes the product's features and a user interface that is consistent with other Company products. Whenever possible, the software is designed to incorporate technology used in existing Company products in an effort to shorten the development cycle and improve quality and consistency. The overall product, including documentation, is designed to meet a manufacturing specification that will meet the Company's margin requirements at consumer price points. The product managers then execute the development project with a team that includes programmers, sound engineers, artists, animators, designers, writers and testers. The Company's internal development efforts are focused primarily on product design and features, consistent user interfaces, and product quality consistency. The Company supplements its internal product development resources by utilizing existing technologies and externally developed programming when such utilization can result in a more efficient method of creating a higher quality product. Using this method, the Company maintains internal control over the creative and market-driven aspects of product development while using external resources to shorten development time and lower development risks. Development costs associated with externally licensed technology are generally paid by royalties based on net sales, which lowers the Company's investment risk. The Company's agreements with its external developers typically grant the Company an exclusive worldwide license to use the developers' software. The agreements typically have three-year terms, with renewal provisions upon mutual agreement of the parties. The Company currently is the licensee under technology licenses with Apple Computer, Iterated Systems, Qsound Labs, Rock Ridge, Echo and Rhode Island Soft Systems. The Company utilizes technology provided by these licensors to develop and operate various of its products. With the exception of the Apple Computer license, there are alternative products for each of the technologies now licensed by the Company. Therefore, the Company believes that it could readily obtain licenses to comparable products from other sources at comparable costs. Products under development are extensively tested by the quality assurance department, and must be approved by the licensor before being released for production. The department tests for bugs, functionality, ease-of-use and compatibility with the many popular Multimedia PC configurations that are available to consumers. Product managers are also responsible for reviewing customer feedback, competitive products, product performance and market positioning in order to introduce upgrades that keep abreast of consumer tastes and trends. The Company has increased its development of new CD-ROM products to address the shift to CD- ROM-based products. OPERATIONS The Company controls all purchasing, inventory, scheduling, order processing and accounting functions related to its operations, with all production and warehousing performed by independent contractors in accordance with the Company's specifications. The Company intends to invest in management information systems and other capital equipment which it believes are necessary to achieve operational efficiencies and support increasing sales volumes. -47-
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Software orders can be automatically tracked through to delivery to enhance customer satisfaction and prompt delivery. Shipments are generally made within 48 hours of receiving an order. The Company has relatively little backlog at any given date, and its backlog is not indicative of potential sales for any future period. The Company prepares master software disks, user manuals and packaging designs. Disk and CD-ROM duplication, printing of documentation and packaging, as well as the assembly of purchased components and the shipment of finished products, are performed by third parties in accordance with the Company's specifications. The Company has multiple sources for all components, with assembly and shipping currently performed by three independent fulfillment houses. To date, the Company has not experienced any material difficulties or delays in the production and assembly of its products. To the extent that the Company's fulfillment houses do not continue to perform assembly and shipping functions in a cost-efficient and timely manner, and transition to substitute fulfillment houses is not completed in a timely fashion, the Company's business, operating results and financial condition could be adversely affected. COMPETITION The market for the Company's consumer software products is intensely and increasingly competitive. The Company's competitors range from small companies with limited resources to large companies with substantially greater financial, technical and marketing resources than those of the Company. Existing consumer software companies may broaden their product lines to compete with the Company's licensed products, and potential new competitors, including computer hardware and software manufacturers, diversified media companies and book publishing companies, may enter or increase their focus on the consumer software market, resulting in greater competition for the Company. Only a small percentage of products introduced in the consumer software market achieve any degree of sustained market acceptance. Principal competitive factors in marketing consumer software include product features, quality, reliability, tradename and licensed title recognition, ease-of-use, merchandising, access to distribution channels and retail shelf space, marketing, price, and the availability and quality of support services. The Company believes that it competes effectively in these areas, particularly in the areas of quality, brand recognition, ease-of-use, merchandising, access to distribution channels and retail shelf space and price. To the extent that competitors achieve performance, price or other selling advantages, the Company could be adversely affected. There can be no assurance that the Company will have the resources required to respond to market or technological changes or to compete successfully in the future. In addition, increasing competition in the consumer software market may cause prices to fall, which could adversely affect the Company's business, operating results and financial condition. The Company considers Microsoft Corp., Broderbund, Inc., Knowledge Adventure, Disney, Maxis, 7th Level, Inc. and A.D.A.M. Software, Inc. its chief competitors in the interactive entertainment CD-ROM market. The Company considers Microsoft, Inc. and Berkeley Systems its chief competitors in the entertainment utility software market. Microsoft has introduced screen savers and generic sounds, as well as licensed sounds from the MGM/Turner film library. The Company considers Berkeley Systems its chief competitor in the screen saver market. The Company developed the concept and provided the introductions that led to the development of the STAR TREK-TM- series of screen savers by Berkeley Systems. The Company has received over $300,000 in earnings from this sub- license, which continues until 1997. The Company notes that there are a number of other smaller entertainment utility publishers competing in this market. -48-
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The Company has entered into license agreements with Warner Bros., Paramount/Viacom, Lucasfilm, Turner Broadcasting, Universal Pictures, Carolco and MGM, among others. Several of the major motion picture studios now have captive interactive software divisions. As these types of software become better known in the marketplace, these profit centers may begin to vie for their studio's product. Management believes that Disney, Lucasfilm and Paramount/Viacom are currently the most active studios in publishing their own product to create software packages. Fox, Universal Pictures, Sony Pictures and Warner Bros. each have announced the formation of divisions to publish software products using their own license content. See "Risk Factors -- Competition." PROPRIETARY RIGHTS AND LICENSES The Company regards its software as proprietary and relies primarily on a combination of trademark, copyright and trade secret laws, employee and third party nondisclosure agreements and other methods to protect its proprietary rights. All of the Company's new products are CD-ROM based, and hence are difficult to copy. However, unauthorized copying occurs within the software industry, and if a significant amount of unauthorized copying of the Company's products were to occur, the Company's business, operating results and financial condition could be adversely affected. Also, as the number of software products in the industry increases and the functionality of these products further overlaps, software developers and publishers may increasingly become subject to infringement claims. There can be no assurance that third parties will not assert infringement claims against the Company in the future with respect to current or future products. Any such claims, with or without merit, can be time consuming and expensive to defend and resolve. Although the Company has not been the subject of any actual, pending or threatened intellectual property litigation, there has been substantial litigation regarding copyright, trademark, and other intellectual property rights involving computer software companies. In the future, litigation may be necessary to enforce the Company's proprietary rights, to protect copyrights, trademarks and trade secrets and other intellectual property rights owned by the Company or its licensors, to defend the Company against claimed infringements of the rights of others and to determine the scope and validity of the proprietary rights of the Company and others. Any such litigation, with or without merit, could be costly and result in a diversion of management's attention, which could have a material adverse effect on the Company's business, operating results and financial condition. Adverse determinations in such litigation could result in the loss of the Company's proprietary rights, subject the Company to significant liabilities, require the Company to seek licenses from third parties or prevent the Company from selling its products, any of which could have a material adverse effect on the Company's business, operating results and financial condition. See "Risk Factors -- Limited Protection of Intellectual Property and Proprietary Rights." The Company's licenses and other intellectual property may not be transferred to third parties without the consent of the licensors. Under the terms of certain such licenses, transfer of ownership of stated percentages of the Common Stock would constitute a prohibited transfer of the licenses. The licensors under such licenses have agreed that neither the sale by the Company of the Common Stock pursuant to this offering nor the issuance by the Company of the Common Stock underlying the Redeemable Warrants and the Representative's Warrant will cause a termination of such licenses. Certain other such licenses are terminable upon a change in the management of the Company. The Company does not believe that any such change in management will occur in the foreseeable future. Any future change in ownership or control of the Company could result in the termination of the licenses referred to above. The potential terminability of such licenses could have the effect of delaying, deferring or preventing a change in control of the Company, may discourage bids for the Common Stock at a premium over the market price of the Common Stock and may adversely affect the market price of the Common Stock. -49-
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The Company's products are based upon licensed content of major motion pictures and television shows under license and/or development agreements with major entertainment studios. See "Business -- General" and "-- Products." All of such license and development agreements to which the Company currently is a party are for fixed terms which will expire over the next one to five years. The Company anticipates that the licensor under each agreement will extend its terms, although no licensor is required to extend any license, provided that the Company is in compliance with all requirements of each license, including most significantly that the Company have satisfied the applicable minimum royalty guarantees. In the event that any licensor failed to renew its license agreement, then the subject license would terminate and the Company would no longer be entitled to sell the licensed product. The loss of one or more of the licenses could have a material adverse effect on the Company's revenues and profits. There can be no assurance that the Company will satisfy its performance obligations under any license or development agreement, or that, even if such requirements are satisfied, all material licenses will be renewed. EMPLOYEES As of March 31, 1996, the Company had 30 full-time employees, including five employees in sales and marketing, 20 employees in development and customer support and five employees in administration and finance. None of the Company's employees are represented by a labor union or are subject to a collective bargaining agreement. The Company has never experienced a work stoppage and believes that its relations with its employees are good. FACILITIES The Company leases approximately 8,000 square feet of office and warehousing space in Westlake Village, Ventura County, California. The lease for the Company's current office space expires on March 31, 1997. The Company currently expects that this facility will be sufficient for its needs at least through the term of the lease. The Company may lease additional adjacent space as its needs require, which it believes will be available on acceptable terms. LEGAL MATTERS At present there is no pending litigation or proceeding involving the Company or any director or officer of the Company. -50-
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MANAGEMENT DIRECTORS AND EXECUTIVE OFFICERS The directors and executive officers of the Company, their ages and their positions with the Company are as follows: NAME AGE POSITION ---- --- --------- Vincent J. Bitetti 41 Chairman of the Board, Chief Executive Officer and Director Eric H. Winston 48 President, Chief Operating Officer and Director Ulrich E. Gottschling 37 Chief Financial Officer, Treasurer, Secretary and Director VINCENT J. BITETTI founded Sound Source Interactive, Inc., a California corporation (the "Subsidiary"), in 1989 and served as the President of the Subsidiary from its formation. Since the Company acquired the Subsidiary in 1994, Mr. Bitetti has served as the Chairman of the Board and Chief Executive Officer and as a director of the Company and the Subsidiary. Prior to founding the Subsidiary, from 1986 to 1988 Mr. Bitetti was President of Fantastic Planet Consultants, a sound and musical instrument design consulting company. Mr. Bitetti is a published music composer and lyricist. From 1986 to 1993, Mr. Bitetti was a consultant to manufacturers of keyboard synthesizers in the music industry. Mr. Bitetti developed the concepts for the Company's MOVIEBOOK-TM-, AUDIOCLIPS-Registered Trademark-, VISUALCLIPS-Registered Trademark-, limited edition and creativity center products. ERIC H. (RICK) WINSTON has served as President and director of the Company and the Subsidiary since April 1994, and Chief Operating Officer of the Company and the Subsidiary since October 1995. Prior to joining the Company, Mr. Winston was President of E.H. Winston & Associates, a business consulting firm which he established in 1991. Mr. Winston was President and Chief Executive Officer of Computer Data Information Systems, Inc. from 1985 to 1989, when it was acquired by NYNEX. As part of that acquisition, Mr. Winston was retained as Vice President and General Manager of The DATAGROUP, a NYNEX subsidiary, and remained with The DATAGROUP until 1991 when he departed to start E.H. Winston & Associates. ULRICH E. GOTTSCHLING was appointed as Chief Financial Officer, Treasurer and director of the Company on October 9, 1995, and as Secretary of the Company on November 17, 1995. Prior to joining the Company, Mr. Gottschling was employed from June 1991 through September 1995 as a certified public accountant with Corbin & Wertz, the Company's independent auditors. From 1987 through May 1991, he was employed as a certified public accountant by Deloitte & Touche. From 1980 through 1986, Mr. Gottschling held various management positions with Westin Hotels and Marriott Corporation. The Company is currently conducting a search for a new Chief Executive Officer. It is anticipated that such person will be appointed following the closing of this offering. Upon the commencement of his or her employment by the Company, Mr. Bitetti will resign his current position as Chief Executive Officer. It is also anticipated that the Board of Directors will be reconstituted following this offering to comprise a total of five members. Mr. Gottschling will resign as a director, and three independent directors are expected to be appointed. Thereafter, all of the Company's directors will be elected -51-
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annually and will serve until the next annual meeting of stockholders or until the election and qualification of their successors. The Board of Directors elects the Company's officers and such officers serve at the discretion of the Board of Directors. There are no family relationships between the directors and executive officers of the Company. See generally "Risk Factors -- Dependence on Key Personnel." The Company has agreed to grant to each of The Boston Group, L.P., Joseph Stevens & Company, L.P. and ASSI, Inc., the right to nominate from time to time one director of the Company or to have an individual designated thereby attend all meetings of the Board of Directors of the Company as a nonvoting advisor. See "Underwriting" and "Certain Transactions -- Agreements With ASSI, Inc." Vincent J. Bitetti and Eric H. Winston have entered into voting agreements with each of The Boston Group, L.P., Joseph Stevens & Company, L.P. and ASSI, Inc. Pursuant to these agreements, Messrs. Bitetti and Winston have agreed to vote their Common Stock for the three director nominees of The Boston Group, L.P., Joseph Stevens & Company, L.P. and ASSI, Inc. In addition, ASSI, Inc. has agreed to vote its shares of Common Stock for two directors nominated by Mr. Bitetti for as long as he holds 20 percent or more of the issued and outstanding Common Stock, and for one director nominated by Mr. Bitetti for as long as he holds at least ten perent but less than 20 percent of the issued and outstanding Common Stock. The voting agreements with ASSI, Inc. will terminate when Messrs. Bitetti and Winston together cease to own at least ten percent of the issued and outstanding Common Stock. BOARD OF DIRECTORS AND COMMITTEES The business of the Company's Board of Directors currently is conducted through full meetings of the Board. Upon the expansion of the Board following the completion of this offering, it is expected that the Board also will conduct business through meetings of its committees. Set forth below is a description of the committees of the Board. The Audit Committee will review and report to the Board on various auditing and accounting matters, including an annual audit report from the Company's independent public accountants. The Chief Financial Officer, if a director, will not be a member of the Audit Committee. The Compensation Committee will establish compensation levels for the Company's executive officers and will administer and determine appropriate awards under the Company's 1995 Stock Option Plan. See "Management -- 1995 Stock Option Plan." Two of the independent directors to be appointed by the Board of Directors will serve on the Compensation Committee. The Executive Committee will have the authority to act on behalf of the full Board of Directors in between meetings of the Board, except that the Executive Committee will not have the authority to amend the Certificate of Incorporation or the Bylaws of the Company, adopt an agreement of merger or consolidation, recommend to the stockholders a dissolution of the Company or a revocation of dissolution or remove or indemnify a director. To the extent authorized by the Board of Directors, the Executive Committee will also be authorized to declare dividends of the Company and to issue shares of authorized and unissued Common Stock of the Company. The Executive Committee will also act as the Nominating Committee to nominate officers and directors of the Company for election. The Executive Committee will consist of the Chairman of the Board, the Chief Executive Officer and an independent director. -52-
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COMPENSATION OF BOARD OF DIRECTORS Directors previously have received no cash compensation for serving on the Board of Directors. Beginning in December 1995, the Company adopted a policy that will provide for payment of fees to its nonofficer directors for serving on its Board of Directors and for their attendance at Board and committee meetings. The Company will pay each nonofficer director an annual fee of $15,000. In addition, each nonofficer director will receive options to purchase 10,000 shares of Common Stock annually. EXECUTIVE COMPENSATION SUMMARY COMPENSATION. The following table sets forth information concerning compensation of the Company's Chief Executive Officer and each of the Company's other executive officers who received compensation from the Company and/or the Subsidiary in excess of $100,000 for the fiscal year ended June 30, 1995 (the "Named Executives"). No other executive officer's compensation exceeded $100,000 during fiscal 1995. [Enlarge/Download Table] Summary Annual Long-Term COMPENSATION COMPENSATION ---------------------------- --------------------------------- NAME AND STOCK OPTIONS ALL OTHER PRINCIPAL POSITION YEAR SALARY BONUS(1) (SHARES) COMPENSATION(2) ------------------ ---- ---------- ------------ -------------- ---------------- Vincent J. Bitetti, 1995 $150,000 $75,000 0 $ 6,200 Chairman of the Board and Chief Executive Officer Eric H. Winston, 1995 150,000 75,000 0 9,600 President and Chief Operating Officer (1) The bonuses accrued for fiscal year 1995 were fully paid in December 1995. (2) The amounts in this column for 1995 consist of the following: (a) personal use of Company car (50 percent of payment for car expenses): Mr. Bitetti - $4,800; Mr. Winston - $4,800; (b) life insurance premiums: Mr. Bitetti - $1,400; and (c) medical insurance premiums: Mr. Winston - $4,800. OPTION GRANTS. The following table provides information concerning options granted by the Company to each of the Named Executives during its fiscal year ended June 30, 1995 and to Ulrich E. Gottschling during its current fiscal year. [Enlarge/Download Table] OPTION GRANTS IN LAST FISCAL YEAR ------------------------------------------------------------------------------------------------------------ NUMBER OF PERCENT OF SHARES SUBJECT TOTAL OPTIONS TO COMMON GRANTED TO STOCK OPTIONS EMPLOYEES IN EXERCISE PRICE EXPIRATION NAME GRANTED FISCAL YEAR PER SHARE(2) DATE ---------------------- -------- ----------- ------------ ---- Vincent J. Bitetti 0 0.0% $ -- -- Eric H. Winston 0 0.0 -- -- Ulrich Gottschling(3) 100,000 70.5 5.00 10/8/05 -53-
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---------------------- (1) This column shows the hypothetical gains or option spreads of the options granted based on assumed annual compound stock appreciation rates of zero percent, five percent and ten percent over the full ten-year term of the options. The five percent and ten percent assumed rates of appreciation are mandated by the rules of the Securities and Exchange Commission and do not represent the Company's estimate or projection of future Common Stock prices. (2) The number of options granted and the exercise price per share were established by negotiation between the Company and Mr. Gottschling at the time of his hiring by the Company. The exercise price is equal to the price per share at which Common Stock was sold in the October 1995 Private Placement. (3) Mr. Gottschling became an executive officer and employee of the Company on October 9, 1995. The information concerning Mr. Gottschling is as of December 31, 1995, and includes an option granted to Mr. Gottschling on October 9, 1995. This option was cancelled on March 31, 1996. See "Management -- Employment Agreements." OPTION EXERCISES AND HOLDINGS. The following table sets forth information concerning each exercise of a stock option during the fiscal year ended June 30, 1995 by each of the Named Executives and the number and value of unexercised options granted by the Company held by each of the Named Executives on June 30, 1995. [Enlarge/Download Table] AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-ENDED OPTION VALUES -------------------------------------------------------------------------------------------------------------------- VALUE OF NUMBER OF SHARES UNEXERCISED UNDERLYING IN-THE-MONEY UNEXERCISED OPTIONS OPTIONS AT AT 6/30/95(1) 6/30/95(1) NUMBER OF ------------------- --------------- SHARES ACQUIRED EXERCISABLE/ EXERCISABLE/ NAME ON EXERCISE VALUE REALIZED UNEXERCISABLE UNEXERCISABLE ----------------- ---------------- -------------- ------------------- --------------- Vincent J. Bitetti 0 $ 0 0/0 $ 0/0 Eric H. Winston(2) 0 0 292,838/0 1,153,782/0 (1) Based on the fair market value of the Common Stock in this offering ($4.00 per share), less the option exercise price. (2) Does not include a presently exercisable option held by Mr. Winston to purchase 100,000 shares of Common Stock from Mr. Bitetti at $2.00 per share. EMPLOYMENT AGREEMENTS The Company has entered into an employment agreement with Vincent J. Bitetti, Chairman of the Board and Chief Executive Officer, for a term ending on September 15, 1998. Pursuant to that employment agreement, Mr. Bitetti is to receive annual base compensation of $200,000, which will be reduced to $160,000 upon the date of this Prospectus. Mr. Bitetti's annual base compensation will be increased by $40,000 at such time as the Company realizes net sales (gross sales less returns and allowances) of $1,500,000 or more for any three consecutive calendar months. Mr. Bitetti's salary also is subject to escalation annually in accordance with the Consumer Price Index (the "CPI"). In addition, Mr. Bitetti's employment agreement entitles him to receive bonuses based on three criteria: attainment of specified gross revenues, attainment of specified gross profits, and attainment of specified pre-tax profitability. If the Company acquires any new business in the future, the related revenues and profits will not be taken into account in determining entitlements to these bonuses. -54-
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The gross revenue bonus would entitle Mr. Bitetti to receive the following amounts if the following gross revenues are attained for the fiscal year ending June 30, 1996. Gross Revenue Cumulative Cash Bonus ------------- --------------------- $ 7,500,000 $ 25,000 10,000,000 75,000 15,000,000 125,000 The gross revenue attainment levels required to receive each bonus level for each subsequent fiscal year will be increased by 60 percent annually. The gross profit bonus would entitle Mr. Bitetti to receive the following amounts if the following gross profit amounts (defined as annual sales revenue less all costs of sale as determined by the Company's independent public accountants) are attained for the fiscal year ending June 30, 1996: Gross Profit Cumulative Cash Bonus ------------ ---------------------- $2,000,000 $ 50,000 2,250,000 75,000 2,500,000 100,000 The gross profit levels required to receive each bonus level for each subsequent fiscal year will be increased by 60 percent annually. The pre-tax profitability bonus would entitle Mr. Bitetti to the following amounts if the following pre-tax profit amounts (defined as annual earnings before interest, taxes, depreciation and amortization) are attained for each fiscal year during the term of Mr. Bitetti's employment agreement: Profitability Cumulative Cash Bonus ------------- --------------------- 10% $ 50,000 15% 100,000 Pursuant to his employment agreement, Mr. Bitetti is entitled to certain other fringe benefits including use of a Company automobile or automobile allowance, $5,000,000 in life insurance coverage (provided that in no event will the Company be required to pay a premium for such insurance in excess of $7,500 per year) and the right to participate in the Company's customary benefit plans. Mr. Bitetti's employment agreement further provides that following the voluntary or involuntary termination of his employment by the Company, Mr. Bitetti is entitled to two demand registration rights with respect to the Common Stock held by or issuable to him. These registration rights will only become effective upon the voluntary or involuntary termination of Mr. Bitetti's employment with the Company. Mr. Bitetti's employment agreement further provides that his salary may not be less than that of the Company's new Chief Executive Officer, up to a maximum of $300,000. The Company has entered into an employment agreement with Eric H. Winston, President and Chief Operating Officer, for a term ending on September 15, 1998. Pursuant to that employment agreement, Mr. Winston is to receive annual base compensation of $175,000, which will be reduced to $140,000 upon the date of this Prospectus. Mr. Winston's annual base compensation will be increased by $35,000 at such time as the Company realizes net sales of $1,500,000 or more for any three consecutive calendar months. Mr. Winston's salary also is subject to escalation annually in accordance with the CPI. Mr. Winston's employment agreement entitles him to receive three annual bonuses payable in accordance with the same provisions described above with respect to Mr. Bitetti's employment agreement. Mr. Winston is also entitled to the same fringe benefits as Mr. Bitetti. -55-
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Pursuant to his employment agreement the Company has granted Mr. Winston options to purchase 292,838 shares of Common Stock at an exercise price of $.06 per share. See "Management -- Executive Compensation." Mr. Winston's employment agreement further provides that following the voluntary or involuntary termination of his employment by the Company, Mr. Winston is entitled to two demand registration rights with respect to the Common Stock held by or issuable to him. The registration rights will only become effective upon the voluntary or involuntary termination of Mr. Winston's employment with the Company. Mr. Bitetti has separately granted Mr. Winston a presently exercisable option to acquire 100,000 shares of Common Stock at a purchase price of $2.00 per share. Pursuant to his employment agreement, Mr. Winston has granted Mr. Bitetti a right of first refusal as to all Common Stock that Mr. Winston may from time to time acquire. Such first offer right provides that before Mr. Winston offers to sell any such Common Stock to any third party, he must first offer to sell such shares to Mr. Bitetti on no less favorable terms that proposed to be offered to the third party. If Mr. Bitetti rejects such offer, then Mr. Winston is free to sell to the third party on terms no less favorable than offered to Mr. Bitetti. The Company also separately agreed to pay each of Messrs Bitetti and Winston a bonus equal to the sum of three percent of the Company's net sales. The entitlement to receive such bonuses ended November 30, 1995. A bonus of $16,578 was paid to each of Messrs. Bitetti and Winston for the two-month period ended November 30, 1995. The Company entered into an employment agreement with Ulrich E. Gottschling, Chief Financial Officer, Treasurer, Secretary and director, for a term ending October 9, 1997. The employment agreement entitles Mr. Gottschling to receive annual cash compensation of $110,000. Pursuant to his employment agreement, on October 9, 1995 Mr. Gottschling also was granted options to purchase 100,000 shares of Common Stock at an exercise price of $5.00 per share. See "Management -- Executive Compensation" and "-- 1992 Stock Option Plan." On April 30, 1996, Mr. Gottschling agreed to the termination of his existing 100,000 share option in consideration for the Company's agreement to grant to him a new 200,000 share option pursuant to the 1992 Stock Option Plan. The Company granted this option to Mr. Gottschling on April 30, 1996. The option is exercisable upon the date of its grant as to 100,000 shares at a purchase price of $3.40 per share, and will become exercisable as to 100,000 shares on September 30, 1997 at a purchase price of $4.00 per share. Mr. Gottschling's employment agreement further provides that following the voluntary or involuntary termination of his employment by the Company, Mr. Gottschling is entitled to a single demand registration right with respect to the Common Stock held by or issuable to him pursuant to his option agreement. 1995 STOCK OPTION PLAN GENERAL On October 9, 1995, the Board of Directors of the Company adopted the Company's 1995 Stock Option Plan, which plan was approved by the stockholders of the Company the same day. The following summary of the Company's 1995 Stock Option Plan is qualified in its entirety by the 1995 Stock Option Plan, a copy of which is filed as an exhibit to the Registration Statement of which this Prospectus is a part. The 1995 Sound Source Interactive, Inc. Stock Option Plan (the "1995 Stock Option Plan") is designed to promote and advance the interests of the Company and its stockholders by (i) enabling the Company to attract, retain, and reward managerial and other key employees and nonemployee directors, and (ii) strengthening the mutuality of interests between participants in the 1995 Stock Option Plan and the stockholders of the Company in its long term growth, profitability and financial success by offering stock options. -56-
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The 1995 Stock Option Plan empowers the Company to award or grant from time to time until September 30, 2005, to officers, directors and key employees of the Company and its subsidiaries, Incentive and Non-Qualified Stock Options ("Options") authorized by the Compensation Committee of the Board of Directors (the "Committee") which will administer the 1995 Stock Option Plan. The Company has not yet granted any options under the 1995 Stock Option Plan. The Board of Directors however, has resolved to grant 13,610 to nonexecutive Company employees on the closing date of this offering at an exercise price of $4.00 per share. ADMINISTRATION The 1995 Stock Option Plan will be administered by the Committee. The 1995 Stock Option Plan provides that the Committee must consist of at least two directors of the Company who are "disinterested directors" within the meaning of Rule 16b-3 under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). The Committee has the sole authority to construe and interpret the 1995 Stock Option Plan, to make rules and procedures relating to the implementation of the 1995 Stock Option Plan, to select participants, to establish the terms and conditions of Options and to grant Options, with broad authority to delegate its responsibilities to others, except with respect to the selection for participation of, and the granting of Options to, persons subject to Sections 16(a) and 16(b) of the Exchange Act. Members of the Committee will not be eligible to receive discretionary Options under the 1995 Stock Option Plan. ELIGIBILITY CONDITIONS All officers and key employees of the Company and its subsidiaries and nonemployee directors will be eligible to receive Options under the 1995 Stock Option Plan. Nonemployee directors are only eligible to receive Non-Qualified Stock Options under the 1995 Stock Option Plan. Except for Non-Qualified Stock Options granted to nonemployee directors, the selection of recipients of, and the nature and size of, Options granted under the 1995 Stock Option Plan will be wholly within the discretion of the Committee. Subject to specific formula provisions relating to the grant of options to nonemployee directors and except with respect to the exercisability of Incentive Stock Options and the total shares available for option grants under the 1995 Stock Option Plan, there is no limit on the number of shares of Common Stock or type of option in respect of which Options may be granted to or exercised by any person. SHARES SUBJECT TO 1995 STOCK OPTION PLAN The maximum number of shares of Common Stock in respect of which Options may be granted under the Plan (the "Plan Maximum") is 500,000. For the purpose of computing the total number of shares of Common Stock available for Options under the 1995 Stock Option Plan, the above limitations shall be reduced by the number of shares of Common Stock subject to issuance upon exercise or settlement of Options previously granted, determined at the date of the grant of such Options. However, if any Options previously granted are forfeited, terminated, settled in cash or exchanged for other Options or expire unexercised, the shares of Common Stock previously subject to such Options shall again be available for further grants under the 1995 Stock Option Plan. The shares of Common Stock which may be issued to participants in the 1995 Stock Option Plan upon exercise of an Option may be either authorized and unissued Common Stock or issued Common Stock reacquired by the Company. No fractional shares may be issued under the 1995 Stock Option Plan. The maximum number of shares of Common Stock issuable upon the exercise of Options granted under the 1995 Stock Option Plan is subject to appropriate equitable adjustment in the event of a reorganization, stock split, stock dividend, combination of shares, merger, consolidation or other -57-
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recapitalization of the Company. The effect of such adjustment would be to provide customary anti-dilution protection. TRANSFERABILITY No Option granted under the 1995 Stock Option Plan, and no right or interest therein, shall be assignable or transferable by a participant except by will or the laws of descent and distribution. TERM, AMENDMENT AND TERMINATION The 1995 Stock Option Plan will terminate on September 30, 2005 except with respect to Options then outstanding. The Board of Directors of the Company may amend or terminate the 1995 Stock Option Plan at any time, except that, to the extent restricted by Rule 16b-3 promulgated under the Exchange Act, as amended and in effect from time to time (or any successor rule), the Board of Directors may not, without approval of the Stockholders of the Company, make any amendment that would increase the total number of shares covered by the 1995 Stock Option Plan, change the class of persons eligible to receive Options granted under the 1995 Stock Option Plan, reduce the exercise price of Options granted under the 1995 Stock Option Plan or extend the latest date upon which Options may be exercised. INCENTIVE STOCK OPTIONS Options designated as Incentive Stock Options, within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended (the "Code"), in respect of up to the Plan Maximum may be granted under the 1995 Stock Option Plan. The number of shares of Common Stock in respect of which Incentive Stock Options are first exercisable by any participant in the 1995 Stock Option Plan during any calendar year shall not have a fair market value (determined at the date of grant) in excess of $100,000 (or such other limit as may be imposed by the Code). To the extent the fair market value of the shares for which options are designated as Incentive Stock Options that are first exercisable by any optionee during any calendar year exceed $100,000, the excess amount shall be treated as Non-Qualified Stock Options. Incentive Stock Options shall be exercisable for such period or periods, not in excess of ten years after the date of grant, as shall be determined by the Committee. NON-QUALIFIED STOCK OPTIONS Non-Qualified Stock Options may be granted for such number of shares of Common Stock and will be exercisable for such period or periods as the Committee shall determine. OPTIONS TO NONEMPLOYEE DIRECTORS The 1995 Stock Option Plan also provides for the grant of Options to nonemployee directors of the Company without any action on the part of the Board or the Committee, only upon the terms and conditions set forth in the 1995 Stock Option Plan. Each nonemployee director shall automatically receive Non- Qualified Options to acquire 10,000 shares of Common Stock upon appointment, and shall receive Non-Qualified Options to acquire an additional 10,000 shares of Common Stock for each additional year that the nonemployee director continues to serve on the Board of Directors. Each Option shall become exercisable as to 50 percent of the shares of Common Stock subject to the Option on the first anniversary date of the grant and 50 percent on the second anniversary date of the grant, and will expire on the earlier of ten years from the date the Option was granted, upon expiration of the 1995 Stock Option Plan or three weeks after the optionee ceases to be a director of the Company. The exercise price of such Options shall be equal to 100 percent of the fair market value of the -58-
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Common Stock subject to the Option on the date on which such Options are granted. Each option shall be subject to the other provisions of the 1995 Stock Option Plan. OPTION EXERCISE PRICES The exercise price of any Option granted under the 1995 Stock Option Plan shall be at lest 100 percent of the fair market value of the Common Stock on the date of grant, except that the exercise price of any Option granted to any participant in the 1995 Stock Option Plan who owns in excess of ten percent of the outstanding voting stock of the Company shall be 110 percent of the fair market value of the Common Stock on the date of grant. Fair market value per share of Common Stock is quoted by the Nasdaq SmallCap Market, or as the amount determined in good faith by the Committee if the Common Stock is neither listed for trading on an exchange or quoted by the Nasdaq SmallCap Market. Options granted effective as of the closing date of this offering will have an exercise price equal to the initial public offering price per share. EXERCISE OF OPTIONS No Option may be exercised, except as provided below, unless the holder thereof remains in the continuous employ or service of the Company. Options shall be exercisable upon the payment in full of the applicable option exercise price in cash or, if approved by the Committee, by instruction to a broker directing the broker to sell the Common Stock for which such Option is exercised and remit to the Company the aggregate exercise price of the Option or upon such terms as the Committee shall approve, in shares of the Common Stock then owned by the optionee (at the fair market value thereof at exercise date). 1992 STOCK OPTION PLAN On May 4, 1992, the Board of Directors adopted the Company's 1992 Stock Option Plan. The Board of Directors has resolved that no further options are to be granted pursuant to the 1992 Stock Option Plan. All existing options previously issued under the 1992 Stock Option Plan will remain enforceable in accordance with their respective terms. Options to purchase a total of 384,070 shares of Common Stock currently are issued pursuant to the 1992 Stock Option Plan. All of such options are non- qualified stock options, all of which have an exercise price of $.06 per share. Of the 384,070 options that have been granted pursuant to the 1992 Stock Option Plan, 191,199 are presently exercisable, 45,840 will become exercisable in fiscal 1997 and the balance will become exercisable in fiscal 1998. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION Prior to November, 1995, the Company did not have a compensation committee or other committee of the Board of Directors performing similar functions. Decisions concerning compensation of executive officers previously were made by Vincent J. Bitetti. LIMITATION OF LIABILITY AND INDEMNIFICATION OF DIRECTORS DIRECTOR EXCULPATION The Company's Certificate of Incorporation provides that a director of the Company, to the maximum extent now or hereafter permitted by Section 102 (b)(7) of the Delaware GCL will have no personal liability to the Company or its stockholders for monetary damages for breach of fiduciary duty as a director. Section 102(b)(7) of the Delaware GCL currently provides that directors of corporations -59-
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that have adopted such a provision will not be so liable, except (i) for any breach of the director's duty of loyalty to the Company or its stockholders, (ii) for acts or omissions not in good faith or that involve intentional misconduct or a knowing violation of law, (iii) as provided under Section 174 of the Delaware GCL for the payment of certain unlawful dividends and the making of certain stock purchases or redemptions or (iv) for any transaction from which the director derived an improper personal benefit. This provision would absolve directors of personal liability for negligence in the performance of their duties, including gross negligence. It would not permit a director to be exculpated, however, for liability for actions involving conflicts of interest or breaches of the traditional "duty of loyalty" to the Company and its stockholders, and it would not affect the availability of injunctive or other equitable relief as a remedy. This provision does not eliminate or alter the duty of the Company's directors; it merely limits personal liability for monetary damages to the maximum extent now or permitted by the Delaware GCL. Moreover, it applies only to claims against a director arising out of his role as a director; it does not apply to claims arising out of his role as an officer (if he is also an officer) or arising out of any other capacity in which he serves. While this provision does not affect the availability of injunctive or other equitable relief as a remedy for breach of duty by directors, it does limit the remedies available to a stockholder who has an otherwise valid claim that a director acted in violation of his duties, if the action is among those as to which liability is limited. Because of this provision, stockholders will not have a claim for monetary damages based on breach of the directors' duty, even if the directors' conduct involved gross negligence (including a grossly negligent business decision involving a takeover proposal for the Company), unless the conduct is of a type for which the Delaware GCL does not permit limitation of liability. If the stockholders do not have a claim for monetary damages, their only remedy may be a suit to enjoin completion of the Board's action or to rescind completed action. The stockholders may not be aware of a proposed transaction that might otherwise give rise to a claim until the transaction is completed or until it is too late to prevent its completion by injunction. In such a case, the Company and its stockholders may have no effective remedy for an injury resulting from the Board's action. This provision may reduce the likelihood of stockholder derivative litigation against directors and may discourage or deter stockholders or management from bringing a lawsuit against directors for breach of their duties, even though such action, if successful, might otherwise have benefited the Company and its stockholders. The Securities and Exchange Commission has taken the position that similar provisions added to other corporations' certificates of incorporation would not protect those corporations' directors from liability for violations of the federal securities laws. The Company included this exculpation provision in its Certificate of Incorporation to provide its directors with the maximum protection from personal liability made available by the Delaware GCL. It is believed that this provision will help the Company to attract and retain as directors the persons most qualified for those positions. DIRECTOR INDEMNIFICATION The Company's Bylaws generally require the Company to indemnify and advance expenses to its directors, officers, employees and other agents to the fullest extent permitted by Delaware law. The Company also has entered into indemnification agreements with each of its existing directors, and plans to enter into indemnification agreements with directors appointed in the future, whereby the Company will indemnify each such person against certain claims arising out of certain past, present or future acts, omissions or breaches of duty committed by an indemnitee while serving as a Company director. Such indemnification does not apply to acts or omissions which are knowingly fraudulent, deliberately dishonest or arise from willful misconduct. Indemnification will only be provided to the extent that the indemnitee has not already received payments in respect of a claim from the Company -60-
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or from an insurance company. Under certain circumstances, such indemnification (including reimbursement of expenses incurred) will be allowed for liability arising under the Securities Act. Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers or person controlling the Company pursuant to the foregoing provisions, the Company has been informed that, in the opinion of the Securities and Exchange Commission, such indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable. The Company intends to purchase a directors' and officers' liability policy insuring directors and officers of the Company effective upon the closing of this offering. -61-
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PRINCIPAL AND SELLING STOCKHOLDERS The following table sets forth certain information regarding the ownership of the Common Stock, prior to the offering and immediately following completion of the offering, by (i) each selling stockholder, (ii) each person who is known to the Company to own, of record or beneficially, more than five percent of the Common Stock; (iii) each of the Company's directors; and (iv) all directors, and executive officers as a group. The Company and the selling stockholders have granted the Underwriters an option to purchase up to an aggregate of 360,000 additional shares of Common Stock, exercisable within 30 days of the date hereof, solely to cover over-allotments, if any. The Common Stock being offered by the selling shareholders will be sold only if such over-allotment option is exercised. See "Underwriting." Unless otherwise indicated, each of the stockholders shown in the table below has sole voting and investment power with respect to the shares beneficially owned. [Enlarge/Download Table] BEFORE OFFERING(2)-(3) NUMBER OF AFTER OFFERING(2)-(3) NUMBER SHARES BEING NUMBER NAME(1) OF SHARES PERCENT OFFERED(4) OF SHARES PERCENT(4) ------- --------- ------- ------------ --------- ---------- Vincent J. Bitetti(5) 1,557,901 86.2% 10,000 1,547,901 36.7% Eric H. Winston(6) 392,838 18.7 10,000 382,838 8.5 Ulrich E. Gottschling(7) 100,000 5.2 0 100,000 2.3 All directors and executive officers as a group (three persons)(8) 1,950,739 88.6 20,000 1,930,739 42.0 Mark Lane 122,323 6.8 0 122,323 2.9 GFL Ultra Fund Limited 183,723 10.2 0 183,723 4.4 ------------------- (1) The address of each of Messrs. Bitetti, Winston and Gottschling is c/o the Company, 2985 E. Hillcrest Drive, Suite A, Westlake Village, California 91362. The address of Mark Lane is 2818 Birch Creek Place, Thousand Oaks, California 91360. The address of GFL Ultra Fund Limited is Kaya Flamboyan 9, P.O. Box 812, Netherlands Antilles. (2) Each person's beneficial ownership is determined by assuming that options and warrants that are held by such person or entity (but not those held by any other person or entity) and which are exercisable within 60 days have been exercised. (3) Unless otherwise noted, the Company believes that all persons and entities named in the table have sole voting and investment power with respect to all shares of stock beneficially owned by them. (4) Reflects the issuance of 2,400,000 shares of Common Stock by the Company, and 20,000 shares of Common Stock by the selling stockholders as part of the Underwriter's over-allotment option, pursuant to this offering. (5) Includes 73,394 and 122,323 shares of Common Stock owned of record by Martin H. Meyer and Mark Lane, respectively, for which Vincent J. Bitetti holds a right of first offer to purchase and an irrevocable -62-
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voting proxy. See "Certain Transactions -- 1994 Acquisition." Also includes 100,000 shares of Common Stock which Mr. Winston is entitled to acquire from Mr. Bitetti pursuant to a presently exercisable option. See "Certain Transactions -- Sales by Controlling Stockholder. (6) Includes 292,838 shares of Common Stock issuable under stock options granted by the Company to Mr. Winston which are presently exercisable. See "Management -- Executive Compensation." Also includes 100,000 shares of Common Stock which Mr. Winston is entitled to acquire from Mr. Bitetti pursuant to a presently exercisable option. See "Certain Transactions -- Sales by Controlling Stockholder." (7) Includes 100,000 shares of Common Stock issuable to Mr. Gottschling under a presently exercisable option. Excludes 100,000 shares of Common Stock issuable to Mr. Gottschling under an option that is not presently exercisable. See "Management -- Employment Agreements." (8) Includes 292,838 shares of Common Stock issuable to Mr. Winston and 100,000 shares of Common Stock issuable to Mr. Gottschling under presently exercisable options. Excludes 100,000 shares of Common Stock issuable to Mr. Gottschling under an option that is not presently exercisable. RESALE OF OUTSTANDING SECURITIES This Prospectus relates to the sale by the Company of 2,400,000 shares of Common Stock and 1,200,000 Redeemable Warrants for aggregate gross consideration of $9,900,000. A separate Prospectus is being filed with the Registration Statement of which this Prospectus is a part which relates, in part, to the sale by the Selling Security Holders of 107,500 shares of Common Stock and 5,689,665 Redeemable Warrants for aggregate gross consideration of $1,852,416 (assuming an offering price of $4.00 per share of Common Stock and $.25 per Redeemable Warrant). None of the Common Stock or Redeemable Warrants being offered by the Selling Security Holders are being underwritten by the Underwriters. The second Prospectus also will be used by the Company for the issuance of Common Stock pursuant to the exercise of Redeemable Warrants. The Company will not receive any of the proceeds of the sale of the Common Stock or Redeemable Warrants by the Selling Security Holders, although it will receive the exercise price of such Redeemable Warrants when and if they are exercised. None of the Selling Security Holders had any position, office or material relationship with the Company or its affiliates during the last three years except for Financial West Group, Inc., which served as dealer manager for the Company's 1995 Bridge Offering and its 1995 Private Placement. See "Certain Transactions -- 1995 Bridge Offering" and "-- 1995 Private Placement." Prior to this offering, the Selling Security Holders collectively held 107,500 shares of Common Stock and Redeemable Warrants to purchase 5,689,665 of Common Stock. Assuming the sale of all such Common Stock and Redeemable Warrants pursuant to the separate Prospectus referred to above, the Selling Security Holders will not own any securities of the Company after the completion of such offering. CERTAIN TRANSACTIONS 1994 ACQUISITION On May 16, 1994, the Company consummated the 1994 Acquisition, whereby the Company acquired all the issued and outstanding capital stock of the Subsidiary in exchange for newly issued -63-
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stock of the Company. The 1994 Acquisition was accomplished by the issuance of 1,278,515 shares of Common Stock and 1,000,000 shares of the Company's Series A Preferred Stock to Vincent J. Bitetti, 73,394 shares of Common Stock to Martin H. Meyer and 122,323 shares of Common Stock to Mark Lane, and the simultaneous cancellation of 60,241 shares of Common Stock held by former directors and officers of the Company, the cancellation of an option to purchase 3,347 shares of Common Stock held by a former director and officer of the Company, which option was to become exercisable only upon the satisfaction of certain contingencies, and the cancellation of an option to purchase 3,347 shares of Common Stock held by a former director of the Company, which option was to become exercisable only upon the satisfaction of certain contingencies. Effective upon the closing of the 1994 Acquisition, all of the Company's former directors and officers resigned and were replaced by Vincent J. Bitetti, Joseph Urquidi, Eric H. Winston and Martin H. Meyer. Mr. Urquidi resigned as an officer and director as of June 29, 1994. Mr. Meyer resigned as a director as of August 5, 1994. Subsequent to the 1994 Acquisition, Mr. Bitetti exchanged his 1,000,000 shares of Series A Preferred Stock for 83,669 shares of Common Stock issued by the Company. Simultaneously with the 1994 Acquisition, Martin H. Meyer and Mark Lane each granted to Vincent J. Bitetti a right of first offer to purchase their Common Stock. Such first offer right provides that before Messrs. Meyer and Lane offer all or any of their shares to any third party, they must first offer to sell such shares to Mr. Bitetti at a price which Mr. Bitetti determines to be their fair market value. If the selling party disagrees with Mr. Bitetti's determination as to fair market value, then the issue will be resolved by an arbitration procedure. If Mr. Bitetti does not elect to purchase the shares proposed for sale, then they may be sold to third parties. Messrs. Meyer and Lane also have granted Mr. Bitetti an irrevocable proxy to vote all their shares of Common Stock on all matters coming before the holders of the Common Stock for a vote. See "Risk Factors -- Control of the Company" and "Principal Stockholders." 1994 PRIVATE PLACEMENT During May through August 1994, the Company conducted a private offering of its Common Stock (the "1994 Private Placement"). Pursuant to that offering, a total of 113,036 shares of Common Stock were sold for total cash consideration of approximately $1,492,000. An additional 1,841 shares were issued to the brother of the Chief Executive Officer in payment of a $22,000 note payable. An additional 81,997 shares of Common Stock were issued to the placement agent for such offering in partial payment for its services as such. Subsequently, the Company's founders, who also were affiliates of the placement agent, distributed all 81,997 such shares plus an additional 26,772 shares held by them to the investors in the 1994 Private Placement in settlement of litigation initiated by one of such investors, and returned 15,120 shares of Common Stock to the Company, which were cancelled. 1995 BRIDGE FINANCING During June through August of 1995, the Company conducted a private offering (the "1995 Bridge Financing") of Units consisting of notes and warrants. Pursuant to that offering, a total of 32 Units were sold at a price of $10,000 per Unit. Each Unit consisted of $9,975 principal amount of the Company's 10% Secured Promissory Notes due August 15, 1995 (the "Bridge Notes") and warrants to purchase 586 shares of Common Stock (the "Bridge Warrants"). The gross offering proceeds of the 1995 Bridge Financing were $320,000. Pursuant to the 1995 Bridge Financing, $319,200 in aggregate principal amount of the Bridge Notes were issued. The Bridge Notes were repaid in full out of the proceeds of the 1995 Private Placement, and the related liens upon the assets of the Company and the Subsidiary were extinguished. Such repayment was in the amount of $332,320. Pursuant to the 1995 Bridge Financing, the Company also issued 18,747 Bridge Warrants to investors, and -64-
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issued 20,918 Bridge Warrants to Financial West Group, Inc. in partial consideration for its services as dealer manager for the 1995 Bridge Offering. Subsequent to the completion of the 1995 Bridge Offering, the Company and the Subsidiary agreed with the holders of all of the Bridge Warrants as to certain changes to the terms of the Bridge Warrants. As amended, the terms of the Bridge Warrants, including the registration rights applicable thereto, are identical to those of the Private Warrants as described below. See "Certain Transactions -- 1995 Private Placement." The terms of the Bridge Warrants provide that if the Company consummates an initial public offering (an "IPO") which includes warrants to purchase shares of Common Stock, then the Bridge Warrants shall automatically be converted into warrants included in the IPO; such warrants into which the Bridge Warrants are automatically converted shall be exercisable to purchase the same number of shares as the Bridge Warrants, and shall contain the same terms (including exercise price) as the warrants offered to the public. Accordingly, the Bridge Warrants, which in the aggregate are exercisable to purchase 39,665 shares of Common Stock, will, upon the consummation of this offering, be automatically converted into Redeemable Warrants to purchase an aggregate of 39,665 shares of Common Stock and such Redeemable Warrants, as well as the underlying shares of Common Stock, have been included in the Registration Statement of which this Prospectus is a part. 1995 PRIVATE PLACEMENT In September and October 1995, the Company conducted a private offering (the "1995 Private Placement"). Pursuant to that offering, a total of 52.5 Units were sold at a price of $100,000 per Unit. Each Unit consisted of $95,000 principal amount of the Company's 10% Secured Promissory Notes due 1996 (the "Private Notes") and warrants to purchase 100,000 shares of Common Stock (the "Private Warrants"). The gross offering proceeds of the 1995 Private Placement were $5,250,000. Pursuant to the 1995 Private Placement, $4,987,500 in aggregate principal amount of the Private Notes were issued. The Private Notes are secured by a first priority lien on substantially all of the assets of the Company (including a pledge of all capital stock of the Subsidiary) and are guaranteed by the Subsidiary. The Private Notes are due and payable in the principal amount plus accrued interest on the earlier of (i) September 1, 1996 or (ii) the completion of any IPO by either the Company or the Subsidiary. Accordingly, the aggregate principal amount of $4,987,500 of the Private Notes, and accrued interest estimated at $242,500 as of March 31, 1996, will be repaid out of the net proceeds of this offering. See "Use of Proceeds." Pursuant to the 1995 Private Placement, the Company issued 5,250,000 Private Warrants to investors and issued 400,000 Private Warrants to Financial West Group, Inc. in partial consideration for its services as dealer manager for the 1995 Private Placement. The Private Warrants become exercisable commencing on the earlier of (i) December 31, 1996 or (ii) one year following the completion by the Company or the Subsidiary of any IPO, and expire on December 31, 2001. The exercise price of the Private Warrants is 110 percent of the price per share of the Common Stock (or the Subsidiary's common stock as applicable) in the IPO, or if the IPO has not occurred by December 31, 1996, $4.50 per share. If the Company has not completed an IPO by the earlier of December 31, 1996 or the date that an IPO by the Subsidiary is completed, the Private Warrants will be automatically converted to warrants exercisable for shares of Subsidiary Common Stock on a one-for-one basis, at an exercise price of $4.50 per share, for the period commencing December 31, 1996 and ending on December 31, 2001. In addition, the holders of the Private Warrants and Common Stock issued or issuable upon the conversion of the Private Warrants have certain registration rights. Concurrently with the registration of the Securities in this offering, the Company is registering the Private Warrants and the underlying Common Stock as part of the Registration Statement of which this Prospectus is a part, satisfying the applicable rights. -65-
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The terms of the Private Warrants provide that, if the Company consummates an IPO which includes warrants to purchase shares of Common Stock, then the Private Warrants shall automatically be converted into warrants included in the IPO; such warrants into which the Private Warrants are automatically converted shall be exercisable to purchase the same number of shares as the Private Warrants, and shall contain the same terms (including exercise price) as the warrants offered to the public. Accordingly, the Private Warrants, which in the aggregate were exercisable to purchase 5,650,000 shares of Common Stock, will, upon the consummation of this offering, be automatically converted into Redeemable Warrants exercisable to purchase an aggregate of 5,650,000 shares of Common Stock and such Redeemable Warrants, as well as the underlying shares of Common Stock, have been included in the Registration Statement of which this Prospectus forms a part, and comprise a portion of the Selling Security Holders' Securities. See "Selling Security Holders." Contemporaneously with the 1995 Private Placement, Vincent J. Bitetti, the Company's Chief Executive Officer, privately sold 107,500 shares of Common Stock for total cash consideration of $537,500. Such shares of Common Stock have been included in the Registration Statement of which this Prospectus is a part, and comprise a portion of the Selling Security Holders' Securities. See "Selling Security Holders." On April 3, 1995, Vincent J. Bitetti, for nominal consideration granted Eric H. Winston, the Company's President, an option to purchase 100,000 shares of the Common Stock owned by Mr. Bitetti at an exercise price of $2.00 per share, such price determined to be the fair market value by management. AGREEMENTS WITH ASSI, INC. In consideration of certain financial and personnel consulting services provided to the Company in 1996, including advising the Company regarding capital raising alternatives and executive recruiting, the Company has issued to ASSI, Inc. warrants to purchase 2,000,000 shares of Common Stock at an exercise price of $4.40 per share (the "ASSI Warrants," as previously defined). The terms of the ASSI Warrants are substantially identical to those of the Private Warrants, except that they become exercisable September 1, 1996, they are not mandatorily redeemable by the Company and they are subject to separate registration rights, including one demand registration right and unlimited piggyback registration rights for as long as they are held by ASSI, Inc. or one of its affiliates. Upon a transfer of the ASSI Warrants to any nonaffiliate of ASSI, Inc., the terms of such transferred ASSI Warrants will become identical to those of the Redeemable Warrants. The demand registration rights will expire on September 1, 2001. Until and unless exercised, the holders of the ASSI Warrants will have no voting, dividend or other rights as shareholders of the Company. The Company also has agreed that the Private Warrants held by ASSI, Inc. will become exercisable September 1, 1996. The Company has also agreed to grant ASSI, Inc. the right to nominate from time to time one director of the Company. Vincent J. Bitetti and Eric H. Winston have entered into a voting agreement with ASSI, Inc. to vote their shares of Common Stock for the election of such nominee. In addition, ASSI, Inc. has agreed to vote its shares of Common Stock for two directors nominated by Mr. Bitetti for as long as he holds 20 percent or more of the Common Stock, and for one director nominated by Mr. Bitetti for as long as he hlds at least ten percent but less than 20 percent of the issued and outstanding Common Stock. The voting agreements with ASSI, Inc. will terminate when Messrs. Bitetti and Winston together cease to own at least ten percent of the Common Stock. See "Management -- Directors and Executive Officers." -66-
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DESCRIPTION OF SECURITIES GENERAL The Securities consist of shares of Common Stock and Redeemable Warrants. One Redeemable Warrant entitles the holder thereof to purchase one share of Common Stock. Under the Company's Restated Certificate of Incorporation, the authorized capital stock of the Company consists of 20,000,000 shares of Common Stock. As of March 31, 1996, the Company had 1,808,291 shares of Common Stock outstanding, which were held by approximately 130 shareholders of record. COMMON STOCK Holders of shares of Common Stock are entitled to one vote for each share on all matters to be voted on by the stockholders. Holders of shares of Common Stock are entitled to share ratably in dividends, if any, as may be declared from time to time by the Board of Directors in its discretion, from funds legally available therefor. In the event of a liquidation, dissolution or winding up of the Company, the holders of shares of Common Stock are entitled to share pro rata all assets remaining after payment in full of all liabilities. Holders of Common Stock have no preemptive rights to purchase Common Stock. There are no conversion rights or redemption or sinking fund provisions with respect to the Common Stock. All of the outstanding shares of Common Stock issuable upon exercise of the Warrants will be, when issued and delivered, fully paid and non-assessable. As a QUASI-California corporation, the Company will be subject to certain provisions of the California GCL, as more fully described under "Description of Securities - Application of California GCL." Amongst other consequences of the Company's status as a QUASI-California corporation, at the request of any stockholder, the election of the Company's directors will be determined by cumulative voting procedures. Consequently, following this offering the Company's stockholders other than its current officers and directors will have sufficient votes, if cumulative voting rights are exercised, to elect two of its three directors (or three of its five directors, upon the anticipated expansion of the Board following this offering) assuming no exercise of the Redeemable Warrants and two of its three (or four of its five, as applicable) directors assuming exercise of the Redeemable Warrants in full. See "Risk Factors -- Control of the Company by Officers and Directors" and "Management -- Directors and Executive Officers." REDEEMABLE WARRANTS The following is a brief summary of certain provisions of the Redeemable Warrants, but such summary does not purport to be complete and is qualified in all respects by reference to the actual text of the Warrant Agreement between the Company and Corporate Stock Transfer Company as warrant agent (the "Warrant Agreement"). A copy of the Warrant Agreement has been filed as an exhibit to the Registration Statement of which this Prospectus is a part. See "Additional Information." Each Redeemable Warrant entitles the holder thereof to purchase, at any time during the 54-month period commencing one year after the date of this Prospectus, one share of Common Stock at a price of 110 percent of the initial public offering price per share, subject to adjustment in accordance with the anti-dilution and other provisions referred to below. The Redeemable Warrants are subject to redemption by the Company, at any time, commencing one year after the date of this Prospectus, at a price of $.25 per Redeemable Warrant if the average closing bid price of the Common Stock equals or exceeds 140 percent of the initial public -67-
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offering price per share for any 20 trading days within a period of 30 consecutive trading days ending on the fifth trading day prior to the date of notice of redemption. If the Redeemable Warrants were redeemed prior to their exercise, the holders thereof would lose the benefit of the difference between the market price of the underlying Common Stock as of such date and the exercise price of such Warrants, as well as any possible future price appreciation in the Common Stock. The exercise price and the terms of the Redeemable Warrants bear no relation to any objective criteria of value and should in no event be regarded as an indication of any future market price of the Securities offered hereby. The exercise price and the number of shares of Common Stock purchasable upon the exercise of the Redeemable Warrants are subject to adjustment upon the occurrence of certain events, including stock dividends, stock splits, combinations or reclassification on or of the common Stock and issuances of shares of Common Stock for a consideration less than the exercise price of the Redeemable Warrants. Additionally, an adjustment would be made in the case of a reclassification or exchange of Common Stock, consolidation or merger of the Company with or into another corporation or sale of all or substantially all of the assets of the Company in order to enable holders of Redeemable Warrants to acquire the kind and number of shares of stock or other securities or property receivable in such event by a holder of the number of shares that might otherwise have been purchased upon the exercise of the Redeemable Warrant. No adjustments will be made unless such adjustment would require an increase or decrease of at least $.10 or more in such exercise price. No adjustment to the exercise price of the shares subject to the Redeemable Warrants will be made for dividends (other than stock dividends), if any, paid on the Common Stock. The Redeemable Warrants may be exercised upon surrender of the warrant certificate on or prior to the expiration date at the offices of the Warrant Agent, with the exercise form on the reverse side of the certificate completed and executed as indicated, accompanied by full payment of the exercise price (by certified check payable to the Company) to the Warrant Agent for the number of Redeemable Warrants being exercised. The holders of Redeemable Warrants do not have the rights or privileges of holders of Common Stock. No Redeemable Warrant will be exercisable unless at the time of exercise the Company has filed a current prospectus with the Securities and Exchange Commission (the "Commission") covering the shares of Common Stock issuable upon exercise of such Redeemable Warrant and such shares have been registered or qualified or deemed to be exempt under the securities laws of the jurisdiction of residence of the holder of such Redeemable Warrant. The Company will use its best efforts to have all such shares so registered or qualified on or before the exercise date and to maintain a current prospectus relating thereto until the expiration of the Redeemable Warrants, subject to the terms of the Warrant Agreement. While it is the Company's intention to do so, there is no assurance that it will be able to do so. The Bridge Warrants issued by the Company in the 1995 Bridge Financing and the Private Warrants issued by the Company in the 1995 Private Placement provide that, if the Company consummates a public offering of its securities which includes warrants to purchase shares of Common Stock, then the Bridge Warrants and the Private Warrants shall automatically be converted into warrants included in the public offering; accordingly, the 39,665 Bridge Warrants issued in the 1995 Bridge Financing and the 5,650,000 Private Warrants issued in the 1995 Private Placement have been converted as of the date of this Prospectus into a like number of Redeemable Warrants. -68-
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APPLICATION OF CALIFORNIA GCL Although incorporated in Delaware, the business of the Company has been conducted through its operating subsidiary which is domiciled and headquartered in the State of California. Section 2115 of the California GCL ("Section 2115") provides that certain provisions of the California GCL shall be applicable to a corporation organized under the laws of another state to the exclusion of the law of the state in which it is incorporated, if the corporation meets certain tests regarding the business done in California and the number of its California stockholders. An entity such as the Company can be subject to Section 2115 even though it does not itself transact business in California if, on a consolidated basis, the average of the property factor, payroll factor and sales factor is more than 50 percent deemed to be in California during its latest full income year and more than one-half of its outstanding voting securities are held of record by persons having addresses in California. Section 2115 does not apply to corporations with outstanding securities listed on the New York or American Stock Exchange, or with outstanding securities designated as qualified for trading as a national market security on NASDAQ, if such corporation has at least 800 beneficial holders of its equity securities. Since the Company currently would be deemed to meet these factors and does not currently qualify as a national market security on NASDAQ, it is subject to Section 2115. During the period that the Company is subject to Section 2115, the provisions of the California GCL regarding the following matters are made applicable to the exclusion of the law of the State of Delaware: (i) general provisions and definitions; (ii) annual election of directors; (iii) removal of directors without cause; (iv) removal of directors by court proceedings; (v) filling of director vacancies where less than a majority in office were elected by the stockholders; (vi) directors' standard of care; (vii) liability of directors for unlawful distributions; (viii) indemnification of directors, officers and others; (ix) limitations on corporate distributions of cash or property; (x) liability of a stockholder who receives an unlawful distribution; (xi) requirements for annual stockholders meetings; (xii) stockholders' right to cumulate votes at any election of directors; (xiii) supermajority vote requirements; (xiv) limitations on sales of assets; (xv) limitations on mergers; (xvi) reorganizations; (xvii) dissenters' rights in connection with reorganizations; (xviii) required records and papers; (xix) actions by the California Attorney General; and (xx) rights of inspection. TRANSFER AGENT AND WARRANT AGENT The Transfer Agent and Registrar for the Common Stock and the Warrant Agent for the Redeemable Warrants is Corporate Stock Transfer Company, 370 17th Street, Suite 2350, Denver, Colorado 80202. SHARES ELIGIBLE FOR FUTURE SALE The offering made by this Prospectus is the initial registered public offering of the Securities. There is no public trading market for any of the Company's securities at the present time. There can be no assurance that a public trading market will ever develop or, if a market develops, that it will be sustained. See "Risk Factors -- No Prior Market; Arbitrary Determination of Offering Price; Possible Volatility of Trading Prices for Securities." Although it has no legal obligation to do so, the Representative and one or more other Underwriters may from time to time become market-makers or otherwise effect transactions in the Securities (and the Representative has indicated to the Company that it intends to do so). The Representative, if it participates in the market, may be a dominating influence in any market that might develop for any of the Securities. The price and liquidity of the Securities may be significantly affected by the degree, if any, of the Representative's participation in -69-
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the market. Such activities, if commenced, may be discontinued at any time or from time to time. See "Risk Factors -- Representative's Potential Influence on the Market." Upon the consummation of this offering, 4,208,291 shares of Common Stock will be outstanding, assuming that the Underwriters' over-allotment option is not exercised and excluding (a) 384,070 shares of Common Stock underlying options granted pursuant to the Company's 1992 Stock Option Plan; (b) 500,000 shares of Common Stock underlying options which may be granted pursuant to the Company's 1995 Stock Option Plan; (c) 292,838 shares of Common Stock underlying options granted to the Company's President; and (d) an aggregate of 9,249,665 shares of Common Stock issuable upon the exercise of (i) the Redeemable Warrants being offered by the Company (1,200,000 shares), (ii) the Redeemable Warrants that were issued in connection with the 1995 Bridge Financing (39,665 shares), (iii) the Redeemable Warrants that were issued in connection with the 1995 Private Placement (5,650,000 shares), (iv) the ASSI Warrants (2,000,000 shares), and (v) the Representative's Warrant (360,000 shares). Of the 4,208,291 shares of Common Stock that will be issued and outstanding upon the consummation of this offering (subject to the assumptions in the preceding paragraph), the 2,400,000 shares offered by the Company and the 107,500 shares offered by the Selling Security Holders will be freely tradeable without further registration under the Securities Act, except for any such shares of Common Stock purchased by an "affiliate" of the Company. Of the remaining 1,700,791 outstanding shares, 183,723 shares are freely tradeable and the remainder are "restricted shares" as defined in Rule 144 under the Securities Act and may not be sold without registration under the Securities Act unless pursuant to an applicable exemption therefrom. In general, under Rule 144, a person (or persons whose shares are required to be aggregated) who has satisfied a two-year holding period may, under certain circumstances, commencing 90 days after the date hereof, sell within any three- month period, in ordinary brokerage transactions or in transactions directly with a market maker, a number of shares of Common Stock equal to the aggregate of one percent of the then outstanding Common Stock or the average weekly trading volume during the four calendar weeks prior to such sale. Rule 144 also permits the sale of shares of Common Stock without any quantity limitations by a person who is not an "affiliate" of the Company and who has owned the shares for at least three years. The foregoing summary of Rule 144 is not intended to be a complete description thereof. Vincent J. Bitetti, Eric H. Winston and Ulrich E. Gottschling have agreed not to directly or indirectly offer, offer to sell, grant an option for the purchase or sale of, transfer, assign, pledge hypothecate or otherwise encumber (either pursuant to Rule 144 or otherwise) any of their securities for a period of 18 months from the date of this Prospectus without the prior written consent of the Company and the Representative. The Company intends to make a public announcement in the event that a material amount of securities subject to a lock-up arrangement described in this paragraph are released prior to the expiration of the term of such arrangement if such announcement is required by the federal securities laws. The 1,200,000 Redeemable Warrants being offered by the Company (assuming that the Underwriters' over-allotment option is not exercised) and the 5,689,665 Redeemable Warrants being registered for the account of the Selling Security Holders entitle the holders of such Redeemable Warrants to purchase up to an aggregate of 6,889,665 shares of Common Stock at any time during the 54-month period commencing one year after the date of this Prospectus. The Redeemable Warrants being registered for the account of the Selling Security Holders or, if exercised, the shares of Common Stock issuable upon the exercise of such Redeemable Warrants, may be sold by the Selling Security Holders or their transferees commencing on the third business day after the date of this Prospectus. Sales of either the Redeemable Warrants or the underlying shares of Common Stock, or -70-
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even the existence of the right to exercise such Redeemable Warrants, may depress the price of the Common Stock or the Redeemable Warrants in any market that may develop for such Securities. See "Selling Security Holders" and "Description of Securities." In connection with this offering, the Company will grant to the Underwriters an over-allotment option, exercisable within 45 days of the date of this Prospectus, to purchase up to an additional 360,000 shares of Common Stock and/or up to an additional 180,000 Redeemable Warrants and issue to the Representative the Representative's Warrant to purchase up to 240,000 shares of Common Stock and/or 120,000 Redeemable Warrants. In the event that any holder of warrants issued by the Company exercises its warrants, the percentage of ownership of the Company by persons who invest hereunder will be diluted and any sales of the securities acquired thereby might have an adverse effect on the market price of the Common Stock and Redeemable Warrants. See "Underwriting." The Company has granted options for the purchase of 384,070 shares of Common Stock to certain key employees, officers, directors and consultants pursuant to the Company's 1992 Stock Option Plan. The Company has determined not to issue any further options under its 1992 Stock Option Plan, but all outstanding options under such plan will remain valid. Of the 384,070 options granted under the 1992 Stock Option Plan, 191,199 are presently exercisable, 45,840 will become exercisable in fiscal 1997 and the balance will become exercisable in fiscal 1998. The Company also has reserved 500,000 shares of Common Stock for issuance to key employees, officers, directors and consultants pursuant to the Company's 1995 Stock Option Plan. All Common Stock issuable upon exercise of such options will be "restricted stock" and will be subject to resale pursuant to Rule 144 as described above. Following completion of this offering, however, the Company intends to take action to register all such options and the underlying Common Stock under the Securities Act. Upon the effectiveness of such registration, the Common Stock issuable upon exercise of the options will be freely tradeable. See "Management -- 1995 Stock Option Plan" and "-- 1992 Stock Option Plan." The holders of the Bridge Warrants issued in the 1995 Bridge Financing and the Private Warrants issued in the 1995 Private Placement have certain registration rights which will be satisfied by virtue of the registration of such Bridge Warrants and Private Warrants (all of which will be converted to Redeemable Warrants upon the consummation of this offering and will comprise a portion of the Selling Security Holders' Securities) pursuant to the Registration Statement of which this Prospectus is a part. See "Certain Transactions -- 1995 Bridge Financing" and "-- 1995 Private Placement." Except for the registration rights of Vincent J. Bitetti and Eric H. Winston and ASSI, Inc. described below, following this offering no other existing security holder of the Company will have registration rights with respect to any Company security which it holds. The Company has granted Eric H. Winston an option to purchase 292,838 shares of Common Stock which is presently exercisable. All Common Stock is issuable upon exercise of such option will be "restricted stock" and will be subject to resale pursuant to Rule 144 as described above. Following termination of his employment with the Company, Mr. Winston is entitled to certain registration rights with respect to the Common Stock issuable upon exercise of this option. Upon the effectiveness of such registration, the Common Stock issued upon exercise of this option will be freely tradeable. Following termination of his employment with the Company, Vincent J. Bitetti also is entitled to certain registration rights with respect to the Common Stock owned by him. Upon the effectiveness of such registration, the Common Stock owned by Mr. Bitetti will be freely tradeable. See "Management -- Employment Agreements." The Company has issued to ASSI, Inc. the ASSI Warrants to purchase 2,000,000 shares of Common Stock. See "Certain Transactions -- Agreements With ASSI." All such ASSI Warrants and the Common Stock issuable upon exercise thereof will be restricted securities and will be subject to resale pursuant to Rule 144 as described above. ASSI, Inc. is entitled to certain registration rights with -71-
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respect to the ASSI Warrants and the Common Stock issuable upon exercise thereof. Upon the effectiveness of such registration, the ASSI Warrants and underlying Common Stock will be freely tradeable. The Company is unable to predict the effect that any subsequent sales of the Company's securities, under this Registration Statement, Rule 144 or otherwise, may have on the then-prevailing market price of the Common Stock, although such sales could have a depressive effect on such market price. See "Risk Factors -- Shares Eligible for Future Sale." UNDERWRITING Subject to the terms and conditions set forth in the Underwriting Agreement (the form of which has been filed as an exhibit to the Registration Statement of which this Prospectus is a part), the Underwriters named below (the "Underwriters") have severally agreed to purchase from the Company the respective number of shares of Common Stock and Redeemable Warrants set forth opposite their name indicated below. The Underwriting Agreement provides that the obligations of the Underwriters are subject to certain conditions precedent, and that the Underwriters will be obligated, as set forth in the Underwriting Agreement, to purchase all of the 2,400,000 shares of Common Stock and 1,200,000 Redeemable Warrants being offered hereby, excluding shares of Common Stock and Redeemable Warrants covered by the over-allotment options granted to the Underwriters, if any are purchased. NUMBER OF UNDERWRITER NUMBER OF SHARES REDEEMABLE WARRANTS ----------------------------- ----------------- -------------------- The Boston Group, L.P. Joseph Stevens & Company, L.P. Both of the Representatives are recently formed, and neither has extensive experience as an underwriter of securities. The Boston Group, L.P., which was formed in March 1995, has acted as the managing underwriter for three public offerings and has not acted as a member of an underwriting syndicate Joseph Stevens & Company, L.P., which was formed in May 1994, has acted as the managing underwriter for four public offerings and as a member of an underwriting syndicate on approximately seven occasions. After interviewing various underwriters, the Company selected the Representatives to act as co-managers for this offering because it believes they have a thorough understanding of its business. Through the Representatives, the Underwriters have advised the Company that the Underwriters propose to offer the Common Stock and Redeemable Warrants to the public initially at the public offering price set forth on the cover page of this Prospectus, and may offer the Common Stock and Redeemable Warrants to selected dealers at such price less a concession of not more than $__ per share and $___ per Redeemable Warrant. The Underwriters may allow, and such dealers may reallow, a concession of not more than $__ per share and $___ per Redeemable Warrant on sales to certain other dealers. The initial public offering price and concessions and re-allowances to dealers may be changed by the Underwriters. The Company has agreed to pay to the Representatives a nonaccountable expense allowance equal to three percent of the gross proceeds from the sales of all shares of Common Stock and Redeemable Warrants offered hereby, including shares sold to cover over-allotments, if any. -72-
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The Underwriters have been granted the option, exercisable within 45 days after the date of this Prospectus, to purchase up to an aggregate of an additional 340,000 shares of Common Stock from the Company and up to 20,000 shares of Common Stock from Vincent J. Bitetti and Eric H. Winston (see "Principal and Selling Stockholders") and to purchase up to 180,000 Redeemable Warrants from the Company to cover over-allotments, at the same price being paid by the Underwriters for the other shares of Common Stock and Redeemable Warrants offered hereby. To the extent that the Underwriters exercise such option, each of the Underwriters will have, subject to certain conditions, a firm commitment, as set forth in the Underwriting Agreement, to purchase approximately the same percentage of the additional shares of Common Stock and Redeemable Warrants as the percentage of Common Stock and Redeemable Warrants to be purchased by it shown in the above table bear to 2,400,000 and 1,200,000, respectively, and the Company and the affiliated selling stockholders will be obligated, pursuant to the option, to sell such shares of Common Stock and Redeemable Warrants to the Underwriters. The Company has agreed to grant to each of the Representatives, effective upon the closing of the offering, the right to nominate from time to time one director of the Company or to have an individual selected by each such Representative attend all meetings of the Board of Directors of the Company as a non-voting advisor. Vincent J. Bitetti and Eric H. Winston have agreed to vote their shares of Common Stock for the election of such nominee. The Company has agreed to indemnify and hold harmless such directors or advisors to the maximum extent permitted by law in connection with such individual's service as a director or advisor. The Company has agreed to sell to the Representatives for an aggregate of $50 the Representatives Warrant to purchase up to 240,000 shares of Common Stock and/or 120,000 Redeemable Warrants at an exercise price of 120 percent of the initial public offering price per share of Common Stock or Redeemable Warrants, as applicable. The Representatives Warrant may not be transferred for one year, except basically to officers or partners of the Representatives, any member of the NASD participating in the offering hereunder, officers or partners of such member or any successor of any of the foregoing, and is exercisable during the four-year period commencing one year from the date of this Prospectus (the "Representatives Warrant Exercise Term"). The Company has granted certain rights to the holders of the Representative's Warrant to register the Common Stock underlying the Representatives Warrant under the Securities Act. Such rights require the Company to file a registration statement pertaining to the Representatives Warrant and the underlying Common Stock and to maintain the effectiveness of such registration statement for the period commencing one year after the date of this Prospectus and continuing until the earlier of the sale of all the registered securities or the fifth anniversary of the initial effectiveness of the registration statement. The Company has agreed, in connection with the exercise of Redeemable Warrants pursuant to solicitation by the Representatives (commencing one year from the date of this Prospectus), to pay to the Representatives a fee of five percent of the Redeemable Warrant exercise price for each Redeemable Warrant exercised, provided, however, that the Representatives will not be entitled to receive such compensation in any Redeemable Warrant exercise transactions in which (i) the market price of the Common Stock of the Company at the time of exercise is lower than the exercise price of the Redeemable Warrants; (ii) the Redeemable Warrants are held in any discretionary account; (iii) disclosure of compensation arrangements is not made, in addition to the disclosure provided in this Prospectus, in documents provided to holders of the Redeemable Warrant at the time of exercise; (iv) the exercise of the Redeemable Warrants is unsolicited; (v) after the Company has called the Redeemable Warrants for redemption; or (vi) the solicitation of exercise of the Redeemable Warrants was in violation of Rule 10b-6 promulgated under the Exchange Act. In addition, unless granted an exemption by the Commission from Rule 10b-6, the Representative will be prohibited from engaging in any market-making activities or solicited brokerage activities with regard to the Company's securities during the period prescribed by Rule 10b-6 before the solicitation of the exercise of any Redeemable -73-
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Warrant until the later of (i) the termination of such solicitation activity, or (ii) the termination by waiver or otherwise of any right the Representatives may have to receive a fee for the exercise of the Redeemable Warrants following such solicitations. The Company has agreed not to solicit Warrant exercise other than through the Representative. The Company's officers and directors, including the controlling beneficial stockholder, have agreed not to, directly or indirectly offer, offer to sell, sell, grant an option to purchase or sell, transfer, assign, pledge, hypothecate or otherwise encumber any shares of Common Stock owned by them for a period of 18 months from the date of this Prospectus without the prior written consent of the Representatives. The Underwriters have informed the Company that no sales to any accounts over which they exercise discretionary authority will be made in this offering. The Company has agreed to indemnify the Underwriters against certain liabilities, including liabilities under the Securities Act, or to contribute to payments the Underwriters may be required to make in respect thereof. Prior to this offering, there has not been an established public market for the Common Stock or Redeemable Warrants of the Company. The initial public offering price of the Company Securities and the exercise price and other terms of the Representatives Warrant have been determined by negotiations between the Company and the Representatives. The major factors considered in determining the public offering price of the Common Stock and the Redeemable Warrants were the prevailing market conditions, the market prices relative to earnings, cash flow and assets for publicly traded Common Stocks of comparable companies, the sales and earnings of the Company and comparable companies in recent periods, the Company's earning potential, the experience of its management and the position of the Company in the industry. LEGAL MATTERS The validity of the Securities offered hereby will be passed upon for the Company by McDermott, Will & Emery, Washington, D.C. Certain legal matters in connection with the offering will be passed upon for the Underwriters by Jeffer, Mangels, Butler & Marmaro LLP, Los Angeles, California. Robert G. Kalik, of counsel to McDermott, Will & Emery, holds a presently exercisable option to purchase 33,467 shares of Common Stock. EXPERTS The financial statements included in this Prospectus have been audited by Corbin & Wertz, independent certified public accountants, to the extent and for the periods set forth in their report appearing elsewhere herein and are included in reliance upon such report. ADDITIONAL INFORMATION The Company has filed with the Securities and Exchange Commission (the "Commission") a registration statement on Form SB-2 (the "Registration Statement") under the Securities Act of 1933, -74-
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as amended (the "Securities Act"), with respect to the securities offered hereby. The Company is currently not a reporting company under the Securities Exchange Act of 1934, as amended. This Prospectus, filed as part of the Registration Statement, does not contain certain information set forth in or annexed as exhibits to the Registration Statement, and reference is made to such exhibits to the Registration Statement for the complete text thereof. For further information with respect to the Company and the securities offered hereby, reference is made to the Registration Statement and to the exhibits filed as part thereof, which may be inspected at the office of the Commission without charge, or copies thereof may be obtained therefrom upon payment of a fee prescribed by the Commission. Statements contained in this Prospectus and the contents of any contract or other document are not necessarily complete, and in each instance reference is made to the complete text of such contract or other document filed as an exhibit to the Registration Statement, each such statement being qualified in all respects by such reference. Such Registration Statement may be inspected and copied at the public facilities maintained by the Commission at 450 Fifth Street, N.W., Room 1024, Washington, D.C. 20549, at the New York Regional Office, 7 World Trade Center, 13th Floor, New York, New York 10048 and at the Chicago Regional Office, 500 West Madison Street, 14th Floor, Chicago, Illinois 60661-2511. -75-
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Sound Source Interactive Index to Consolidated Financial Statements Independent Auditors' Report . . . . . . . . . . . . . . . . . . . . . . . F-1 Financial statements Consolidated Balance Sheets. . . . . . . . . . . . . . . . . . . . F-2 Consolidated Statements of Operations. . . . . . . . . . . . . . . F-4 Consolidated Statements of Stockholders' Deficit . . . . . . . . . F-6 Consolidated Statements of Cash Flows. . . . . . . . . . . . . . . F-9 Notes to Consolidated Financial Statements . . . . . . . . . . . . F-13 -76-
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INDEPENDENT AUDITORS' REPORT Board of Directors Sound Source Interactive, Inc. We have audited the accompanying consolidated balance sheet of Sound Source Interactive, Inc. (a Delaware corporation) and subsidiary (collectively referred to as the "Company") as of June 30, 1995 and the related consolidated statements of operations, stockholders' deficit and cash flows for each of the years in the two-year period then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Sound Source Interactive, Inc. and subsidiary as of June 30, 1995, and the results of their operations and their cash flows for each of the years in the two-year period then ended in conformity with generally accepted accounting principles. The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company's recurring losses from operations, its excess of current liabilities (which, as of December 31, 1995, include notes payable of $4,987,500 plus accrued interest which come due September 1, 1996) over current assets and its stockholders' deficit raises substantial doubt about its ability to continue as a going concern. The Company is currently funding operations from the proceeds of the 1995 Private Placement and is in the process of filing a Registration Statement for an initial public offering of its common stock as more fully described in Note 14. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ Corbin & Wertz CORBIN & WERTZ Irvine, California September 8, 1995, except for Notes 7, 14 and 15, as to which the dates are as specified therein F-1
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SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS [Download Table] December 31, June 30, 1995 1995 (Unaudited) ASSETS (Note 14) ---------- ------------ Current assets: Cash $ 213,730 $ 1,492,507 Accounts receivable, net of allowances of $104,250 and $447,310 (unaudited), as of June 30, 1995 and December 31, 1995, respectively (Notes 5 and 11) 60,828 405,279 Inventories (Note 2) 150,320 457,232 Prepaid royalties 481,412 673,503 Deferred financing costs, net of accumulated amortization of $262,732 (unaudited) as of December 31, 1995 (Note 14) --- 730,868 Deferred offering costs (Note 14) --- 106,160 Prepaid expenses and other --- 94,882 ---------- ---------- Total current assets 906,290 3,960,431 Property and equipment, net of accumulated depreciation of $84,724 and $104,161 (unaudited) as of June 30, 1995 and December 31, 1995, respectively (Notes 3 and 7) 92,841 193,027 Other assets 3,060 12,400 ---------- ---------- $ 1,002,191 $ 4,165,858 ---------- ---------- ---------- ---------- Continued F-2
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SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS - CONTINUED [Download Table] December 31, June 30, 1995 1995 (Unaudited) LIABILITIES AND STOCKHOLDERS' EQUITY ----------- ----------- Current liabilities: Notes payable (Note 14) $ --- 4,987,500 Accrued interest (Note 14) --- 118,176 Accounts payable and accrued expenses (Notes 7 and 12) 535,046 745,430 Accrued compensation and related taxes 244,039 53,686 Commissions payable (Note 7) 159,593 35,555 Accrued royalties 542,513 37,124 Short-term advance (Note 5) 400,000 400,000 Deferred revenue (Note 6) 64,000 66,000 Notes payable to officers (Note 4) 13,500 --- Current portion of capital lease obligations (Note 7) 12,921 30,000 ---------- ---------- Total current liabilities 1,971,612 6,873,471 ---------- ---------- Capital lease obligations, net of current portion (Note 7) 16,771 25,601 ---------- ---------- Commitments and contingencies (Notes 5 and 7) Stockholders' deficit (Notes 8, 9, 10 and 14): Series A preferred common stock, $.001 par value; 1,000,000 shares authorized, no shares issued and outstanding; liquidation value of $.001 per share --- --- Common stock, $.001 par value; 20,000,000 shares authorized; 1,859,182 and 1,808,291 shares issued and outstanding at June 30, 1995 and December 31, 1995 (unaudited), respectively 1,859 1,808 Warrants (Note 14) --- 263,350 Additional paid-in capital 5,124,525 5,124,576 Accumulated deficit (6,112,576) (8,122,948) ---------- ---------- Total stockholders' deficit (986,192) (2,733,214) ---------- ---------- $ 1,002,191 $ 4,165,858 ---------- ---------- ---------- ---------- See accompanying notes to consolidated financial statements F-3
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SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS [Enlarge/Download Table] For The Six Months Ended December 31, For The Years Ended June 30, 1994 1995 1994 1995 (Unaudited) (Unaudited) ------------ ------------ ----------- ----------- Revenues (Notes 6 and 11): Product sales $ 1,313,890 $ 1,255,230 $ 1,006,849 $ 1,077,547 Development fees 112,520 343,250 127,250 --- Original equipment manufacturing 5,500 479,675 389,979 21,466 Royalties 253,961 76,771 76,253 21,678 ---------- ---------- ---------- ---------- Net revenues 1,685,871 2,154,926 1,600,331 1,120,691 Cost of sales 1,180,803 1,072,691 956,368 682,510 ---------- ---------- ---------- ---------- Gross profit 505,068 1,082,235 643,963 438,181 ---------- ---------- ---------- ---------- Operating costs and expenses: Marketing and sales (Note 7) 356,381 516,886 291,805 572,778 Compensation in connection with common stock and common stock options issued for services rendered (Note 10) 2,992,862 733,165 193,332 --- Other general and administrative 828,866 1,049,858 495,642 1,208,838 Research and development 116,559 378,471 76,725 266,153 ---------- ---------- ---------- ---------- Total operating costs and expenses 4,294,668 2,678,380 1,057,504 2,047,769 ---------- ---------- ---------- ---------- Operating loss (3,789,600) (1,596,145) (413,541) (1,609,588) Interest income 855 8,550 --- 22,172 Interest expense (38,513) (2,698) (4,439) (118,176) Amortization of deferred loan costs (Note 14) --- --- --- (262,732) Other income (expense) (32,988) 839 (16,461) (40,848) ---------- ---------- ---------- ---------- Loss before provision for income taxes (3,860,246) (1,589,454) (434,441) (2,009,172) Provision for income taxes (Note 13) 1,600 1,600 1,200 1,200 ---------- ---------- ---------- ---------- Loss from continuing operations (3,861,846) (1,591,054) (435,641) (2,010,372) ---------- ---------- ---------- ---------- Continued F-4
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SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS - CONTINUED For The Six Months Ended December 31, For The Years Ended June 30, 1994 1995 1994 1995 (Unaudited) (Unaudited) ------------ ------------ ----------- ----------- Discontinued operations (Note 12): Loss from operations of discontinued music division (115,887) (111,106) (13,376) --- Estimated operating loss and loss on disposal of discontinued music division during phase-out period --- (32,000) --- --- ---------- ---------- ---------- ---------- Loss from discontinued operations (115,887) (143,106) (13,376) (2,010,372) ---------- ---------- ---------- ---------- Net loss $ (3,977,733) $ (1,734,160) $ (449,017) $ (2,010,372) ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Net loss per common share (Note 14): Loss from continuing operations $ (2.38) $ (0.85) $ (0.23) $ (1.08) ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Loss from discontinued operations $ (0.07) $ (0.08) $ (0.01) $ --- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Net loss per common share $ (2.45) $ (0.93) $ (0.24) $ (1.08) ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Weighted average number of common shares outstanding 1,626,107 1,862,908 1,869,998 1,868,145 ---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
See accompanying notes to consolidated financial statements F-5
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SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT For The Six Months Ended December 31, 1995 (Unaudited) And For Each Of The Years In The Two-Year Period Ended June 30, 1995 [Enlarge/Download Table] Series A Preferred Stock Common Stock Additional --------------------- -------------------- Paid-in Accumulated Shares Amount Shares Amount Warrants Capital Deficit Total --------------------- -------- -------- -------- ---------- ----------- --------- Balance, July 1, 1993 1,000,000 $ 1,000 1,474,463 $ 1,474 $ --- $ 27,526 $ (400,683) $ (370,683) Shares issued in connection with reverse acquisition 99,992 100 (100) Issuance of stock options for services (Note 10) 2,347,862 2,347,862 Issuance of common stock in exchange for preferred stock (Note 9) (1,000,000) (1,000) 83,669 84 644,916 644,000 Issuance of common stock in connection with private offering, net of offering costs of $58,312 (Note 8) 55,639 56 664,944 665,000 Shares issued for services performed in connection with private offering (Note 8) 39,770 40 475,275 475,315 Offering costs (Note 8) (475,315) (475,315) Continued F-6
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SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT - CONTINUED For The Six Months Ended December 31, 1995 (Unaudited) And For Each Of The Years In The Two-Year Period Ended June 30, 1995 Series A Preferred Stock Common Stock Additional --------------------- -------------------- Paid-in Accumulated Shares Amount Shares Amount Warrants Capital Deficit Total -------- -------- -------- -------- -------- ---------- ----------- --------- Net loss (3,977,733) (3,977,733) ---------- ------- ---------- ------- ------- --------- ---------- --------- Balance, June 30, 1994 --- --- 1,753,533 1,754 --- 3,685,108 (4,378,416) (691,554) Issuance of common stock in connection with private offering, net of offering costs of $61,759 (Note 8) 59,238 59 706,048 706,107 Shares issued for services performed in connection with private offering (Note 8) 42,227 42 504,644 504,686 Offering costs (Note 8) (504,686) (504,686) Issuance of stock options for services (Note 10) 733,165 733,165 Issuance of common stock in connection with exercise of options (Note 10) 4,184 4 246 250 Net loss (1,734,160) (1,734,160) ---------- ------- ---------- ------- ------- --------- ---------- ---------- Balance, June 30, 1995 --- --- 1,859,182 1,859 --- 5,124,525 (6,112,576) (986,192) Continued F-7
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SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT - CONTINUED For The Six Months Ended December 31, 1995 (Unaudited) And For Each Of The Years In The Two-Year Period Ended June 30, 1995 Series A Preferred Stock Common Stock Additional --------------------- -------------------- Paid-in Accumulated Shares Amount Shares Amount Warrants Capital Deficit Total -------- -------- -------- -------- -------- ---------- ----------- --------- Issuance of warrants in connection with private offerings (Note 14) 263,350 263,350 Cancellation of shares in connection with settlement (Note 7) (15,120) (15) 15 Cancellation of shares for which the Company had not received valid consideration (Note 8) (35,771) (36) 36 Net loss (2,010,372) (2,010,372) ---------- ------- ---------- ------- ------- --------- ---------- ---------- Balance, December 31, 1995 $ --- $ --- $ 1,808,291 $ 1,808 $263,350 $5,124,576 $(8,122,948) $(2,733,214) ---------- ------- ---------- ------- ------- --------- ---------- ---------- ---------- ------- ---------- ------- ------- --------- ---------- ----------
See accompanying notes to consolidated financial statements F-8
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SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS [Enlarge/Download Table] For The Six Months Ended December 31, For The Years Ended June 30, 1994 1995 1994 1995 (Unaudited) (Unaudited) ------------ ------------ ----------- ----------- Cash flows from operating activities: Net loss from continuing operations $ (3,861,846) $ (1,591,054) $ (435,641) $ (2,010,372) Adjustments to reconcile net loss to net cash used by operating activities: Depreciation and amortization (Note 14) 25,852 27,541 13,600 282,169 Allowance for sales returns (29,173) (8,732) 77,537 407,310 Allowance for doubtful accounts 69,306 (56,566) 55,218 (64,250) Common stock and stock options issued for services rendered 2,992,862 733,165 193,332 --- Changes in operating assets and liabilities: Accounts receivable (68,570) 66,352 (262,652) (687,511) Inventories 83,006 (99,576) (98,004) (306,912) Prepaid royalties (146,903) 1,537 (56,833) (192,091) Prepaid expenses and other 1,934 --- --- (94,882) Other assets --- --- --- (9,340) Accrued interest (Note 14) --- --- --- 118,176 Accounts payable and accrued expenses 83,186 (125,686) (298,493) 210,384 Accrued compensation and related taxes 139,838 92,394 60,170 (190,353) Commissions payable 44,807 114,786 (9,252) (124,038) Accrued royalties 189,780 (20,697) 43,177 (105,389) Deferred revenue 72,795 (8,795) 139,705 2,000 ---------- ---------- ---------- ---------- Net cash used by continuing operations (403,126) (875,331) (578,136) (2,765,099) ---------- ---------- ---------- ---------- Continued F-9
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SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED For The Six Months Ended December 31, For The Years Ended June 30, 1994 1995 1994 1995 (Unaudited) (Unaudited) ------------ ------------ ----------- ----------- Net loss from discontinued operations (115,887) (143,106) (13,376) --- Reserve for estimated loss on disposal --- 32,000 --- --- Depreciation 8,328 8,878 4,441 --- Changes in operating assets and liabilities of discontinued operations: Accounts receivable (5,007) (2,471) (2,021) --- Inventories 12,248 1,351 9,842 --- Accounts payable and accrued expenses 10,601 3,098 1,884 --- Accrued royalties --- 3,415 --- --- Commissions payable --- 12,498 --- --- ---------- ---------- ---------- ---------- Net cash used by discontinued operations (89,717) (84,337) 770 --- ---------- ---------- ---------- ---------- Cash flows from investing activities of continuing operations - Purchases of property and equipment (3,376) (38,876) (48,561) (81,152) ---------- ---------- ---------- ---------- Cash flows from investing activities of discontinued operations - Purchases of property and equipment (1,036) (6,665) (6,665) --- ---------- ---------- ---------- ---------- Continued F-10
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SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED For The Six Months Ended December 31, For The Years Ended June 30, 1994 1995 1994 1995 (Unaudited) (Unaudited) ------------ ------------ ----------- ----------- Cash flows from financing activities: Proceeds from issuance of common stock (Note 8) 665,000 684,107 684,107 --- Proceeds from issuance of warrants (Note 14) --- --- --- 263,350 Proceeds from issuance of notes payable (Note 14) 22,000 --- --- 4,987,500 Notes payable to officers --- 13,500 --- (13,500) Payments on note payable (16,999) (19,587) (19,587) --- Deferred financing costs (Note 14) --- --- --- (993,600) Deferred offering costs (Note 14) --- --- --- (106,160) Payments on capital lease obligation (18,257) (13,678) (8,059) (12,562) Short-term advance --- 400,000 --- --- ---------- ---------- ---------- ---------- Net cash provided by financing activities 651,744 1,064,342 656,461 4,125,028 ---------- ---------- ---------- ---------- Net increase in cash 154,489 59,133 23,869 1,278,777 Cash, beginning of period 108 154,597 154,597 213,730 ---------- ---------- ---------- ---------- Cash, end of period $ 154,597 $ 213,730 $ 178,466 $ 1,492,507 ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Supplemental disclosure of cash flow information - Cash paid during the period for: Interest $ 14,785 $ 9,742 $ 14,301 $ 13,120 ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Income taxes $ 1,800 $ 1,600 $ 1,800 $ 1,600 ---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Continued F-11
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SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED Supplemental disclosure of noncash investing and financing activities: During the fiscal years ended June 30, 1994 and 1995, the Company purchased property and equipment valued at $5,653 and $8,979, respectively, through the issuance of capital leases (Note 7). During the fiscal year ended June 30, 1995, the Company repaid a note to an affiliate of a stockholder totalling $22,000 through issuance of common stock shares in connection with a private placement (Note 4). During the six months ended December 31, 1995, the Company purchased property and equipment valued at $38,471 (unaudited) through issuance of capital leases (Note 7). See accompanying notes to consolidated financial statements F-12
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SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION Sound Source Interactive, Inc., (a California corporation) was incorporated on March 5, 1990, under the name Sound Source Unlimited, Inc. On May 16, 1994, Sound Source Interactive, Inc. ("SSI") consummated a stock-for-stock exchange with Basic Science Associates, Inc. ("BSA"), a Delaware corporation. As part of the exchange, BSA issued 1,474,232 shares of its common stock and 1,000,000 shares of its Series A preferred stock (see Note 11) in exchange for all of the outstanding shares of SSI. The exchange has been accounted for as a reverse acquisition because stockholders of SSI maintained control of the surviving entity, BSA. Accordingly, for financial reporting purposes, the shares issued by BSA are considered outstanding since the date of incorporation of SSI, and the 99,992 shares of common stock retained by the stockholders of BSA are reflected as consideration issued to consummate the stock-for-stock exchange. No value was ascribed to the shares of common stock retained by the stockholders of BSA since as of the date of the exchange, BSA had nominal assets and stockholders' equity and was an inactive company. Concurrent with the stock- for-stock exchange, BSA changed its name to Sound Source Interactive, Inc. (a Delaware corporation) (the "Company"). The Company, through its wholly-owned subsidiary (SSI), is in the business of developing, publishing and distributing entertainment software, specializing in interactive educational software, "screen savers" software and sound clips. BASIS OF PRESENTATION The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates, among other things, the realization of assets and the satisfaction of liabilities in the normal course of business. As shown in the accompanying consolidated financial statements, at December 31, 1995, the Company's current liabilities exceeded its current assets by $2,913,040 (unaudited) and the Company had a stockholders' deficit of $2,733,214 (unaudited). In addition, the Company has incurred net losses of $3,977,733, $1,734,160, $449,017 (unaudited) and $2,010,372 (unaudited) for the years ended June 30, 1994 and 1995 and for the six months ended December 31, 1994 and 1995, respectively. The Company is currently funding operations from the proceeds of the 1995 Private Placement (see Note 14). The notes payable of $4,987,500 at December 31, 1995 (unaudited) and related accrued interest of $118,176 is due September 1, 1996. The Company has also not generated sufficient cash flows to fund operations due in part to its problems with its major distributor, Acclaim Entertainment, Inc. ("Acclaim") (see Note 15). The Company plans to effect an initial public offering to raise proceeds to repay these notes payable and related accrued interest and to fund its working capital requirements (see Note 14). These factors, among others, raise substantial doubt about the Company's ability to continue as a going concern. The accompanying consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could materially differ from those estimates. Continued F-13
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SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED DISCONTINUED OPERATIONS In July 1995, the Company approved a formal plan to license the rights to its music division (which developed and sold sound patches for electronic keyboards and synthesizers) and sold the related inventory and property and equipment to an unrelated third party (see Note 12). Accordingly, the Company has classified such as discontinued operations in the accompanying consolidated financial statements for all years presented. PRINCIPLES OF CONSOLIDATION The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiary, Sound Source Interactive, Inc. (a California corporation). The results of operations of BSA, the acquired business, have been consolidated with those of Sound Source Interactive, Inc. commencing May 16, 1994. The results of operations of BSA for the period July 1, 1993 to May 16, 1994 were not material. All significant intercompany transactions and balances have been eliminated in consolidation. INTERIM FINANCIAL STATEMENTS The consolidated financial statements for the six months ended December 31, 1994 and 1995 and the related notes thereto are unaudited, but include all adjustments (consisting only of normal recurring adjustments) which the Company considers necessary for a fair presentation of the financial position at December 31, 1995, and the results of operations and cash flows for the six months ended December 31, 1994 and 1995. Results for the 1995 interim period are not necessarily indicative of the results to be expected for the fiscal year ended June 30, 1996. ACCOUNTS RECEIVABLE Accounts receivable are principally from distributors and retailers of the Company's products. The Company performs periodic credit evaluations of its customers and maintains allowances for potential credit losses and returns. The Company estimates credit losses and returns based on management's evaluation of historical experience and current industry trends. As of June 30, 1995, reserves for credit losses and returns totalled $40,000 and $64,250, respectively. As of December 31, 1995, reserves for returns totalled $447,310 (unaudited). As of December 31, 1995, reserves for credit losses were not deemed necessary by management of the Company (see Note 5). The Company is subject to rapid changes in technology and shifts in consumer demand which could result in product returns in excess of the Company's reserves at June 30, 1995 and December 31, 1995. INVENTORIES Inventories, which consist primarily of software media, manuals and related packaging materials, are stated at the lower of cost or market with cost determined on a first-in, first-out (FIFO) basis. Provision has been made to write-down obsolete inventories to market value. Continued F-14
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SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED PROPERTY AND EQUIPMENT Property and equipment are stated at cost less accumulated depreciation. Property and equipment are depreciated using the straight-line method over the estimated useful lives of the related assets, generally ranging from five to seven years. Depreciation expense related to continuing operations totalled $25,852 and $27,541 for the years ended June 30, 1994 and 1995, respectively, and totalled $13,600 (unaudited) and $19,437 (unaudited), respectively, for the six months ended December 31, 1994 and 1995, and is included in other general and administrative expense in the accompanying consolidated statements of operations. DEFERRED FINANCING COSTS Deferred financing costs represent costs associated with the issuance of debt. Deferred financing costs are amortized over the term of the related debt. For the six months ended December 31, 1995, amortization expense totalled $262,732. DEFERRED OFFERING COSTS Deferred offering costs represent costs associated with the Company's intended Initial Public Offering ("IPO") (see Note 14). Deferred offering costs will be recorded as a reduction in proceeds upon completion of the intended IPO. If the IPO is unsuccessful, such costs will be charged to operations. REVENUE RECOGNITION Sales are recognized at the time the products are shipped, in accordance with the provisions of Statement of Position 91-1, "SOFTWARE REVENUE RECOGNITION". While the Company has no obligations to perform future services subsequent to shipment, the Company provides telephone customer support as an accommodation to purchasers of its products for a limited time. Costs associated with this effort are expensed as incurred (see Note 5). The Company recognizes revenue for product shipped to Acclaim on the date that Acclaim purchases such product and ships it to their customers. Acclaim is obligated to pay the Company on the earlier of the month following the date of receipt of payment by it or 120 days following the end of the month that the product was shipped. The Company is responsible for product returns, and records a reserve for returns based on management's evaluation of historical experience and current industry trends (see Note 15). Continued F-15
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SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED ROYALTIES The Company enters into license agreements with movie studios, actors and sound developers for recognizable movie and television properties which require the Company to pay royalties to such movie studios, actors and sound developers. The license agreements generally require the Company to pay a percentage of sales of the products but no less than a specified amount (the minimum guaranteed royalty). The Company records the minimum guaranteed royalty as a liability and a related asset at the time the agreement is consummated. The liability is extinguished as payments are made to the license holders and the asset is amortized on a straight-line basis over the expected number of units to be sold. Royalties are recognized upon the sale of the related product. Royalty liabilities in excess of the minimum guaranteed amount are recorded when such amounts are earned. Royalties for the years ended June 30, 1994 and 1995 amounted to $275,407 and $325,981, respectively. Royalties for the six months ended December 31, 1994 and 1995 amounted to $252,505 (unaudited) and $190,977 (unaudited), respectively, and are included in cost of sales in the accompanying consolidated statements of operations. Generally, the terms of a license agreement state that, upon any bankruptcy or liquidation of the Company, licensing rights revert to the license holder. The Company's products are based upon such licensed content of major motion pictures and television shows under license and/or development agreements with major entertainment studios. All of such license and development agreements to which the Company currently is a party are for fixed terms which will expire over the next one to five years. Although no licensor is required to extend any license, the Company anticipates that the licensor under each agreement will extend its terms, provided that the Company is in compliance with all requirements of each license, including most significantly that the Company has satisfied the applicable minimum royalty guarantees. In the event that any licensor fails to renew its license agreement, then the subject license will terminate and the Company will no longer be entitled to sell the licensed product. The loss of one or more of the licenses could have a material adverse effect on the Company's revenues and operating results. There can be no assurance that the Company will satisfy its performance obligations under any license or development agreement or, that even if such requirements are satisfied, all material licenses will be renewed. SOFTWARE DEVELOPMENT COSTS In accordance with Statement of Financial Accounting Standards No. 86, "ACCOUNTING FOR THE COST OF CAPITALIZED SOFTWARE TO BE SOLD, LEASED OR OTHERWISE MARKETED," ("SFAS No. 86"), the Company examines its software development costs after technological feasibility has been established to determine if capitalization is required. Through December 31, 1995, all software development costs have been expensed. INCOME TAXES The Company accounts for income taxes under Statement on Financial Accounting Standards No. 109, "ACCOUNTING FOR INCOMES TAXES" ("SFAS No. 109"), which requires that deferred income taxes be recognized for the tax consequences in future years of differences between the tax basis of assets and liabilities and their financial reporting basis at rates based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Continued F-16
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SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Current income tax expense represents the tax payable for the period. The deferred income tax expense (benefit) represents the change during the period in the balance of deferred taxes (see Note 13). STOCK SPLIT In September, 1995, the Company effectuated a 1-for-5.976 reverse stock split of issued and outstanding common shares and common shares reserved for options in connection with the August 1995 private placement (see Note 14). The accompanying consolidated financial statements have been adjusted to reflect the reverse stock split. NET LOSS PER COMMON SHARE Net loss per common share is computed by dividing net loss by the weighted average number of shares of common stock and common stock equivalents outstanding during the respective period. Common stock equivalents include shares issuable upon the exercise of the Company's stock options. For the years ended June 30, 1994 and 1995 and for the six months ended December 31, 1994 (unaudited) and 1995 (unaudited), common stock equivalents were excluded from the computation of loss per common share because the effect of including such in the computation would have been anti-dilutive (see Notes 10 and 14), except as discussed below. Pursuant to Securities and Exchange Commission Staff Bulletin No. 83, common shares issued for consideration below an assumed initial public offering price (estimated at $4.00 per share) and stock options granted (see Note 14) with exercise prices below the IPO price during the twelve-month period preceding the date of the filing of the Registration Statement have been included in the calculation of common share equivalents, using the treasury stock method, as if they were outstanding for all periods presented, including loss years where the impact is anti-dilutive. The only securities issued within twelve months of the registration statement are options to purchase 100,000 shares granted at $3.40 per share (see Note 14). The computations of the weighted average common shares and equivalents outstanding follows: [Enlarge/Download Table] Year Ended June 30, Six Months Ended December 31, ------------------- ----------------------------- 1994 1995 1994 (unaudited) 1995 ---- ---- ---- ---- Weighted average common shares outstanding during the period 1,611,107 1,847,908 1,854,998 1,853,145 Incremental shares assumed to be outstanding related to stock options granted 15,000 15,000 15,000 15,000 --------- --------- --------- --------- Weighted average common shares and equivalents outstanding 1,626,107 1,862,908 1,869,998 1,868,145 --------- --------- --------- ---------- --------- --------- --------- ---------- Continued F-17
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SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED SEASONALITY The consumer software business traditionally has been seasonal. Typically, net sales are highest during the fourth calendar quarter and decline sequentially in the first and second calendar quarters. The seasonal pattern is due primarily to the increased demand for consumer software during the year-end holiday buying season. The Company expects its net sales and operating results to continue to reflect seasonality. CONCENTRATION OF CREDIT RISK The Company, at times, maintains cash balances at certain financial institutions in excess of the federally insured maximum. RECLASSIFICATIONS Certain reclassifications have been made to 1994 amounts to conform to the 1995 presentation. NOTE 2 - INVENTORIES Inventories consisted of the following: December 31, June 30, 1995 1995 (Unaudited) ----------- ------------ Finished goods $ 66,114 $ 390,036 Raw materials (components) 84,206 67,196 ----------- ----------- $ 150,320 $ 457,232 ----------- ------------ ----------- ------------ NOTE 3 - PROPERTY AND EQUIPMENT Property and equipment consisted of the following: December 31, June 30, 1995 1995 (Unaudited) ----------- ------------ Studio computers and equipment $ 118,496 $ 236,274 Office furniture and equipment 59,069 60,914 ----------- ------------ 177,565 297,188 Less accumulated depreciation (84,724) (104,161) ----------- ------------ $ 92,841 $ 193,027 ----------- ------------ ----------- ------------ Continued F-18
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SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE 4 - NOTES PAYABLE During the year ended June 30, 1995, the Company repaid a note due to a stockholder amounting to $19,587. The Company also repaid a $22,000 note due to an affiliate of a stockholder through issuance of shares in conjunction with the 1994 private placement. As of June 30, 1995, the Company owed certain officers of the Company $13,500 in the form of short-term non-interest bearing advances. In July 1995, such advances were paid. For discussion of notes payable issued in connection with the August 1995 private placement (see Note 14). NOTE 5 - SHORT-TERM ADVANCE In June 1995, the Company entered into a five-year sales and distribution agreement (the "Agreement") with a subsidiary of Acclaim, a distributor of entertainment software. Under the terms of the Agreement, Acclaim was responsible for the distribution of the Company's products on a world-wide basis to retail accounts. The Company retained the rights to certain direct distribution, such as direct mail and infomercials. In conjunction with the signing of the Agreement, the Company received a non- interest bearing advance from Acclaim in the amount of $400,000. The advance is due in twelve monthly installments of $33,333 each, commencing no later than 90 days subsequent to first billing by the Company. The installments are to be deducted from amounts due the Company from Acclaim related to product sales. Management of the Company expects that this advance will be deducted in its entirety from amounts due from Acclaim prior to June 30, 1996. The Company is required under the terms of the Agreement to expend six percent of the "projected sales revenues", as defined by Acclaim, related to each product on the advertising and marketing of such product. Under the Acclaim Distribution Agreement, all risks associated with collection of accounts receivable with respect to all products sold by the Company through Acclaim are solely the responsibility of Acclaim, whereas the risk of product returns remains with the Company. The Company, however, is exposed to the risk of credit collection from retailers and distributors other than Acclaim. As discussed in Note 1, the Company establishes reserves for returns that it believes to be adequate based upon historical return data and its analysis of current customer inventory levels and sell through rates. Nonetheless, the Company could be forced to accept substantial product returns to maintain its relationships with retailers and its access to distribution channels. The Company's policies also allow for returns of defective merchandise for credit. Any significant amount of product returns could have a material adverse effect on the Company's business, operating results and financial condition. In March 1996, such agreement was terminated (see Note 15). Continued F-19
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SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE 6 - DEFERRED REVENUE In August 1994, the Company entered into a contract to develop computer software for Fox Interactive, a division of Fox, Inc. In exchange, the Company received nonrefundable advances based upon the attainment of certain milestones. The Company recognizes these advances into revenues based upon the percentage of completion method. As of June 30, 1995 and as of December 31, 1995 (unaudited), the Company had received $24,000 of advances in excess of earnings and has therefore recorded such amount as deferred revenue in the accompanying consolidated balance sheet. The Company has entered into various agreements with computer manufacturers to sell and distribute certain of the Company's products. In exchange, the Company receives royalties and advances against expected royalties. As of June 30, 1995, the Company received $40,000 of advances in excess of royalties earned. Accordingly, the Company has recorded such amounts as deferred revenues on the accompanying June 30, 1995 consolidated balance sheet. As of December 31, 1995, the Company had earned $10,000 (unaudited) of such advances. As of December 31, 1995, the Company received $12,000 (unaudited) of advance royalties in connection with the licensing of the music division (see Note 12). NOTE 7 - COMMITMENTS AND CONTINGENCIES EMPLOYMENT CONTRACTS The Company has entered into employment contracts with five of its employees, including three officers, which expire on various dates through April, 1998. Certain of the employment contracts provided for mandatory increases in salary if the Company completed an initial public offering or a secondary offering (see Note 14), provided for commissions based on net sales and provide for automobile allowances. In May 1996, the employment contracts of the two officers were modified. During September 1995, the employment contracts of two of the officers were modified as follows: i) The terms were extended through August 31, 1998 and 2000, respectively. ii) The contracts no longer provide for commissions after November 1995, or increases in base salaries other than cost of living increases. iii) The contracts provide for bonuses based on the attainment of certain milestones related to gross revenues, gross profits, and pre-tax profit percentages. Effective September 5, 1995, another officer of the Company with an employment contract resigned from the Company. Effective October 9, 1995, the Company entered into a two-year employment contract with a new officer of the Company. The contract provides for a minimum base salary and certain expense reimbursements. Continued F-20
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SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE 7 - COMMITMENTS AND CONTINGENCIES, CONTINUED Future minimum base salaries, by year and in the aggregate, after giving effect to the modification of two of the contracts, the termination of another due to resignation of the officer and the new contract, consist of the following at June 30, 1995: 1996 $ 459,167 1997 485,000 1998 402,500 1999 229,166 2000 200,000 2001 33,333 --------- $ 1,809,166 --------- --------- Commissions under employment contracts for the year ended June 30, 1994 and 1995, related to continuing operations amounted to $44,807 and $132,078, respectively, and are included in marketing and sales costs in the accompanying consolidated statements of operations. At June 30, 1995, $156,063 of such amounts remain unpaid and are included as commissions payable in the accompanying consolidated balance sheet. OPERATING LEASES The Company leases its facilities and certain equipment under noncancelable operating leases which expire at various dates through February 1997. The facility lease expense is being recognized on a straight-line basis over the term of the related lease. The excess of the expense recognized over the cost paid is included in accounts payable and accrued expenses in the accompanying consolidated balance sheet. Future minimum annual lease payments at June 30, 1995 are as follows: 1996 $ 89,916 1997 55,667 --------- $ 145,583 --------- --------- Rent expense under operating lease agreements totalled $75,311 and $94,006 for the years ended June 30, 1994 and 1995, respectively, and $38,903 (unaudited) and $48,514 (unaudited) for the six months ended December 31, 1994 and 1995, respectively, and is included in other general and administrative expenses on the accompanying consolidated statements of operations. CAPITAL LEASES The Company leases certain equipment and computers under capital lease obligations with interest rates ranging from 13.35% to 30.45% per annum. Aggregate monthly principal and interest payments total $1,717 at June 30, 1995. Continued F-21
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SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE 7 - COMMITMENTS AND CONTINGENCIES, CONTINUED Future minimum lease payments, by year and in the aggregate, under capital leases for equipment and computers with initial or remaining terms of one year or more, consist of the following at June 30, 1995: 1996 $ 17,387 1997 11,462 1998 6,513 1999 2,365 --------- 37,727 Less amount representing interest (8,035) --------- Present value of net minimum lease payments 29,692 Less current portion (12,921) --------- $ 16,771 --------- --------- During the six months ended December 31, 1995, the Company entered into two capital leases for certain office equipment aggregating $38,471 (unaudited) with interest rates ranging from 17.38% to 27.93% (unaudited) per annum and which expire through 1998 (unaudited). Interest expense under capital lease obligations amounted to $5,888 and $7,045 for the years ended June 30, 1994 and 1995, respectively, and was insignificant for the six months ended December 31, 1994 (unaudited) and 1995 (unaudited) and is included in other income (expense) on the accompanying consolidated statements of operations. LITIGATION In July 1995, a stockholder of the Company filed a complaint in the United States District Court for the District of Washington, naming, among others, the Company and its subsidiary, and Bentley Richards Investments (the "Placement Agent") claiming federal and state securities violations, breach of contract, and negligent misrepresentation related to the 1994 Private Placement (see Note 8). The complaint sought rescission of all monies paid to the Company and unspecified amounts of punitive damages, attorney's fees and costs, prejudgment and postjudgment interest and cost of suit. In September 1995, the stockholder entered into a settlement agreement whereby the stockholder dismissed all defendants, including the Company and its subsidiary, upon delivery of certain shares of the Company's common stock owned by the Placement Agent and its affiliates. A portion of these shares have been distributed to the 1994 Private Placement holders and the balance are to be canceled. Pursuant to the settlement, the Placement Agent's options also were canceled. The Company was not required to pay any consideration as a part of the settlement. The Company has been dismissed with prejudice from the complaint (see Note 8). Continued F-22
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SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE 8 - COMMON STOCK During the fiscal year 1994, the Company engaged a Placement Agent to sell a private placement of up to 125,502 shares of its common stock at $13.00 per share. Through June 30, 1994, the Company issued 55,639 shares of its common stock for $665,000 in cash, net of offering costs of $58,312. During the fiscal year 1995, the Company issued an additional 59,238 shares of its common stock in exchange for $706,107 in cash, net of costs of $61,759. In accordance with the terms of the private offering, the Company agreed to compensate the Placement Agent with up to 81,997 shares of its common stock and an option to purchase up to 60,241 shares of its common stock at a price equal to the closing bid price of the common stock on the first day of trading following the stock-for-stock exchange (see Note 1). For the years ended June 30, 1994 and 1995, the Placement Agent earned 39,770 and 42,227 shares valued at $475,315 and $504,686, respectively. During September 1995, the Placement Agent notified the Company that all shares held by the Placement Agent or its affiliates, or held in escrow for the benefit of the Placement Agent or its affiliates, representing and aggregate of 108,769 shares of the Company's common stock, will be distributed to the holders of the 1994 Private Placement shares and approximately 15,000 will be returned to the Company for retirement (see Note 7). CANCELLATION OF SHARES In fiscal 1996, it has been determined by the Company that 35,771 shares of common stock were improperly issued in 1992 due to the fact no consideration was received. Accordingly, such common shares were cancelled effective December 31, 1995. NOTE 9 - SERIES A PREFERRED STOCK In connection with the Company's reverse acquisition of BSA (see Note 1) on May 16, 1994, the Company issued to its major stockholder 1,000,000 shares of Series A preferred stock, par value of $.001. The Series A preferred stockholder was entitled to vote as a single class with the holders of the Company's common stock on all matters coming before the Company's stockholders for a vote. The holder of the Series A preferred stock was entitled to ten votes per share whereas the holders of common stock are entitled to only one vote per share. The Series A preferred stock was not redeemable or convertible, and the holder of the Series A preferred stock was not entitled to receive any dividends. The holder was entitled to a liquidation preference of $.001 per share, provided the holder would not share any liquidating distribution except to the extent of such preference. The Company did not ascribe any value to the preferred shares. Prior to June 30, 1994, the 1,000,000 shares of Series A preferred stock were converted into 83,669 shares of the Company's common stock. The Company ascribed a value to the 83,669 shares of common stock of $645,000 and included such amount under operating costs and expenses in the 1994 accompanying consolidated statement of operations. Subsequent to June 30, 1995, the Company amended its articles of incorporation and deleted the authorization to issued Series A preferred stock. Continued F-23
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SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE 10 - STOCK OPTIONS The Company adopted the 1992 Stock Option Plan (the "Plan") in May, 1992, authorizing the issuance of up to 2,000,000 shares of common stock to employees, officers and directors and to employees of companies who do business with the Company. Any shares which are subject to an award but are not used because the terms and conditions of the award are not met, or any shares which are used by participants to pay all or part of the purchase price of any option may again be used for awards under the Plan. However, shares with respect to which a stock appreciation right (see below) has been exercised may not again be made subject to an award. At the discretion of a committee comprised of directors, officers and key employees of the Company and its subsidiaries or employees of companies with which the Company does business may become participants in the Plan upon receiving grants in the form of stock options or restricted stock. Stock options may be granted as non-qualified stock options or incentive stock options, upon stockholder approval as defined, but incentive stock options may not be granted at a price less than 100% of the fair market value of the stock as of the date of grant (110% as to any 10% stockholder at the time of grant); non-qualified stock options may not be granted at a price less than 85% of fair market value of the stock as of the date of grant. Restricted stock may not be granted under the Plan in connection with incentive stock options. Stock options granted under the Plan may include the right to acquire an Accelerated Ownership Non-Qualified Stock Option ("AO"). All options granted to date have included the AO feature. If an option grant contains the AO feature and if a participant pays all or part of the purchase price of the option with shares of the Company's common stock, then upon exercise of the option the participant is granted an AO to purchase, at the fair market value as of the date of the AO grant, the number of shares of common stock of the Company equal to the sum of the number of whole shares used by the participant in payment of the purchase price and the number of whole shares, if any, withheld by the Company as payment for withholding taxes. An AO may be exercised between the date of grant and the date of expiration, which will be the same as the date of expiration of the option to which the AO is related. Stock appreciation rights and/or restricted stock may be granted in conjunction with, or may be unrelated to stock options. A stock appreciation right entitles a participant to receive a payment, in cash or common stock or a combination thereof, in an amount equal to the excess of fair market value of the stock at the time of exercise over the fair market value of the date of grant. Stock appreciation rights may be exercised during a period of time fixed by the Committee. Continued F-24
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SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE 10 - STOCK OPTIONS, CONTINUED Restricted stock requires the recipient to continue in service as an officer, director, employee or consultant for a fixed period of time for ownership of the shares to vest. If restricted shares or stock appreciation rights are issued in tandem with options, the restricted stock or stock appreciation right is canceled upon exercise of the option and the option will likewise terminate upon vesting of the restricted shares. On April 6, 1994, the Company issued a non-qualified stock option outside of the Plan to an officer of the Company to purchase an aggregate of 251,004 shares of the Company's common stock for $.06 per share and subsequently in fiscal 1994 an option was granted to the officer to purchase 41,834 shares of the Company's common stock for $.06 per share. All stock options issued to the officer were immediately vested and are exercisable for a period of up to four years after termination of employment from the Company. The difference between the fair market value of the common stock underlying the options at the date of grant and the exercise price has been included in operating costs and expenses in the accompanying 1994 consolidated statement of operations. On April 6, 1994, the Company issued options to purchase 199,130 shares of the Company's common stock at $.06 per share to employees of the Company and to certain consultants. The difference between fair market value of the common stock underlying the options at the date of grant and the exercise price has been included in operating costs and expenses in the accompanying consolidated statement of operations. These options had an original vesting period of four years. In connection with the offerings (see Note 14), the Company modified the vesting period to 50% vested on the first year anniversary from the date of grant, 25% on the third year anniversary and 25% on the fourth year anniversary from the date of grant. On September 5, 1995, in connection with the resignation of an officer of the Company, 12,550 options were canceled in accordance with the Plan and the officer's employment contract. In connection with the resignation of such officer, 4,184 options were exercised effective June 30, 1995. On October 9, 1995, the Company granted 100,000 options to an employee/officer with an exercise price of $5.00, the fair market value of the common stock as determined by the Company. The options vested immediately and expire 10 years from the date of grant. On March 31, 1996, such options were cancelled and new options issued (see Note 14). Continued F-25
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SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE 10 - STOCK OPTIONS, CONTINUED The following table summarizes option transactions during the years ended June 30, 1994 and 1995 and for the six months ended December 31, 1995: Number of Price Shares Per Share --------- --------- Balances at July 1, 1993 --- --- Granted 491,642 $0.06 Exercised --- --- Canceled --- --- --------- ------- Balances at June 30, 1994 491,642 $0.06 Granted --- --- Exercised (4,184) $0.06 Canceled (12,550) $0.06 --------- ------- Balances at June 30, 1995 474,908 $0.06 Granted 100,000 $5.00 Exercised --- --- Canceled --- --- --------- ------- Balances at December 31, 1995 (unaudited) 574,908 $0.06-$5.00 --------- ----------- --------- ----------- Vested as of December 31, 1995 (unaudited) 484,037 --------- The Financial Accounting Standards Board has issued Statement of Financial Accounting Standards No. 123 "ACCOUNTING FOR STOCK BASED COMPENSATION" ("Statement No. 123"). Statement No. 123 is primarily a disclosure standard for the Company because the Company will continue to account for employee stock options under Accounting Principles Board Opinion No. 25. The disclosure requirements for the Company required by Statement No. 123 will be effective for financial statements issued after fiscal year 1996. NOTE 11 - SIGNIFICANT CUSTOMERS During the year ended June 30, 1994, four of the Company's customers accounted for 29% of total revenues. A listing of revenues, as a percentage of total revenues from continuing operations, for each of such customers for the years ended June 30, 1994 is as follows: Customer A 10% Customer B 8% Customer C 7% Customer D 4% ----- 29% ----- ----- During the year ended June 30, 1995, one customer accounted for 18% of total revenues from continuing operations. Continued F-26
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SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE 11 - SIGNIFICANT CUSTOMERS, CONTINUED During the six months ended December 31, 1994, three different customers accounted for an aggregate 17% (unaudited) of total revenues from continuing operations. During the six months ended December 31, 1995, one of the Company's customers, a subsidiary of Acclaim (see Note 5), accounted for 73% (unaudited) of total revenues from continuing operations. Significantly, all accounts receivable as of December 31, 1995 is due from such customer. NOTE 12 - DISCONTINUED OPERATIONS In July 1995, the Company approved a formal plan to license certain proprietary assets to Greytsounds Sound Development ("GSD") in exchange for royalties, as defined. Upon commencement of a license agreement with GSD, $15,000 is to be paid to the Company representing advance royalties. GSD also is to guarantee $50,000 of royalties over the license term of two years. The expected date of the agreement is to be no later than November 1, 1995. The license agreement is to be exclusive and worldwide. The proprietary assets licensed to GSD include the Company's musical instrument sound library, all music related inventory and all music related fixed assets owned and leased by the Company. As of June 30, 1995, the net carrying value of these assets included on the accompanying consolidated balance sheet amounted to $50,913. Net liabilities related to the Company's music division not licensed to GSD totalled $32,722 as of June 30, 1995. The Company recorded a liability of $32,000 as of June 30, 1995 representing estimated losses on disposal and estimated operating losses from July 1, 1995 to the date of disposal, net of guaranteed royalties of $50,000. The net liabilities related to the disposal of the music division are included in accounts payable and accrued expenses on the accompanying consolidated balance sheet as of June 30, 1995. Continued F-27
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SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE 12 - DISCONTINUED OPERATIONS, CONTINUED The following summarized the assets and liabilities of the music division at June 30, 1995: [Download Table] Assets: Accounts receivable $ 4,458 Inventory 24,049 Property and equipment, net 26,864 ------------ $ 55,371 ------------ ------------ Liabilities: Accounts payable and accrued expenses $ 21,267 Accrued royalties 3,415 Commissions payable 12,498 ------------ $ 37,180 ------------ ------------ As of December 31, 1995 (unaudited) no assets or liabilities of the music division are included on the accompanying consolidated balance sheet. Included in deferred revenue on the accompanying consolidated balance sheet is $12,000 (unaudited) as of December 31, 1995. The following summarizes the results of operations for the discontinued operations: [Download Table] For The Years Ended December 31, December 31, 1994 1995 1994 1995 (Unaudited) (Unaudited) ---------- ---------- ----------- ----------- Revenues $ 217,837 $ 220,937 $ 138,394 $ --- Costs and expenses (333,724) (332,043) (151,770) --- ---------- ---------- ---------- ---------- Loss from operations $ (115,887) $ (111,106) $ (13,376) $ ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- NOTE 13 - INCOME TAXES The provision for income taxes from continuing operations for the years ended June 30, 1994 and 1995 is comprised of minimum state taxes only. A reconciliation of the provision for income taxes from continuing operations with expected income tax benefit computed by applying the federal statutory income tax rate to loss before provision for income taxes for the years ended June 30, 1994 and 1995 is as follows: [Download Table] 1994 1995 ----------------- ----------------- $ % $ % ------- ----- ------- ----- Income tax benefit computed at federal statutory tax rate (1,312,484) (34.0)% (540,414) (34.0)% State and local taxes 1,600 0.0 1,600 0.0 Expenses not deductible for income tax purposes 1,028,553 26.6 252,173 15.9 Continued F-28
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SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE 13 - INCOME TAXES, CONTINUED [Download Table] 1994 1995 ----------------- ----------------- $ % $ % ----------------- ----------------- Change in the beginning-of- the-period balance of the valuation allowance for deferred tax assets allocated to income tax benefit 283,931 7.4 288,241 18.1 --------- ----- ---------- ----- $ 1,600 0.0% $ 1,600 0.0% --------- ----- ---------- ----- --------- ----- ---------- ----- The components of the net deferred tax asset recorded in the accompanying balance sheets for the year ended June 30, 1995 is as follows: [Download Table] Accounts receivable, principally due to allowances for sales returns and doubtful accounts $ 48,104 Accrued liabilities, principally due to accrual for financial reporting purposes 1,882,280 Net operating loss carryforwards 931,659 Less valuation allowance (2,862,043) ---------- $ --- ---------- ---------- The valuation allowance increased $1,185,225 during the year ended June 30, 1995. At June 30, 1995, the Company had federal and state net operating loss carryforwards of approximately $2,513,000 and $1,248,000, respectively, available to offset future taxable federal and state income. The federal and state carryforward amounts expire in varying amounts through 2011 and 2000, respectively. Due to the change in ownership provisions of the Tax Reform Act of 1986, net operating loss carryforwards for federal income tax reporting purposes are subject to annual limitations. Should a change of ownership occur, net operating loss carryforwards may be limited as to use in future years. NOTE 14 - SUBSEQUENT EVENTS 1995 BRIDGE FINANCING During June through August 1995, the Company offered up to $700,000 of Units (the "1995 Bridge Financing"), each consisting of $9,975 in principal amount of the Company's 10% Secured Promissory Notes (the "Bridge Notes") and warrants to purchase 586 shares of the Company's common stock (the "Bridge Warrants"). Pursuant to this offering, the Company sold 32 Units for aggregate proceeds to the Company of $278,400, net of costs of $41,600. A total of 18,747 Bridge Warrants were issued in connection therewith which are exercisable as indicated below. The dealer/manager received 20,918 Bridge Warrants for $50 as partial consideration for services in connection with this offering which are exercisable as indicated below. During August 1995, the Company notified the dealer/manager to discontinue offering additional units. Continued F-29
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SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE 14 - SUBSEQUENT EVENTS, CONTINUED The principal and accrued interest on the Bridge Notes was due and payable in full on August 15, 1995. The Company did not repay the Bridge Notes upon their maturity. During the pendency of any such default, the Bridge Note holders were entitled to receive a penalty of two percent per month in addition to the interest otherwise payable on the Bridge Notes. These notes were repaid in full during September 1995 in connection with the 1995 Private Placement (see below). The obligations of the Company under the Bridge Notes were secured by a security interest in all the assets of the Company, including a pledge of all of the issued and outstanding capital stock of the Subsidiary. Each Bridge Warrant entitles its holder to purchase one share of common stock. The Bridge Warrants become exercisable commencing on the earlier of (I) December 31, 1996 or (II) the completion by the Company of an initial registered public offering of its common stock (IPO). The Bridge Warrants will expire on the earlier of (I) December 31, 2000 or (II) the date 18 months after completion of an IPO. The exercise price of the Bridge Warrants will equal 110% of the price per share of the common stock in the IPO, or if the IPO has not occurred by December 31, 1996, $5.98 per share. In November 1995, the Bridge Warrant holders exchanged these Bridge Warrants for new warrants with the same terms as the warrants issued in connection with the 1995 Private Placement (see below). 1995 PRIVATE PLACEMENT In August 1995, the Company engaged two dealer/managers to assist in a private placement (the "1995 Private Placement") to sell a minimum of $1,000,000 of Units to a maximum of $5,000,000 of Units, each consisting of $95,000 in principal amount of the Company's 10% Secured Promissory Notes (the "Private Notes") due on the earlier of September 1, 1996 or the completion by the Company of an IPO, and 100,000 warrants (the "Private Warrants") to purchase one share of the Company's common stock. A total of 5,250,000 Private Warrants were issued in connection therewith which are exercisable as indicated below. As of December 31, 1995, the Company had sold 52.5 units for aggregate proceeds of $4,256,400, of which $262,500 represents the Private Warrants, net of costs of $993,600. In connection with this offering, the Company issued 400,000 Private Warrants as partial consideration for services provided by a dealer/manager, which are exercisable as indicated below. The obligations of the Company under the Private Notes are secured by a security interest in all the assets of the Company, including a pledge of all of the issued and outstanding capital stock of its Subsidiary. A portion of the net proceeds of this private placement were utilized to retire all of the outstanding indebtedness of the 1995 Bridge Financing. Each Private Warrant entitles its holder to purchase one share of common stock. The Private Warrants become exercisable commencing on the earlier of (I) December 31, 1996 or (II) the completion by the Company of an IPO. The Private Warrants expire on December 31, 2001. The exercise price of the Private Warrants will equal 110% of the price per share of the common stock in the IPO, or if the IPO has not occurred by December 31, 1996, $4.50 per share. Upon completion of any IPO, each outstanding Private Warrant will be converted into warrants included in the IPO (the "IPO Warrants"). The terms of the IPO Warrants may not be any less favorable than the terms of the Private Warrants, except that the IPO Warrants may be redeemable at the option of the Company upon certain terms. Continued F-30
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SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE 14 - SUBSEQUENT EVENTS, CONTINUED STOCKHOLDER PRIVATE PLACEMENT Concurrent with the 1995 Private Placement, a current stockholder conducted a private placement of up to 200,000 shares of common stock, held by such stockholder, at a purchase price of $5.00 per share. If the Company has not completed an IPO by the earlier of December 31, 1996 or the date that an initial public offering of the Company's subsidiary's common stock is completed, the common stock purchased in this private placement will be exchanged for shares of the Company's subsidiary's common stock on a one-for-one basis. Through December 31, 1995, the stockholder had sold 107,500 shares. REGISTRATION STATEMENT The Company has filed a registration statement on Form SB-2, as amended, with the Securities and Exchange Commission for an initial public offering of 2,400,000 shares at an estimated offering price of $4.00 and 1,200,000 redeemable warrants at $.25 per warrant. In connection with the proposed offering, the Company has incurred expenses amounting to $106,160. Such expenses have been capitalized on the accompanying balance sheet as of December 31, 1995 (unaudited). In connection therewith, the Company is also registering 340,000 shares of its common stock and 20,000 shares of common stock held by selling stockholders to cover over-allotments and 107,500 shares of common stock registered for the account of certain selling stockholders. The Company is also registering 180,000 redeemable warrants to cover over-allotments. The Company has also, in connection with the IPO, given the underwriter a warrant, for $50, which entitles the underwriter to purchase 240,000 shares of common stock and/or 120,000 redeemable warrants at 120 percent of the IPO price. ASSI WARRANTS On May 1, 1996, in consideration of certain financial and personnel consulting service provided to the Company in 1996, including advising the Company regarding capital raising alternatives and executive recruiting, the company has entered into an agreement to issue to ASSI, Inc. warrants to purchase 2,000,000 shares of common stock at an exercise price of $4.40 per share (the "ASSI Warrants"). The terms of the ASSI Warrants will be identical to those of the public warrants except that they will not be mandatorily redeemable. The ASSI Warrants and shares issuable upon their exercise will not be transferable for one year following the effective date of the Registration Statement, other than to than to officers of ASSI, Inc. The holders of the ASSI Warrants and the shares issuable upon their exercise will have one demand registration right, providing for registration, at the Company's expense, of the shares issuable pursuant to the ASSI Warrants. The demand registration rights will expire five years from the date of the registration statement discussed above. Until and unless exercised, the holders of the ASSI Warrants will have no voting, dividend or other rights as stockholders of the Company. Continued F-31
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SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE 14 - SUBSEQUENT EVENTS, CONTINUED OPTIONS On October 9, 1995, the Company adopted the 1995 stock option plan, whereby the Company can grant up to 500,000 options for shares of the Company's common stock. Currently, no options have been granted under this plan. On March 31, 1996, an employee/officer agreed to the termination of his existing 100,000 share option in consideration for the Company's agreement to grant to him a new 200,000 share option pursuant to the 1992 stock option plan. Such option will be vested and exercisable upon the date of its grant as to 100,000 shares at a purchase price of $3.40 per share, and will become vested and exercisable as to 100,000 shares ratably between June 30, 1996 and September 30, 1997 at a purchase price of $4.00 per share. The employee/officer's employment agreement further provides that following the voluntary or involuntary termination of his employment by the Company, the employee/officer is entitled to a single demand registration right with respect to the common stock held by or issuable to him pursuant to his option agreement. The Company has also agreed to grant 13,610 options under the 1995 stock option plan to other non-executive employees at an exercise price of $4.00 per share. EMPLOYMENT CONTRACTS In April 1996, the Company modified the employment contracts of two officers. Such modifications reduced the annual base compensation by a specified amount. Upon the Company achieving specified sales levels, the annual base compensation is increased by the amount of the specified reduction. The Company also modified the employment contract of a third officer in April 1996 to change the number and vesting period of options previously granted and to grant additional options (see Note 1). NOTE 15 - TERMINATION OF DISTRIBUTION AGREEMENT The Company and Acclaim have terminated the distribution agreement as of April 30, 1996. On or before June 30, 1996, Acclaim will render a final accounting to the Company together with payment of the balances of any amounts due to the Company under the distribution agreement. Acclaim has notified its accounts that it will not accept returns of any of the Company's software products after June 30, 1996. The Company, however, will remain liable for all such returns regardless of when received by Acclaim. F-32
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CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Stockholders of Sound Source Interactive, Inc. We consent to the use of our report included herein and to the reference to our firm under the heading "Experts" in the Prospectus. /s/ Corbin & Wertz CORBIN & WERTZ Irvine, California May 3, 1996
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[GRAPHIC] [GRAPHIC] Interactive MovieBook-TM- - Storybooks designed to promote literacy with definitions, synonyms, and spelling activities and early learning games for young children. Shown here: Screen shots form "Babe-TM-".(Universal Pictures) [GRAPHIC] [GRAPHIC] Creativity Centers - Designed to foster creativity in kids and challenge their critical thinking skills. Shown here: Work in progress from "Dragonheart-TM-" (Universal Pictures) [GRAPHIC] [GRAPHIC] Entertainment Utilities - Products designed to put the fun and excitement back into your workday. Shown here: Screen saver image and user interface from "Babylon 5-TM-" (Warner Bros.)
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-------------------------------------------------------------------------------- -------------------------------------------------------------------------------- No dealer, salesperson or any other person has been authorized to give any information or to make representations other than those contained in this Prospectus and, if given or made, such information or representations must not be relied upon as having been authorized by the Company or the Underwriter. This Prospectus does not constitute an offer to sell or a solicitation of an offer to buy any security other than the securities offered by the Prospectus. This Prospectus does not constitute an offer to sell or a solicitation of an offer to buy any security by any person in any jurisdiction in which such offer or solicitation is not authorized or in which the person making such offer or solicitation is not qualified to do so or to anyone to whom it is unlawful to make such offer or solicitation. Neither the delivery of this Prospectus nor any sale made hereunder shall, under any circumstances, create any implication that the information in this Prospectus is correct as of any time subsequent to the date of this Prospectus. ________________________ TABLE OF CONTENTS PAGE ---- Prospectus Summary . . . . . . . 3 Risk Factors . . . . . . . . . . 10 Use of Proceeds . . . . . . . . . 25 Dividend Policy . . . . . . . . . 26 Dilution . . . . . . . . . . . . 27 Capitalization . . . . . . . . . 30 Selected Financial Data . . . . 31 Management's Discussion and Analysis of Financial Condition and Results of Operations . . . . . . . . . 33 Business . . . . . . . . . . . . 38 Management . . . . . . . . . . . 51 Principal and Selling Stockholders . . . . . . . . . . 62 Resale of Outstanding Securities . 63 Certain Transactions . . . . . . 63 Description of Securities . . . . 66 Shares Eligible for Future Sale . 69 Underwriting . . . . . . . . . . 72 Legal Matters . . . . . . . . . . 74 Experts . . . . . . . . . . . . 74 Additional Information . . . . . 74 Index to Consolidated Financial Statements . . . . . . . . . . . 76 Until __________, 1996 (25 days after the date of this Prospectus), all dealers effecting transactions in the registered securities, whether or not participating in this distribution, may be required to deliver a Prospectus. This obligation is in addition to the obligation of dealers to deliver a Prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions. 2,400,000 SHARES OF COMMON STOCK AND 1,200,000 REDEEMABLE WARRANTS [SOUND SOURCE INTERACTIVE, INC. LOGO] ________________________ P R O S P E C T U S ________________________ THE BOSTON GROUP, L.P. JOSEPH STEVENS & COMPANY, L.P. -------------------------------------------------------------------------------- --------------------------------------------------------------------------------
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INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE.
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SUBJECT TO COMPLETION, DATED MAY 9, 1996 PROSPECTUS [SOUND SOURCE INTERACTIVE, INC. LOGO] 107,500 SHARES OF COMMON STOCK 5,689,665 REDEEMABLE WARRANTS 9,069,665 SHARES OF COMMON STOCK ISSUABLE UPON EXERCISE OF REDEEMABLE WARRANTS --------------------- This Prospectus relates to the registration by Sound Source Interactive, Inc. (the "Company"), at its expense, for the account of certain non-affiliated security holders (the "Selling Security Holders") of 107,500 shares of common stock, par value $.001 (the "Common Stock"), and 5,689,665 Redeemable Warrants (the "Redeemable Warrants") (the Common Stock and Redeemable Warrants offered by the Selling Security Holders are sometimes collectively referred to herein as the "Selling Security Holders' Securities"). The Selling Security Holders' Securities are not being underwritten in this offering and the Company will not receive any proceeds from the sale of the Selling Security Holders Securities. See "Selling Security Holders". The Selling Security Holders' Securities may be sold by the Selling Security Holders or their respective transferees commencing on the date of this Prospectus. Sales of the Selling Security Holders' Securities may depress the price of the Common Stock and Redeemable Warrants in any market that may develop for the Common Stock and Redeemable Warrants. See "Prospectus Summary -- The Offering," "Selling Security Holders" and "Certain Transactions." This Prospectus also relates to the registration by the Company for its own account of 9,069,665 shares of Common Stock issuable by the Company upon exercise of the 5,689,665 Redeemable Warrants being registered for the account of the Selling Security Holders as described in the preceding paragraph, 1,380,000 Redeemable Warrants issued by the Company pursuant to a separate Prospectus (the "Primary Offering Prospectus") filed with the Registration Statement of which this Prospectus is a part, and 2,000,000 warrants issued by the Company to ASSI, Inc., a consultant to and creditor of the Company. This Prospectus, except for this Cover Page, the back Cover Page and the information contained herein under the heading "Selling Security Holders" and "Plan of Distribution," is identical to the Primary Offering Prospectus. This Prospectus includes certain information that may not be pertinent to the sale by the Selling Security Holders. Prior to this offering, there has been no public market for the Common Stock or the Redeemable Warrants and there can be no assurance that such a market will exist after this offering. ------------------------ THESE SECURITIES ARE HIGHLY SPECULATIVE AND INVOLVE A HIGH DEGREE OF RISK AND IMMEDIATE SUBSTANTIAL DILUTION. SEE "RISK FACTORS" AND "DILUTION" COMMENCING ON PAGES 10 AND 26, RESPECTIVELY. --------------------- THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. ------------------------ The date of this Prospectus is , 1996 SS-1
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The sale of the Selling Security Holders' Securities may be effected from time to time in transactions (which may include block transactions by or for the account of the Selling Security Holders) in the over-the-counter market or in negotiated transactions, through the writing of options on the Selling Security Holders' Securities, through a combination of such methods of sale or otherwise. Sales may be made at fixed prices which may be changed, at market prices prevailing at the time of sale, or at negotiated prices. If any Selling Security Holder sells his, her or its Selling Security Holders' Securities pursuant to this Prospectus at a fixed price or at a negotiated price which is, in either case, other than the prevailing market price or in a block transaction to a purchaser who resells, or if any Selling Security Holder pays compensation to a broker-dealer that is other than the usual and customary discounts, concessions or commissions, or if there are any arrangements either individually or in the aggregate that would constitute a distribution of the Selling Security Holders' Securities, a post-effective amendment to the Registration Statement of which this Prospectus is a part would need to be filed and declared effective by the Securities and Exchange Commission before such Selling Security Holder could make such sale, pay such compensation or make such a distribution. The Company is under no obligation to file a post-effective amendment to the Registration Statement of which this Prospectus is a part under such circumstances. SS-2
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SELLING SECURITY HOLDERS An aggregate of 107,500 shares of Common Stock and 5,689,665 Redeemable Warrants are being registered in this offering for the account of the Selling Security Holders. The Selling Security Holders' Securities may be sold by the Selling Security Holders or their respective transferees commencing on the date of this Prospectus. Sales of such shares of Common Stock by the Selling Security Holders or their respective transferees may depress the price of the Common Stock and Redeemable Warrants in any market that may develop for such securities. The following table sets forth certain information with respect to persons for whom the Company is registering such shares of Common Stock and Redeemable Warrants for resale to the public. The Company will not receive any of the proceeds from the sale of such shares of Common Stock and Redeemable Warrants. None of the Selling Security Holders has had any position, office or material relationship with the Company or its affiliates during the last three years except for Financial West Group, Inc., which served as dealer manager for the Company's 1995 Bridge Offering and 1995 Private Placement. See "Certain Transactions -- 1995 Bridge Offering" and "-- 1995 Private Placement." The Selling Security Holders' Securities are not being underwritten by the Underwriters. The Selling Security Holders, however, may sell the Selling Security Holders' Securities through the Underwriters. [Enlarge/Download Table] NUMBER OF SHARES NUMBER OF SHARES NUMBER OF SHARES NAME OF SELLING / WARRANTS OWNED / WARRANTS BEING / WARRANTS OWNED SECURITY HOLDER(1) BEFORE OFFERING REGISTERED AFTER OFFERING(2) ---------------------------------------- ---------------- ---------------- ---------------- Robert Ahr and Antoinette Ahr, Joint Tenants with Right of Survivorship 50,000 (4) 50,000 (wt) 0 Stanley S. Arkin 100,000 (4) 100,000 (wt) 0 Lester C. Aroh 100,000 (4) 100,000 (wt) 0 5,000 (5) 5000 (sh) 0 Assi, Inc. 3,100,000 (4) 1,100,000 (wt) 2,000,000 40,000 (5) 40,000 (sh) Jonathan Axelrod 200,000 (4) 200,000 (wt) 0 10,000 (5) 10,000 (sh) 0 Harvey Bibicoff 100,000 (4) 100,000 (wt) 0 5,000 (5) 5,000 (sh) 0 Marvin H. Bluman 50,000 (4) 50,000 (wt) 0 Charles R. Buckridge, Grantor and Trustee of Charles R. Buckridge Revocable Trust 100,000 (4) 100,000 (wt) 0 Robert Burkhardt 50,000 (4) 50,000 (wt) 0 Burford A. Carlson and Joan E. Carlson, Grantors and Trustees for Burford A. Carlson Revocable Trust 586 (3) 586 (wt) 0 Mark Jeffrey Chayet, Grantor and Trustee for Mark Jeffrey Chayet Revocable Trust 100,000 (4) 100,000 (wt) 0 Cliffdale Investments, Inc. 100,000 (4) 100,000 (wt) 0 Arlene Colman-Schwimmer, Grantor and 100,000 (4) 100,000 (wt) 0 Trustee for Arlene Colman-Schwimmer APC 5,000 (5) 5,000 (sh) 0 Profit Sharing Plan and Trust SS-3
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NUMBER OF SHARES NUMBER OF SHARES NUMBER OF SHARES NAME OF SELLING / WARRANTS OWNED / WARRANTS BEING / WARRANTS OWNED SECURITY HOLDER(1) BEFORE OFFERING REGISTERED AFTER OFFERING(2) ---------------------------------------- ---------------- ---------------- ---------------- David B. Coward and Linda J. Coward, 50,000 (4) 50,000 (wt) 0 Grantors and Trustees for David B. and 2,500 (5) 2,500 (sh) 0 Linda J. Coward Trust Deller Capital Corporation 1,758 (3) 1,758 (wt) 0 Laura M. Durso 50,000 (4) 50,000 (wt) 0 Gerald F. Edelstein 50,000 (4) 50,000 (wt) 0 Financial West Group, Inc. 20,918 (6) 420,918 (wt) 0 400,000 (6) Robert Gault and Thelma Gault, Joint Tenants with Right of Survivorship 100,000 (4) 100,000 (wt) 0 25,000 (5) 25,000 (sh) 0 Barbara Goldstein 100,000 (4) 100,000 (wt) 0 Larry R. Gordon 600,000 (4) 600,000 (wt) 0 Nicholas Gotten Jr. and Pamela Gotten, Joint Tenants with Right of Survivorship 2,929 (3) 2,929 (wt) 0 Donald B. Greenwood 50,000 (4) 50,000 (wt) 0 Prabhakar R. Guniganti 100,000 (4) 100,000 (wt) 0 W. Burns Hoffman 100,000 (4) 100,000 (wt) 0 Edward Hookstratten 100,000 (4) 100,000 (wt) 0 Richard Houlihan 100,000 (4) 100,000 (wt) 0 Edward Jones 50,000 (4) 50,000 (wt) 0 John Paul DeJoria 100,000 (4) 100,000 (wt) 0 Gabriel Kaplan 250,000 (4) 250,000 (wt) 0 10,000 (5) 10,000 (sh) 0 Gabriel Kaplan, P/ADM City National Bank C/F Rotunda Productions Inc. MPPP 250,000 (4) 250,000 (wt) 0 Hazen Peter Kelley and Valerie Kelley, Joint Tenants with Right of Survivorship 50,000 (4) 50,000 (wt) 0 Honorata Knight 586 (3) 586 (wt) 0 Marc Levin 50,000 (4) 50,000 (wt) 0 Fred Martell and Barbara Martell, Joint Tenants with Right of Survivorship 100,000 (4) 100,000 (wt) 0 Edward I. Miller 586 (3) 586 (wt) 0 L.A. Moore 50,000 (4) 50,000 (wt) 0 Louis M. Mucci 100,000 (4) 100,000 (wt) 0 David A. Mulkey, Grantor and Trustee for 100,000 (4) 100,000 (wt) 0 David A. Mulkey 1987 Living Trust 5,000 (5) 5,000 (sh) 0 T.W. Muller 2,929 (3) 2,929 (wt) 0 SS-4
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NUMBER OF SHARES NUMBER OF SHARES NUMBER OF SHARES NAME OF SELLING / WARRANTS OWNED / WARRANTS BEING / WARRANTS OWNED SECURITY HOLDER(1) BEFORE OFFERING REGISTERED AFTER OFFERING(2) ---------------------------------------- ---------------- ---------------- ---------------- Steve Natale 100,000 (4) 100,000 (wt) 0 Saburo Oto 100,000 (4) 100,000 (wt) 0 Resources Trust Co., FBO Donald B. Pooley 1,172 (3) 1,172 (wt) 0 Patrick J. Riley 100,000 (4) 100,000 (wt) 0 Patricia C. Rinaldi 2,929 (3) 2,929 (wt) 0 Stanley B. Schneider 100,000 (4) 100,000 (wt) 0 Izhar Shy and Nitza Shy, Trustees for Izhar 1,172 (3) 1,172 (wt) 0 and Nitza Shy Revocable Estate Trust David H. Smith 4,100 (3) 4,100 (wt) 0 Isaac Starkman 100,000 (4) 100,000 (wt) 0 Triventures 50,000 (4) 50,000 (wt) 0 James Edward Willard 50,000 (4) 50,000 (wt) 0
-------------------- (1) Information set forth in the table regarding the Non-Affiliated Selling Security Holders' Securities is provided to the best knowledge of the Company based on information furnished to the Company by the respective Non-Affiliated Selling Security Holders and/or available to the Company through its stock ledgers. (2) Assumes that each Selling Security Holder sells all of the Selling Security Holders' Securities held by such Selling Security Holder. (3) Pursuant to the 1995 Bridge Financing, 32 Units were sold, each Unit consisting in part of 586 Bridge Warrants, each such warrant to purchase one share of Common Stock. See "Certain Transactions." (4) Pursuant to the 1995 Private Placement, 52.5 Units were sold, each Unit consisting in part of 100,000 Private Warrants, each such warrant to purchase one share of Common Stock. See "Certain Transactions." (5) Pursuant to the Concurrent Secondary Placement, 107,500 shares of Common Stock were sold. See "Certain Transactions." (6) Dealer Manager Warrants. (sh) Shares of Common Stock. (wt) Redeemable Warrants, each warrant to purchase one share of Common Stock. SS-5
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PLAN OF DISTRIBUTION The sale of the Selling Security Holders' Securities may be effected from time to time in transactions (which may include block transactions by or for the account of the Selling Security Holders) in the over-the-counter market or in negotiated transactions, through a combination of such methods of sale, or otherwise. Sales may be made at fixed prices which may be changed, at market prices prevailing at the time of sale, or at negotiated prices. If any Selling Security Holder sells his, her or its Selling Security Holders' Securities, pursuant to this Prospectus at a fixed price or at a negotiated price which is, in either case, other than the prevailing market price or in a block transaction to a purchaser who resells, or if any Selling Security Holder pays compensation to a broker-dealer that is other than the usual and customary discounts, concessions or commissions, or if there are any arrangements either individually or in the aggregate that would constitute a distribution of the Selling Security Holders' Securities, a post-effective amendment to the Registration Statement of which this Prospectus is a part would need to be filed and declared effective by the Securities and Exchange Commission before such Selling Security Holder could make such sale, pay such compensation or make such a distribution. The Company is under no obligation to file a post-effective amendment to the Registration Statement of which this Prospectus is a part under such circumstances. The Selling Security Holders may effect transactions in their Selling Security Holders' Securities by selling such securities directly to purchasers, through broker-dealers acting as agents for the Selling Security Holders or to broker-dealers who may purchase the Selling Security Holders' Securities as principals and thereafter sell such securities from time to time in the over- the-counter market, in negotiated transactions, or otherwise. Such broker- dealers, if any, may receive compensation in the form of discounts, concessions or commissions from the Selling Security Holders and/or the purchasers for whom such broker-dealers may act as agents or to whom they may sell as principals or both. The Selling Security Holders and broker-dealers, if any, acting in connection with such sales might be deemed to be "underwriters" within the meaning of Section 2(11) of the Securities Act and any commission received by them and any profit on the resale of such securities might be deemed to be underwriting discounts and commissions under the Securities Act. SS-6
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-------------------------------------------------------------------------------- -------------------------------------------------------------------------------- No dealer, salesperson or any other person has been authorized to give any information or to make representations other than those contained in this Prospectus and, if given or made, such information or representations must not be relied upon as having been authorized by the Company or the Underwriter. This Prospectus does not constitute an offer to sell or a solicitation of an offer to buy any security other than the securities offered by the Prospectus. This Prospectus does not constitute an offer to sell or a solicitation of an offer to buy any security by any person in any jurisdiction in which such offer or solicitation is not authorized or in which the person making such offer or solicitation is not qualified to do so or to anyone to whom it is unlawful to make such offer or solicitation. Neither the delivery of this Prospectus nor any sale made hereunder shall, under any circumstances, create any implication that the information in this Prospectus is correct as of any time subsequent to the date of this Prospectus. ________________________ TABLE OF CONTENTS PAGE ---- Prospectus Summary . . . . . . . __ Risk Factors . . . . . . . . . . __ Use of Proceeds . . . . . . . . . __ Dividend Policy . . . . . . . . . __ Dilution . . . . . . . . . . . . __ Capitalization . . . . . . . . . __ Selected Financial Data . . . . __ Management's Discussion and Analysis of Financial Condition and Results of Operations . . . __ Business . . . . . . . . . . . . __ Management . . . . . . . . . . . __ Principal Stockholders . . . . . __ Selling Security Holders . . . . __ Certain Transactions . . . . . . __ Description of Securities . . . . __ Shares Eligible for Future Sale . __ Plan of Distribution . . . . . . __ Legal Matters . . . . . . . . . . __ Experts . . . . . . . . . . . . __ Additional Information . . . . . __ Index to Consolidated Financial Statements . . . . . . . . . . . __ Until __________, 1996 (25 days after the date of this Prospectus), all dealers effecting transactions in the registered securities, whether or not participating in this distribution, may be required to deliver a Prospectus. This obligation is in addition to the obligation of dealers to deliver a Prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions. 107,500 SHARES OF COMMON STOCK 5,689,665 REDEEMABLE WARRANTS AND 9,069,665 SHARES OF COMMON STOCK ISSUABLE UPON EXERCISE OF REDEEMABLE WARRANTS [SOUND SOURCE INTERACTIVE, INC. LOGO] ________________________ P R O S P E C T U S ________________________ -------------------------------------------------------------------------------- --------------------------------------------------------------------------------
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PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 24. INDEMNIFICATION OF DIRECTORS AND OFFICERS. Section 145 of the Delaware General Corporation Law, as amended (the "Delaware GCL"), permits under certain circumstances, the indemnification of any person with respect to any threatened, pending, or completed action, suit, or proceeding, whether civil, criminal, administrative or investigative, to which such person was or is a party or is threatened to be made a party by reason of the fact that such person is or was a director, officer, employee, or agent of the corporation or was serving in a similar capacity for another enterprise at the request of the corporation. To the extent that a director, officer, employee, or agent of the corporation has been successful in defending any such proceeding, the Delaware GCL provides that he shall be indemnified against expenses (including attorneys' fees) actually and reasonably incurred by him in connection therewith. With respect to a proceeding by or in the right of the corporation, such person may be indemnified against expenses (including attorneys' fees) if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the corporation. The statute provides, however, that no indemnification is allowed in such a proceeding if such person is adjudged liable to the corporation unless, and only to the extent that, the court may, upon application, determine that he is entitled to indemnification under the circumstances. With respect to proceedings other than those brought by or in the right of the corporation, such person may be indemnified against judgments, fines, and amounts paid in settlement, as well as expenses, if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the corporation and, with respect to any criminal action, had no reasonable cause to believe his conduct was unlawful, notwithstanding the outcome of the proceeding. Except with respect to mandatory indemnification of expenses to successful defendants as described in the preceding paragraph or pursuant to a court order, the indemnification described in this paragraph may be made only upon a determination in each specific case by majority vote of a quorum of directors not parties to the proceeding, by written opinion of independent legal counsel, or by the stockholders, that the defendant met the applicable standard of conduct described above. The Delaware GCL permits a corporation to advance expenses incurred by a proposed indemnitee in advance of final disposition of the proceeding provided the indemnitee undertakes to repay such advanced expenses if it is ultimately determined that he is not entitled to indemnification. A corporation may purchase insurance on behalf of an indemnitee against any liability asserted against him in his designated capacity, whether or not the corporation itself would be empowered to indemnify him against such liability. Delaware law also provides that the above rights shall not be deemed exclusive of other rights of indemnification or advancement of expenses under any bylaw, agreement, vote of stockholders or disinterested directors, or otherwise. The Registrant's Bylaws generally require the Registrant to indemnify and advance expenses to its directors and its officers, employees and other agents to the fullest extent permitted by the Delaware GCL as the same exists or may hereafter be amended. The Registrant also has entered into indemnification agreements with each of its directors whereby the Company will indemnify each such person against certain claims arising out of certain past, present or future acts, omissions or breaches of duty committed by an indemnitee while serving as a Company director. Such indemnification does not apply to acts or omissions which are knowingly fraudulent, deliberately dishonest or arise from willful misconduct. Indemnification will only be provided to the extent that the indemnitee has not already received payments in respect of a claim from the Company II-1
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or from an insurance company. Under certain circumstances, such indemnification (including reimbursement of expenses incurred) will be allowed for liability arising under the Securities Act. Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers or person controlling the Company pursuant to the foregoing provisions, the Company has been informed that, in the opinion of the Securities and Exchange Commission, such indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable. The Company intends to purchase a directors' and officers' liability policy insuring directors and officers of the Company effective upon the closing of this offering. Section 102(b)(7) of the Delaware GCL permits Delaware corporations in their certificates of incorporation to eliminate or limit the personal liability of directors to the corporation or its stockholders for monetary damages for breaches of certain duties. Under the Registrant's Certificate of Incorporation, a director of the Registrant shall, to the maximum extent currently or hereafter permitted by Section 102(b)(7) of the Delaware GCL (or any successor provision), have no personal liability to the Registrant or its stockholders for monetary damages for breach of fiduciary duty as a director. Section 102(b)(7) of the Delaware GCL provides that Delaware corporations may not eliminate or limit the liability of a director (i) for any breach of the director's duty of loyalty to the Registrant or its stockholders, (ii) for acts or omissions not in good faith or that involve intentional misconduct or a knowing violation of law, (iii) as provided under Section 174 of the Delaware GCL (involving certain unlawful dividends and stock purchases or redemptions), or (iv) for any transaction from which the director derived an improper peroneal benefit. The foregoing descriptions are general summaries only. Reference is made to the full text of Registrant's Certificate of Incorporation and Bylaws filed as part of this Registration Statement. ITEM 25. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION. The following tables sets forth the various expenses in connection with the sale and distribution of the securities being registered, other than underwriting discounts and commissions and non-accountable expense allowance. All of the amounts shown are estimates except the Securities and Exchange Commission registration and NASD filing fees. Securities and Exchange Commission registration fee. . . . . . . . $21,157.85 NASD fees and expenses . . . . . . . . . . . . . . . . . . . . . . * Nasdaq listing fee . . . . . . . . . . . . . . . . . . . . . . . . * Accounting fees and expenses . . . . . . . . . . . . . . . . . . . * Printing and engraving expenses . . . . . . . . . . . . . . . . . * Transfer agent and registrar (fees and expenses) . . . . . . . . . * Blue Sky fees and expenses (including counsel fees). . . . . . . . * Other legal fees and legal expenses. . . . . . . . . . . . . . . . * Miscellaneous expenses . . . . . . . . . . . . . . . . . . . . . . * Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . * ------------------- * To be supplied by amendment. II-2
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ITEM 26. RECENT SALES OF UNREGISTERED SECURITIES. On May 16, 1994, the Registrant consummated the 1994 Acquisition, whereby the Registrant acquired all the issued and outstanding capital stock of the Subsidiary in exchange for newly issued stock of the Company. Pursuant to the 1994 Acquisition, the Registrant issued 1,278,515 shares of Common Stock and 1,000,000 shares of the Registrant's Series A Preferred Stock to Vincent J. Bitetti, 73,394 shares of Common Stock to Martin H. Meyer and 122,323 shares of Common Stock to Mark Lane. Each of such persons was an "accredited investor" as defined in Securities Act Rule 501(a). The issuance of Common Stock to such persons was exempt from the registration requirements of the Securities Act of 1993, as amended (the "Securities Act") pursuant to Section 4(2) thereof. During May through August 1994, the Registrant conducted a private offering of its Common Stock (the "1994 Private Placement"). Pursuant to that offering, a total of 113,036 shares of Common Stock were sold for total cash consideration of approximately $1,492,000. An additional 1,841 shares were issued to the brother of the Chief Executive Officer in payment of a $22,000 note payable. The 1994 Private Placement was made on a private basis only to persons who were "accredited investors" as defined in Securities Act Rule 501(a). The issuance of Common Stock to such persons was exempt from the registration requirements of the Securities Act pursuant to Sections 4(2) and 4(6) thereof. As compensation for its services as the placement agent for the 1994 Private Placement, the Registrant paid Bentley, Richards Investments ("Bentley, Richards"), an affiliate of the Registrant's then controlling stockholders, Jehu Hand and Eric Anderson, 81,997 shares of Common Stock, and issued to Bentley, Richards an option to purchase up to 60,241 shares of Common Stock, subject to the satisfaction of certain contingencies, at a price to be determined in accordance with a formula. In July 1995, one of the investors in the 1994 Private Placement filed a suit naming as defendants the following: Jehu Hand and Eric Anderson (who together organized the Registrant and managed it prior to the 1994 Acquisition), and their spouses Jacqueline Hand and Marie Anderson; the Registrant and the Subsidiary; and Bentley Richards. No then current director or officer of the Registrant was named as a defendant. Such litigation was settled in September 1995. In connection with such settlement, Bentley, Richards distributed all 81,997 shares of Common Stock issued to it for its services as placement agent for the 1994 Private Placement to the investors in the 1994 Private Placement. Bentley, Richards also agreed to the cancellation of its option to purchase 60,241 shares of the Registrant's Common Stock. In addition, Jehu Hand distributed an additional 26,772 shares of Common Stock held by him to the investors in the 1994 Private Placement, and returned 15,120 shares of Common Stock to the Company, which were cancelled. The Company did not pay any consideration to any party in connection with such settlement. During May 1992 through October 1994, the Registrant, pursuant to its 1992 Stock Option Plan, issued options to purchase 190,763 shares of Common Stock to its directors, employees and one unaffiliated party. The issuance of such options to such persons was exempt from the registration requirements of the Securities Act pursuant to Section 4(2) thereof. Of these, options to purchase a total of 184,070 shares of Common Stock currently are issued pursuant to the 1992 Stock Option Plan. All of such options are non-qualified stock options with an exercise price of $.06 per share, and are presently exercisable. On June 30, 1995, David Weiss, then an executive officer and director of the Registrant, exercised an option to purchase 4,184 shares of Common Stock for an aggregate purchase price of $251, which option had been granted pursuant to the Registrant's 1992 Stock Option Plan. The issuance of Common Stock to Mr. Weiss upon such exercise was exempt from the registration requirements of the Securities Act pursuant to Section 4(2) and 4(6) thereof. No one other than Mr. Weiss has ever exercised an option granted pursuant to the 1992 Stock Option Plan. II-3
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In April 1994, the Registrant granted Eric H. Winston, its President, an option to purchase 251,004 shares of Common Stock. In June 1994, the Registrant granted Mr. Winston an option to purchase 41,834 shares of Common Stock. The issuance of such options to such person was exempt from the registration requirements of the Securities Act pursuant to Section 4(2) thereof. During June through August of 1995, the Registrant conducted a private offering (the "1995 Bridge Financing") of Units consisting of notes and warrants. Pursuant to that offering, a total of 32 Units were sold at a price of $10,000 per Unit. Each Unit consisted of $9,975 principal amount of the Registrant's 10% Secured Promissory Notes due August 15, 1995 and warrants to purchase 586 shares of Common Stock (the "Bridge Warrants"). The gross offering proceeds of the 1995 Bridge Financing were $320,000. The 1995 Bridge Financing was made on a private basis only to persons who were "accredited investors" as defined in Securities Act Rule 501(a). The issuance of the Units to such persons was exempt from the registration requirements of the Securities Act pursuant to Sections 4(2) and 4(6) thereof and Rule 506 of Regulation D thereunder. In consideration for its services as dealer manager for the 1995 Bridge Offering, the Registrant paid Financial West Group, Inc. aggregate commissions and fees of $41,600. The Registrant also issued to Financial West Group, Inc. a Bridge Warrant to purchase 20,918 shares of Common Stock for $50. Such Bridge Warrant is on the same terms as the other Bridge Warrants, except that the Company separately agreed that it may be exercised on a cashless basis. During November 1995, the Registrant effectuated an exchange offer with the holders of the Bridge Warrants, whereby all of the Bridge Warrants originally issued in connection with the 1995 Bridge Financing were exchanged for new Bridge Warrants having terms substantially identical to those of the Private Warrants referred to below. Such exchange offer was made on a private basis only to persons who were "accredited investors" as defined in Securities Act Rule 501(a). The exchange offer was exempt from the registration requirements of the Securities Act pursuant to Sections 4(2) and 4(6) thereof and Rule 506 of Regulation D thereunder. As described under "Certain Transactions -- 1995 Bridge Financing," upon the effectiveness of this Registration Statement, all of the Bridge Warrants (including the warrant issued to Financial West Group, Inc.) will be converted to Redeemable Warrants. In connection with the 1995 Bridge Financing, the Registrant retained Financial West Group, Inc. as its warrant agent for the Bridge Warrants. Subsequently, Financial West Group, Inc. assigned to The Boston Group, L.P. (the "Representative") its right to serve as warrant agent for the Bridge Warrants. As compensation for such services as warrant agent, the Representative will receive a solicitation fee of five percent of the exercise price of the Bridge Warrants, payable upon exercise of the Bridge Warrants. In September and October 1995, the Registrant conducted a private offering (the "1995 Private Placement"). Pursuant to that offering, a total of 52.5 Units were sold at a price of $100,000 per Unit. Each Unit consisted of $95,000 principal amount of the Registrant 10% Secured Promissory Notes due 1996 and warrants to purchase 100,000 shares of Common Stock (the "Private Warrants"). The gross offering proceeds of the 1995 Private Placement were $5,250,000. The 1995 Private Placement was made on a private basis only to persons who were "accredited investors" as defined in Securities Act Rule 501(a). The issuance of the Units to such persons was exempt from the registration requirements of the Securities Act pursuant to Sections 4(2) and 4(6) thereof and Rule 506 of Regulation D thereunder. In consideration for its services as dealer manager for the 1995 Private Placement, the Registrant paid Financial West Group, Inc. aggregate commissions and fees of $199,500. Additionally, $483,000 was allocated to the Representative for its services as a selected broker. The Registrant also issued to Financial West Group, Inc. a warrant to purchase 400,000 shares of Common Stock. Such warrant is on the same terms as the Private Warrants, except that the Company separately agreed that it may be exercised on a cashless basis. As described under "Certain Transactions -- 1995 Private Placement," upon the effectiveness of this Registration Statement all of II-4
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the Private Warrants (including the warrant issued to Financial West Group, Inc.) will be converted to Redeemable Warrants. In connection with the 1995 Private Placement, the Registrant retained Financial West Group, Inc. as its warrant agent for the Private Warrants. Subsequently, Financial West Group, Inc. assigned to the Representative its right to serve as warrant agent for the Private Warrants. As compensation for its services as warrant agent, the Representative will receive a solicitation fee of five percent of the exercise price of the Private Warrants, payable upon exercise of the Private Warrants. On October 9, 1995, the Registrant granted to Ulrich E. Gottschling, who is the Chief Financial Officer, Treasurer and a director of the Registrant, an option to purchase 100,000 shares of Common Stock pursuant to the Registrant's 1992 Stock Option Plan. On April 30, 1996, Mr.Gottschling agreed to the termination of the existing 100,000 share option in consideration for the Registrant's granting him a new 200,000 share option. Such transactions were exempt from the registration requirements of the Securities Act pursuant to Sections 4(2) and 4(6) thereof. On April 30, 1996, the Company granted ASSI, Inc. warrants to purchase 2,000,000 shares of Common Stock. Such transaction was exempt from the registration requirements of the Securities Act pursuant to Sections 4(2) and 4(6) thereof. See "Certain Transactions" for additional information concerning the Registrant's stock issuances for the past three years. ITEM 27. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES. (a) Exhibits Exh. No. Description of Exhibits ---- ----------------------- 1 Form of Underwriting Agreement, between the Registrant and The Boston Group, L.P. ("Representative"), as Representative of the Several Underwriters (as defined therein). Filed herewith. 3.1 Second Restated Articles of Incorporation of the Registrant. Previously filed. 3.2 Amended and Restated Bylaws of the Registrant. Previously filed. 4.1 Specimen Common Stock Certificate. Previously filed. 4.2 Form of Warrant Agreement and Warrant. Filed herewith. 4.3 Form of Representative's Warrant Agreement and Warrant. Filed herewith. 4.4 Warrant dated April 30, 1996 issued to ASSI, Inc. Filed herewith. 5 Opinion of McDermott, Will & Emery. Filed herewith. 9.1 Stockholder Voting Agreement, dated as of April 30, 1996, among ASSI, Inc., Vincent J. Bitetti and Eric H. Winston. Filed herewith. 9.2 Irrevocable Proxy of Vincent J. Bitetti to ASSI, Inc., dated April 30, 1996. Filed herewith. 9.3 Irrevocable Proxy of Eric H. Winston to ASSI, Inc., dated April 30, 1996. Filed herewith. 9.4 Irrevocable Proxy of ASSI, Inc. to Vincent J. Bitetti, dated April 30, 1996. Filed herewith. 10.1 Second Amended and Restated Employment Agreement of Vincent J. Bitetti dated as of April 30, 1996. Filed herewith. 10.2 Second Amended and Restated Employment Agreement of Eric H. Winston dated as of April 30, 1996. Filed herewith. II-5
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10.3 Employment Agreement of Ulrich E. Gottschling, as amended. Filed herewith. 10.4 Sound Source Interactive, Inc. 1992 Stock Option Plan. Previously filed. 10.5 Sound Source Interactive, Inc. 1995 Stock Option Plan. Previously filed. 10.6 Warrant Agreement, dated as of September 26, 1995, among the Registrant, Sound Source Interactive, Inc., a California corporation ("Subsidiary") and Financial West Group, Inc., a California corporation ("FWG"), as Warrant Agent, pertaining to the Bridge Warrants (as defined in the Prospectus). Previously filed. 10.7 Warrant Agreement, dated as of June 30, 1995, between the Registrant and FWG, as Warrant Agent, pertaining to the Private Warrants (as defined in the Prospectus). Previously filed. 10.8 Form of Bridge Warrant and Private Warrant. Previously filed. 10.9 Form of 10% Secured Promissory Note due 1996 of the Registrant (the "Private Notes"). Previously filed. 10.10 Company Security Agreement, dated as of September 26, 1995, among the Registrant, the Secured Parties (as defined therein) and Paradox Holdings, Inc. ("PHI"), as Security Agent, pertaining to the Private Notes. Previously filed. 10.11 Guaranty of the Subsidiary, dated September 26, 1995, pertaining to the Private Notes. Previously filed. 10.12 Subsidiary Security Agreement, dated as of September 26, 1995, among the Registrant, the Subsidiary and PHI, as Security Agent, pertaining to the Private Notes. Previously filed. 10.13 Sales and Distribution Agreement, dated as of June 15, 1995, between the Registrant and Acclaim Distribution, Inc. Previously filed. 10.14 Retail License Agreement, dated June 16, 1994, between Warner Bros. Consumer Products and "Sound Source Interactive," pertaining to the motion picture, "Willy 2." Previously filed. 10.15 Retail License Agreement, dated July 7, 1995, between Warner Bros. Consumer Products and "Sound Source Interactive," pertaining to the television series, "Babylon 5." Previously filed. 10.16 Retail License Agreement, dated June 16, 1994, between Warner Bros. Consumer Products and "Sound Source Interactive," pertaining to the motion picture, "The Secret Garden." Previously filed. 10.17 Retail License Agreement, dated June 16, 1994, between Warner Bros. Consumer Products and "Sound Source Interactive," pertaining to the motion picture, "Black Beauty." Previously filed. 10.18 Merchandising License Agreement, dated March 7, 1995, between Sony Signature, Inc., as agent for Columbia Pictures Industries, Inc., and the Subsidiary, pertaining to the motion picture, "Close Encounters of the Third Kind." Previously filed. 10.19 CD-ROM Development Agreement, dated August 30, 1994, between Fox Electronic Publishing, Inc., doing business as Fox Interactive, and "Sound Source Interactive." Previously filed. 10.20 (a) Merchandising Licensing Agreement, dated December 5, 1994, between MCA/Universal Merchandising, Inc. and "Sound Source Interactive," pertaining to the motion picture, "The Little Rascals." Previously filed. (b) Multimedia Rights License, dated June 14, 1995, between The Harry Fox Agency, Inc. and "Sound Source Interactive," pertaining to the motion picture, "The Little Rascals." Previously filed. (c) Letter of Agreement, dated June 28, 1995, between Roy Shield Music Company and "Sound Source Interactive," pertaining to the motion picture, "The Little Rascals." Previously filed. II-6
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(d) Multi Media Rights License, dated July 27, 1995, between MCA, Inc. and "Sound Source Interactive," pertaining to the motion picture, "The Little Rascals." Previously filed. 10.21 Merchandising Licensing Agreement, dated March 16, 1995, between MCA/Universal Merchandising, Inc. and "Sound Source Interactive," pertaining to the animated television series, "ExoSquad." Previously filed. 10.22 Merchandising Licensing Agreement, dated August 10, 1995, between MCA/Universal Merchandising, Inc. and "Sound Source Interactive," pertaining to the motion picture, "Babe." Previously filed. 10.23 (a) License Agreement, dated October 1, 1994, between Lucasfilm Ltd. ("LFL") and "Sound Source Interactive," pertaining to AUDIOCLIPS-C- of sound effects, dialogue and movie soundtracks for the motion pictures, "Star Wars," "The Empire Strikes Back," and "Return of the Jedi." Previously filed. (b) License Agreement, dated October 1, 1994, between LFL and "Sound Source Interactive," pertaining to VISUALCLIPS-C- of film/video cues for the motion pictures, "Star Wars," "The Empire Strikes Back," and "Return of the Jedi." Previously filed. (c) Soundtrack License Agreement, dated October 1, 1994, between LFL and "Sound Source Interactive," pertaining to the use of the soundtrack of the "Star Wars Films" (as defined therein). Previously filed. (d) Film Footage License, dated October 1, 1994, between LFL and "Sound Source Interactive," pertaining to the use of the film footage of the "Star Wars Films" (as defined therein). Previously filed. (e) Letter of Intent and Star Wars Classic License Agreement, dated September 15, 1995, between LFL and "Sound Source Interactive, Inc.," pertaining to the grant of a license for sales in Canada. Previously filed. (f) Addendum to the agreement dated October 28, 1992, between Horatio Productions and the Subsidiary, pertaining to the use of preexisting dialogue of the Darth Vader character. Previously filed. 10.24 Merchandising License Agreement, dated July 8, 1994, between Viacom Consumer Products, as agent for Paramount Pictures Corporation, and "Sound Source Interactive, Inc.," pertaining to the television series, "Star Trek: The Original Series," the first six motion pictures based thereon and the television series, "Star Trek: The Next Generation." Previously filed. 10.25 (a) License Agreement, dated as of July 10, 1995, between DC Comics and "Sound Source Interactive," pertaining to the animated television series initially entitled "Batman: The Animated Series" and thereafter entitled, "The Adventures of Batman and Robin." Previously filed. (b) Interactive/Multimedia Adherence Letter, dated November 10, 1995, between the Screen Actors Guild and "Sound Source Interactive," pertaining to the animated television series initially entitled "Batman: The Animated Series" and thereafter entitled, "The Adventures of Batman and Robin." Previously filed. 10.26 Licensing Agreement, dated as of June 14, 1994 among CBS Entertainment ("CBS"), Rod Serling Trust and "Sound Source Interactive," pertaining to the television series, "The Twilight Zone." Previously filed. 10.27 Merchandising License Agreement, dated as of October 30, 1992, among Carolco Pictures Inc., Carolco International N.V. and "Sound Source Unlimited, Inc.," pertaining to the motion picture, "Total Recall." Previously filed. 10.28 Merchandising License Agreement, dated as of October 30, 1992, among Carolco Pictures Inc., Carolco International N.V. and "Sound Source Unlimited, Inc.," pertaining to the motion picture, "Terminator 2: Judgment Day." Previously filed. II-7
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10.29 License Agreement, dated as of September 20, 1994, between Palladium Limited Partnership and "Sound Source Interactive," pertaining to the motion picture, "Lassie." Previously filed. 10.30 License Agreement, dated as of September 20, 1994, between Broadway Video Entertainment and "Sound Source Interactive," pertaining to the television series, "Saturday Night Live." Previously filed. 10.31 Merchandising License Agreement, dated as of October 12, 1995, between DESILU, TOO, CBS and "Sound Source Interactive," pertaining to the television series, "I Love Lucy." Previously filed. 10.32 Memorandum of Understanding, dated May 26, 1994, between Brian Leader, doing business as Sentient Software, and "Sound Source Interactive, Inc.," pertaining to program development and licensing agreements related to MOVIEBOOKS-TM-. Previously filed. 10.33 (a) Royalty Programming Contract, dated July 12, 1993, between Rhode Island Soft Systems ("RISS") and the Subsidiary, pertaining to screen saver modules. Previously filed. (b) Amendment to Royalty Programming Contract, dated September 12, 1994, between RISS and the Subsidiary. Previously filed. (c) Agreement, dated April 12, 1995, between RISS and "Sound Source Interactive," pertaining to MOVIEBOOKS-TM-. Previously filed. (d) Letter of Intent, dated August 24, 1995, between RISS and "Sound Source Interactive," pertaining to MOVIEBOOKS-TM-. Previously filed. 10.34 Merchandising License Agreement, dated September 1, 1995, between Greytsounds Sound Development and "Sound Source Interactive," pertaining to Registrant's Sound Library. Previously filed. 10.35 Indemnification Agreement, dated as of January 1, 1996, between the Company and Vincent J. Bitetti. Filed herewith. 10.36 Indemnification Agreement, dated as of January 1, 1996, between the Company and Eric H. Winston. Filed herewith. 10.37 Indemnification Agreement, dated as of January 1, 1996, between the Company and Ulrich Gottschling. Filed herewith. 10.38 Merchandising License Agreement, dated October 24, 1995, between MCA/Universal Merchandising, Inc. and "Sound Source Interactive," pertaining to the motion picture, "Dragonheart." Filed herewith. 10.39 Merchandising License Agreement, dated January 10, 1996, between MCA/Universal Merchandising, Inc. and "Sound Source Interactive," pertaining to the motion pictures, "The Land Before Time" (I, II and III). Filed herewith. 10.40 Agreement, dated March 18, 1996, between Musicians' Union and "Sound Source Interactive," pertaining to the use of music from the motion pictures, "The Land Before Time" (I, II and III). Filed herewith. 10.41 License Agreement, dated February 27, 1996, between MGM/UA Merchandising, Inc. and Subsidiary, pertaining to the motion picture, "All Dogs Go To Heaven 2." Filed herewith. 10.42 Agreement, dated January 4, 1996, between Universal Studios Florida and "Sound Source Interactive," pertaining to the "Universal Studios Florida T2 Screensaver Sweepstakes." Filed herewith. 10.43 Agreement, dated January 24, 1996, between Warner Bros. Television and "Sound Source Interactive," pertaining to the "Babylon 5 Contest." Filed herewith. 10.44 Form of Registration Procedures Agreement for execution between the Company and each of the Selling Security Holders. Filed herewith. II-8
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10.45 Consulting Agreement, dated as of April 30, 1996, between the Company and ASSI, Inc. Filed herewith. 10.46 Share Purchase Agreement, dated April 3, 1995, between Eric Winston and Vincent Bitetti. Filed herewith. 21.1 Subsidiary of the Registrant. Previously filed. 23.1 Consent of Corbin & Wertz. Filed herewith. 23.2 Consent of McDermott, Will & Emery (included in Exhibit 5). 24.1 Power of Attorney (incorporated by reference to page II-11 of the Registration Statement on Form SB-2). (b) Financial Statement Schedules None Required ITEM 28. UNDERTAKINGS. The undersigned Registrant hereby undertakes: (1) To file, during any period in which offers or sales are being made, a post-effective amendment to this Registration Statement: (i) To include any Prospectus required by section 10(a)(3) of the Securities Act; (ii) To reflect in the Prospectus any facts or events arising after the effective date of the Registration Statement (or the most recent post-effective amendment thereof) which, individually, or in the aggregate, represent a fundamental change in the information set forth in the Registration Statement; notwithstanding the foregoing, any increase or decrease in volume of securities offered (if the total dollar value of securities offered would not exceed that which was registered) and any deviation from the low or high end of the estimated maximum offering range may be reflected in the form of prospectus filed with the Commission pursuant to Rule 424(b) (Section 230.424(b) of this Chapter) if, in the aggregate, the changes in volume and price represent no more than a 20 percent change in the maximum aggregate offering price set forth in the "Calculation of Registration Fee" table in the effective registration statement; and (iii) To include any material information with respect to the plan of distribution not previously disclosed in the Registration Statement or any material change to such information in the Registration Statement. (2) That, for the purpose of determining any liability under the Securities Act, each such post-effective amendment shall be deemed to be a new Registration Statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. II-9
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(3) To remove from registration by means of a post-effective amendment any of the securities being registered which remain unsold at the termination of the offering. Insofar as indemnification for liabilities arising from the Securities Act may be permitted to directors, officers, and controlling persons of the Registrant pursuant to the foregoing provisions, or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer, or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against policy polish as expressed in the Securities Act and will be governed by the final adjudication of such issue. The undersigned Registrant hereby undertakes to provide to the underwriters at the closing specified in the underwriting agreement certificates in such denominations and registered in such names as required by the Underwriters to permit prompt delivery to each purchaser. For purposes of determining any liability under the Securities Act, the information omitted from the form of Prospectus filed as part of this Registration Statement in reliance upon Rule 430A and contained in a form of Prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or Rule 497(h) under the Securities Act shall be deemed to be part of this Registration Statement as of the time it was declared effective. For the purpose of determining any liability under the Securities Act, each post-effective amendment that contains a form of Prospectus shall be deemed to be a new Registration Statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. II-10
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SIGNATURES In accordance with the requirements of the Securities Act of 1933, the registrant certifies that it has reasonable grounds to believe that it meets all of the requirements for filing on Form SB-2 and authorized this registration statement to be signed on its behalf by the undersigned, in the City of Los Angeles, State of California, on May 6, 1996. SOUND SOURCE INTERACTIVE, INC. By: /S/ VINCENT J. BITETTI ---------------------------- Vincent J. Bitetti, Chairman of the Board and Chief Executive Officer POWER OF ATTORNEY Each person whose signature appears below constitutes and appoints Vincent J. Bitetti and/or Eric H. Winston his true and lawful attorney-in-fact and agent, acting alone, with full powers of substitution and re-substitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments (including post-effective amendments) to this Registration Statement, any Amendments thereto and any Registration Statement for the same offering which is effective upon filing pursuant to Rule 462(b) under the Securities Act of 1933, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorney-in-fact and agent, each acting alone, full powers and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all said attorney-in-fact and agent, acting alone, or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. In accordance with the requirements of the Securities Act of 1933, this registration statement has been signed by the following persons in the capacities and on the dates stated. [Enlarge/Download Table] SIGNATURE TITLE DATE CHIEF EXECUTIVE OFFICER /s/ Vincent J. Bitetti Director, Chairman of May 6, 1996 ---------------------- the Board and Chief Vincent J. Bitetti Executive Officer PRINCIPAL ACCOUNTING OFFICER /s/ Ulrich E. Gottschling Director, May 6, 1996 ------------------------- Chief Financial Officer, Ulrich E. Gottschling Treasurer and Secretary PRESIDENT /s/ Eric H. Winston Director, May 6, 1996 ------------------------ President and Eric H. Winston Chief Operating Officer II-11
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-------------------------------------------------------------------------------- -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ---------------- EXHIBITS TO PRE-EFFECTIVE AMENDMENT NO. 1 TO FORM SB-2 REGISTRATION STATEMENT (No. 33-80827) UNDER THE SECURITIES ACT OF 1933 ---------------- SOUND SOURCE INTERACTIVE, INC. (Exact name of registrant as specified in its charter) -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- --------------------------------------------------------------------------------
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Registration Statement on Form SB-2 Exhibit Volume Index Exh. Sequential No. Description of Exhibits Page No. ----- ----------------------- ---------- 1 Form of Underwriting Agreement, between the Registrant and The Boston Group, L.P. ("Representative"), as Representative of the Several Underwriters (as defined therein). Filed herewith. 3.1 Second Restated Articles of Incorporation of the Registrant. Previously filed. 3.2 Amended and Restated Bylaws of the Registrant. Previously filed. 4.1 Specimen Common Stock Certificate. Previously filed. 4.2 Form of Warrant Agreement and Warrant. Filed herewith. 4.3 Form of Representative's Warrant Agreement and Warrant. Filed herewith. 4.4 Warrant dated April 30, 1996 issued to ASSI, Inc. Filed herewith. 5 Opinion of McDermott, Will & Emery. Filed herewith. 9.1 Stockholder Voting Agreement, dated as of April 30, 1996, among ASSI, Inc., Vincent J. Bitetti and Eric H. Winston. Filed herewith. 9.2 Irrevocable Proxy of Vincent J. Bitetti to ASSI, Inc., dated April 30, 1996. Filed herewith. 9.3 Irrevocable Proxy of Eric H. Winston to ASSI, Inc., dated April 30, 1996. Filed herewith. 9.4 Irrevocable Proxy of ASSI, Inc. to Vincent J. Bitetti, dated April 30, 1996. Filed herewith. 10.1 Second Amended and Restated Employment Agreement of Vincent J. Bitetti dated as of April 30, 1996. Filed herewith. 10.2 Second Amended and Restated Employment Agreement of Eric H. Winston dated as of April 30, 1996. Filed herewith. 10.3 Employment Agreement of Ulrich E. Gottschling, as amended. Filed herewith. 10.4 Sound Source Interactive, Inc. 1992 Stock Option Plan. Previously filed. 10.5 Sound Source Interactive, Inc. 1995 Stock Option Plan. Previously filed. 10.6 Warrant Agreement, dated as of September 26, 1995, among the Registrant, Sound Source Interactive, Inc., a California corporation ("Subsidiary") and Financial West Group, Inc., a California corporation ("FWG"), as Warrant Agent, pertaining to the Bridge Warrants (as defined in the Prospectus). Previously filed. 10.7 Warrant Agreement, dated as of June 30, 1995, between the Registrant and FWG, as Warrant Agent, pertaining to the Private Warrants (as defined in the Prospectus). Previously filed. 10.8 Form of Bridge Warrant and Private Warrant. Previously filed. 10.9 Form of 10% Secured Promissory Note due 1996 of the Registrant (the "Private Notes"). Previously filed. 10.10 Company Security Agreement, dated as of September 26, 1995, among the Registrant, the Secured Parties (as defined therein) and Paradox Holdings, Inc. ("PHI"), as Security Agent, pertaining to the Private Notes. Previously filed. 10.11 Guaranty of the Subsidiary, dated September 26, 1995, pertaining to the Private Notes. Previously filed. 10.12 Subsidiary Security Agreement, dated as of September 26, 1995, among the Registrant, the Subsidiary and PHI, as Security Agent, pertaining to the Private Notes. Previously filed. 10.13 Sales and Distribution Agreement, dated as of June 15, 1995, between the Registrant and Acclaim Distribution, Inc. Previously filed.
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Registration Statement on Form SB-2 Exhibit Volume Index Exh. Sequential No. Description of Exhibits Page No. ----- ----------------------- ---------- 10.14 Retail License Agreement, dated June 16, 1994, between Warner Bros. Consumer Products and "Sound Source Interactive," pertaining to the motion picture, "Willy 2." Previously filed. 10.15 Retail License Agreement, dated July 7, 1995, between Warner Bros. Consumer Products and "Sound Source Interactive," pertaining to the television series, "Babylon 5." Previously filed. 10.16 Retail License Agreement, dated June 16, 1994, between Warner Bros. Consumer Products and "Sound Source Interactive," pertaining to the motion picture, "The Secret Garden." Previously filed. 10.17 Retail License Agreement, dated June 16, 1994, between Warner Bros. Consumer Products and "Sound Source Interactive," pertaining to the motion picture, "Black Beauty." Previously filed. 10.18 Merchandising License Agreement, dated March 7, 1995, between Sony Signature, Inc., as agent for Columbia Pictures Industries, Inc., and the Subsidiary, pertaining to the motion picture, "Close Encounters of the Third Kind." Previously filed. 10.19 CD-ROM Development Agreement, dated August 30, 1994, between Fox Electronic Publishing, Inc., doing business as Fox Interactive, and "Sound Source Interactive." Previously filed. 10.20 (a) Merchandising Licensing Agreement, dated December 5, 1994, between MCA/Universal Merchandising, Inc. and "Sound Source Interactive," pertaining to the motion picture, "The Little Rascals." Previously filed. (b) Multimedia Rights License, dated June 14, 1995, between The Harry Fox Agency, Inc. and "Sound Source Interactive," pertaining to the motion picture, "The Little Rascals." Previously filed. (c) Letter of Agreement, dated June 28, 1995, between Roy Shield Music Company and "Sound Source Interactive," pertaining to the motion picture, "The Little Rascals." Previously filed. (d) Multi Media Rights License, dated July 27, 1995, between MCA, Inc. and "Sound Source Interactive," pertaining to the motion picture, "The Little Rascals." Previously filed. 10.21 Merchandising Licensing Agreement, dated March 16, 1995, between MCA/Universal Merchandising, Inc. and "Sound Source Interactive," pertaining to the animated television series, "ExoSquad." Previously filed. 10.22 Merchandising Licensing Agreement, dated August 10, 1995, between MCA/Universal Merchandising, Inc. and "Sound Source Interactive," pertaining to the motion picture, "Babe." Previously filed. 10.23 (a) License Agreement, dated October 1, 1994, between Lucasfilm Ltd. ("LFL") and "Sound Source Interactive," pertaining to AUDIOCLIPS-C- of sound effects, dialogue and movie soundtracks for the motion pictures, "Star Wars," "The Empire Strikes Back," and "Return of the Jedi." Previously filed. (b) License Agreement, dated October 1, 1994, between LFL and "Sound Source Interactive," pertaining to VISUALCLIPS-C- of film/video cues for the motion pictures, "Star Wars," "The Empire Strikes Back," and "Return of the Jedi." Previously filed. (c) Soundtrack License Agreement, dated October 1, 1994, between LFL and "Sound Source Interactive," pertaining to the use of the soundtrack of the "Star Wars Films" (as defined therein). Previously filed. -2-
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Registration Statement on Form SB-2 Exhibit Volume Index Exh. Sequential No. Description of Exhibits Page No. ----- ----------------------- ---------- (d) Film Footage License, dated October 1, 1994, between LFL and "Sound Source Interactive," pertaining to the use of the film footage of the "Star Wars Films" (as defined therein). Previously filed. (e) Letter of Intent and Star Wars Classic License Agreement, dated September 15, 1995, between LFL and "Sound Source Interactive, Inc.," pertaining to the grant of a license for sales in Canada. Previously filed. (f) Addendum to the agreement dated October 28, 1992, between Horatio Productions and the Subsidiary, pertaining to the use of preexisting dialogue of the Darth Vader character. Previously filed. 10.24 Merchandising License Agreement, dated July 8, 1994, between Viacom Consumer Products, as agent for Paramount Pictures Corporation, and "Sound Source Interactive, Inc.," pertaining to the television series, "Star Trek: The Original Series," the first six motion pictures based thereon and the television series, "Star Trek: The Next Generation." Previously filed. 10.25 (a) License Agreement, dated as of July 10, 1995, between DC Comics and "Sound Source Interactive," pertaining to the animated television series initially entitled "Batman: The Animated Series" and thereafter entitled, "The Adventures of Batman and Robin." Previously filed. (b) Interactive/Multimedia Adherence Letter, dated November 10, 1995, between the Screen Actors Guild and "Sound Source Interactive," pertaining to the animated television series initially entitled "Batman: The Animated Series" and thereafter entitled, "The Adventures of Batman and Robin." Previously filed. 10.26 Licensing Agreement, dated as of June 14, 1994 among CBS Entertainment ("CBS"), Rod Serling Trust and "Sound Source Interactive," pertaining to the television series, "The Twilight Zone." Previously filed. 10.27 Merchandising License Agreement, dated as of October 30, 1992, among Carolco Pictures Inc., Carolco International N.V. and "Sound Source Unlimited, Inc.," pertaining to the motion picture, "Total Recall." Previously filed. 10.28 Merchandising License Agreement, dated as of October 30, 1992, among Carolco Pictures Inc., Carolco International N.V. and "Sound Source Unlimited, Inc.," pertaining to the motion picture, "Terminator 2: Judgment Day." Previously filed. 10.29 License Agreement, dated as of September 20, 1994, between Palladium Limited Partnership and "Sound Source Interactive," pertaining to the motion picture, "Lassie." Previously filed. 10.30 License Agreement, dated as of September 20, 1994, between Broadway Video Entertainment and "Sound Source Interactive," pertaining to the television series, "Saturday Night Live." Previously filed. 10.31 Merchandising License Agreement, dated as of October 12, 1995, between DESILU, TOO, CBS and "Sound Source Interactive," pertaining to the television series, "I Love Lucy." Previously filed. 10.32 Memorandum of Understanding, dated May 26, 1994, between Brian Leader, doing business as Sentient Software, and "Sound Source Interactive, Inc.," pertaining to program development and licensing agreements related to MOVIEBOOKS-TM-. Previously filed. -3-
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Registration Statement on Form SB-2 Exhibit Volume Index Exh. Sequential No. Description of Exhibits Page No. ----- ----------------------- ---------- 10.33 (a) Royalty Programming Contract, dated July 12, 1993, between Rhode Island Soft Systems ("RISS") and the Subsidiary, pertaining to screen saver modules. Previously filed. (b) Amendment to Royalty Programming Contract, dated September 12, 1994, between RISS and the Subsidiary. Previously filed. (c) Agreement, dated April 12, 1995, between RISS and "Sound Source Interactive," pertaining to MOVIEBOOKS-TM-. Previously filed. (d) Letter of Intent, dated August 24, 1995, between RISS and "Sound Source Interactive," pertaining to MOVIEBOOKS-TM-. Previously filed. 10.34 Merchandising License Agreement, dated September 1, 1995, between Greytsounds Sound Development and "Sound Source Interactive," pertaining to Registrant's Sound Library. Previously filed. 10.35 Indemnification Agreement, dated as of January 1, 1996, between the Company and Vincent J. Bitetti. Filed herewith. 10.36 Indemnification Agreement, dated as of January 1, 1996, between the Company and Eric H. Winston. Filed herewith. 10.37 Indemnification Agreement, dated as of January 1, 1996, between the Company and Ulrich Gottschling. Filed herewith. 10.38 Merchandising License Agreement, dated October 24, 1995, between MCA/Universal Merchandising, Inc. and "Sound Source Interactive," pertaining to the motion picture, "Dragonheart." Filed herewith. 10.39 Merchandising License Agreement, dated January 10, 1996, between MCA/Universal Merchandising, Inc. and "Sound Source Interactive," pertaining to the motion pictures, "The Land Before Time" (I, II and III). Filed herewith. 10.40 Agreement, dated March 18, 1996, between Musicians' Union and "Sound Source Interactive," pertaining to the use of music from the motion pictures, "The Land Before Time" (I, II and III). Filed herewith. 10.41 License Agreement, dated February 27, 1996, between MGM/UA Merchandising, Inc. and Subsidiary, pertaining to the motion picture, "All Dogs Go To Heaven 2." Filed herewith. 10.42 Agreement, dated January 4, 1996, between Universal Studios Florida and "Sound Source Interactive," pertaining to the "Universal Studios Florida T2 Screensaver Sweepstakes." Filed herewith. 10.43 Agreement, dated January 24, 1996, between Warner Bros. Television and "Sound Source Interactive," pertaining to the "Babylon 5 Contest." Filed herewith. 10.44 Form of Registration Procedures Agreement for execution between the Company and each of the Selling Security Holders. Filed herewith. 10.45 Consulting Agreement, dated as of April 30, 1996, between the Company and ASSI, Inc. Filed herewith. 10.46 Share Purchase Agreement, dated April 3, 1995, between Eric Winston and Vincent Bitetti. Filed herewith. 21.1 Subsidiary of the Registrant. Previously filed. 23.1 Consent of Corbin & Wertz. Filed herewith. -4-

Dates Referenced Herein   and   Documents Incorporated by Reference

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9/30/056465
12/31/017211310-Q
9/1/0173
12/31/0011310QSB
8/31/00103
9/15/981962
8/31/98103
10/9/9763
9/30/976311510QSB
3/31/97445710QSB,  SB-2
12/31/967211410QSB
9/1/9613113
6/30/961711510KSB40,  10KSB40/A
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