-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, EOEWMU32HXp9eiNpFxFi4lcxZtaW9fhWnOOdOCPH7vzmzQvoVP1lAZU3Q7c8bJh/ 9MND8+S3Pzy0ZsoIn25kWw== /in/edgar/work/20000609/0000944209-00-001010/0000944209-00-001010.txt : 20000919 0000944209-00-001010.hdr.sgml : 20000919 ACCESSION NUMBER: 0000944209-00-001010 CONFORMED SUBMISSION TYPE: S-1/A PUBLIC DOCUMENT COUNT: 8 FILED AS OF DATE: 20000609 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FUTURE MEDIA PRODUCTIONS CENTRAL INDEX KEY: 0001069003 STANDARD INDUSTRIAL CLASSIFICATION: [3652 ] IRS NUMBER: 954486758 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: S-1/A SEC ACT: SEC FILE NUMBER: 333-32444 FILM NUMBER: 652845 BUSINESS ADDRESS: STREET 1: FUTURE MEDIA PRODUCTIONS INC STREET 2: 25136 ANZA DRIVE CITY: VALENCIA STATE: CA ZIP: 91355 BUSINESS PHONE: 8052945575 MAIL ADDRESS: STREET 1: FUTURE MEDIA PRODUCTIONS INC STREET 2: 25136 ANZA DRIVE CITY: VALENCIA STATE: CA ZIP: 91355 S-1/A 1 0001.txt AMENDMENT NO. 2 TO FORM S-1 As filed with the Securities and Exchange Commission on June 9, 2000 Registration No. 333-32444 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 --------------- AMENDMENT NO. 2 TO FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 --------------- FUTURE MEDIA PRODUCTIONS, INC. (Exact Name of Registrant as Specified in its Charter)
California 3652 95-4486758 (State or Other Jurisdiction of (Primary Standard Industrial (I.R.S. Employer Incorporation or Organization) Classification Code Number) Identification No.)
--------------- 24811 Avenue Rockefeller Valencia, California 91355 (661) 294-5575 (Address, Including Zip Code, and Telephone Number, Including Area Code, of Registrant's Principal Executive Offices) --------------- ALEX SANDEL, President Future Media Productions, Inc. 24811 Avenue Rockefeller Valencia, California 91355 (661) 294-5575 (Address, Including Zip Code, and Telephone Number, Including Area Code, of Agent for Service) --------------- Copies to: Murray Markiles, Esq. Robert K. Montgomery, Esq. Scott D. Galer, Esq. Anton W. Leung, Esq. Phillip Gharabegian, Esq. Gibson, Dunn & Crutcher LLP Troop Steuber Pasich Reddick & 2029 Century Park East Tobey, LLP Los Angeles, California 90067 2029 Century Park East (310) 552-8500 Los Angeles, California 90067 (310) 728-3000 --------------- 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 in 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. [_] If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_] If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_] If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_] If the delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. [_] --------------- CALCULATION OF REGISTRATION FEE - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
Proposed Maximum Title of Each Class of Aggregate Amount of Securities to be Registered Offering Price(1) Registration Fee - -------------------------------------------------------------------------------- Common Stock, no par value................... $70,000,000 $18,480
- -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- (1) Estimated solely for the purpose of calculating the registration fee, pursuant to Rule 457(o) under the Securities Act of 1933. --------------- 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 the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ +The information in this prospectus is not complete and may be changed. Future + +Media may not sell these securities until the registration statement filed + +with the Securities and Exchange Commission is effective. This prospectus is + +not an offer to sell these securities and it is not soliciting an offer to + +buy these securities in any state where the offer or sale is not permitted. + ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ SUBJECT TO COMPLETION-JUNE 9, 2000 PROSPECTUS - -------------------------------------------------------------------------------- 4,685,185 Shares [LOGO OF FUTURE MEDIA PRODUCTIONS] Common Stock - -------------------------------------------------------------------------------- Future Media is offering 4,685,185 shares and the selling shareholders are offering 500,000 shares of common stock in an initial public offering. Prior to this offering, there has been no public market for Future Media's common stock. Future Media will not receive any proceeds from the sale of shares by the selling shareholders. Future Media is an independent manufacturer/replicator of Digital Versatile Discs (DVDs) and Compact Discs (CDs). Future Media targets its sales to companies in industries including Internet/online, film and entertainment, edutainment software, publishing and computer hardware. It is anticipated that the public offering price will be between $12 and $15 per share. Application has been made to include the common stock for quotation in the Nasdaq National Market under the symbol "FMPI".
Per Share Total Public offering price........................................ $ $ Underwriting discounts and commissions....................... $ $ Proceeds, before expenses, to Future Media................... $ $ Proceeds to selling shareholders............................. $ $
See "Risk Factors" on pages 8 to 13 for factors that should be considered beforeinvesting in the shares of Future Media. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Neither the Securities and Exchange Commission nor any state securities commission hasapproved or disapproved of these securities or passed upon the accuracy or adequacy of thisprospectus. Any representation to the contrary is a criminal offense. - -------------------------------------------------------------------------------- The underwriters may purchase up to 777,777 additional shares from Future Media at the public offering price, less underwriting discounts and commissions. Delivery of the shares will be on , 2000. Prudential Volpe Technology CIBC World Markets a unit of Prudential Securities , 2000 Description of Photographs: . Photographs of Future Media's headquarters, mastering facility, replication machines and printing machines. . Collage of manufactured DVDs and CDs. TABLE OF CONTENTS
Page ---- Prospectus Summary.................. 4 Risk Factors........................ 8 Forward-Looking Statements.......... 13 Termination Of S Corporation Status............................. 14 Use Of Proceeds..................... 15 Dividend Policy..................... 15 Dilution............................ 16 Capitalization...................... 17 Selected Financial Data............. 18 Management's Discussion and Analysis Of Financial Condition and Results Of Operations...................... 20 Industry Overview................... 28 Page ---- Business............................ 30 Management.......................... 40 Related Party Transactions.......... 46 Principal and Selling Shareholders.. 49 Description Of Capital Stock........ 50 Shares Eligible For Future Sale..... 52 Underwriting........................ 53 Legal Matters....................... 55 Experts............................. 55 Where You Can Find More Information........................ 55 Index To Financial Statements....... F-1
- -------------------------------------------------------------------------------- You should rely only on the information contained in this prospectus. We have not authorized anyone to provide you with information different from that contained in this prospectus. We are offering to sell, and seeking offers to buy, shares of common stock only in jurisdictions where offers and sales are permitted. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of our common stock. PROSPECTUS SUMMARY This summary highlights information contained elsewhere in this prospectus. This summary may not contain all of the information you should consider before investing in the common stock of Future Media. You should read the entire prospectus carefully. Future Media We are an independent manufacturer/replicator of Digital Versatile Discs (DVDs) and Compact Discs (CDs). We target our sales to companies in industries including Internet/online, film and entertainment, edutainment software, publishing and computer hardware. Our major customers include America Online, Inc., Modus Media International Holdings, Inc., and Havas Interactive, Inc., each of which accounted for more than 10% of our net sales for the year ended December 31, 1999. We have successfully implemented our business model, which consists of the following elements: . High volume customers: We believe our customer base is comprised of some of the highest volume customers of DVDs and CDs, often requiring production runs in excess of 25,000 units. . High replication capacity: Since inception we have continued to add new equipment and believe we are one of the largest, in terms manufacturing capacity, independent manufacturers/replicators of DVDs and CDs in the United States. . Low cost structure: We achieve economies of scale through our optimally designed facility at a single locale, our dedication to maximizing machine uptime and our flat organizational structure. . Superior turnaround service: We are dedicated to providing superior turnaround service, as short as a few hours, by maintaining high throughput mastering technologies and high DVD/CD graphic printing capacity and by efficiently managing operational workflow. To implement our business model, we have developed a focused operating approach founded on the following key principles: . High capacity manufacturing capabilities at a single locale; . Optimally designed manufacturing facilities; . Self sufficient repair, maintenance and engineering capabilities; . Technologically advanced manufacturing equipment; and . Marketing our services directly to senior management. We believe that our focused operating approach distinguishes us from our competitors. We also believe that the effectiveness of our operating approach has been proven through the growth in our targeted customer base, the retention of our customers and our demonstrated long-term financial performance. To foster our continued growth in line with our business model, we plan to pursue the following opportunities: . Capitalize on the continuing growth of the DVD market; . Expand our position as a low cost CD manufacturer within the Internet/online, film and entertainment, edutainment software, publishing and computer hardware industries; and . Actively stimulate new CD replicating business through targeted Internet related marketing programs. We are a California corporation. Our executive offices are located at 24811 Avenue Rockefeller, Valencia, California 91355, and our telephone number is (661) 294-5575. 4 The Offering Shares offered by Future Media................ 4,685,185 shares Shares offered by the selling shareholders.... 500,000 shares Total shares outstanding after this offering.. 19,535,185 shares Use of proceeds by Future Media............... To repay all existing debt, to purchase capital equipment, to distribute retained earnings including an amount for the purpose of paying income taxes on our 2000 S Corporation earnings to our existing shareholders, and for general corporate purposes, including potential strategic investments. Proposed Nasdaq National Market symbol........ FMPI
All information in this prospectus has been adjusted to give effect to a 1.65 for 1 stock split approved by the board of directors on April 13, 2000. Also, except as otherwise noted, all information in this prospectus regarding the number of outstanding shares of common stock does not include: . 777,777 shares that the underwriters may purchase if they exercise their over-allotment option; . 3,250,000 shares of common stock available for issuance pursuant to our stock incentive plans, of which 1,598,350 shares were subject to outstanding options as of the date of this prospectus; . 604,890 shares of common stock issuable upon exercise of warrants issued to David Moss, our Vice President-Operations, at an exercise price of $0.0010 per share; and . 25,000 shares of common stock issuable upon exercise of warrants issued to Levy, Small & Lallas, at an exercise price equal to the initial public offering price. 5 Summary Selected Financial and Other Data (in thousands, except for per share and employee data) The following table summarizes certain selected financial and operating data contained in the financial statements and elsewhere in this prospectus.
Three Months Year Ended December 31 Ended March 31 ------------------------------------------- ---------------- 1995 1996 1997 1998 1999 1999 2000 ------- ------- ------- ------- ------- ------- ------- (unaudited) Statement of Income Data: Net sales............... $26,972 $25,814 $36,042 $43,311 $53,002 $ 8,675 $14,780 Cost of goods sold...... 14,821 11,972 23,132 27,304 31,938 5,865 9,342 ------- ------- ------- ------- ------- ------- ------- Gross profit............ 12,151 13,842 12,910 16,007 21,064 2,810 5,438 Selling, general and administrative expenses............... 6,093 2,537 4,214 4,232 4,201 1,072 1,593 Other general and administrative expense--stock related compensation(1)........ -- -- -- 3,055 720 -- -- Abandoned offering costs.................. -- -- -- 676 -- -- -- ------- ------- ------- ------- ------- ------- ------- Income from operations.. 6,058 11,305 8,696 8,044 16,143 1,738 3,845 Interest income......... 12 252 42 35 1 -- 8 Interest expense........ (957) (1,108) (818) (1,264) (1,404) (351) (399) Loss in equity of unconsolidated entity.. -- -- -- -- -- -- (155) Change in accounting estimate for royalties(2)........... -- 3,770 -- -- -- -- -- ------- ------- ------- ------- ------- ------- ------- Income before state income taxes........... 5,113 14,219 7,920 6,815 14,740 1,387 3,299 Provision for state income taxes........... 72 223 120 102 2 1 1 ------- ------- ------- ------- ------- ------- ------- Net income.............. $ 5,041 $13,996 $ 7,800 $ 6,713 $14,738 $ 1,386 $ 3,298 ======= ======= ======= ======= ======= ======= ======= Earnings per share: Basic.................. $ 0.34 $ 0.94 $ 0.53 $ 0.45 $ 0.99 $ 0.09 $ 0.22 ======= ======= ======= ======= ======= ======= ======= Diluted................ $ 0.34 $ 0.94 $ 0.53 $ 0.43 $ 0.92 $ 0.09 $ 0.20 ======= ======= ======= ======= ======= ======= ======= Shares used in computing earnings per share Basic.................. 14,850 14,850 14,850 14,850 14,850 14,850 14,850 ======= ======= ======= ======= ======= ======= ======= Diluted................ 14,850 14,850 14,850 15,672 16,026 15,859 16,124 ======= ======= ======= ======= ======= ======= ======= Pro Forma Statement of Income Data (unaudited)(3): Income before provision for income taxes....... $14,740 $ 3,299 Pro forma income tax provision.............. 5,896 1,320 ------- ------- Pro forma net income.... $ 8,844 $ 1,979 ======= ======= Pro forma basic earnings per share.............. $ 0.55 $ 0.12 ======= ======= Pro forma diluted earnings per share..... $ 0.52 $ 0.11 ======= ======= Weighted average shares outstanding--basic..... 16,200 16,200 ======= ======= Weighted average shares outstanding--diluted... 17,136 17,435 ======= ======= Other Data: Capital expenditures.... $ 6,277 $ 1,585 $ 3,642 $ 6,752 $15,226 $ 1,456 $ 5,266 Depreciation and amortization........... 1,053 1,389 1,950 2,861 4,368 897 1,150 Number of full-time employees at period end.................... 44 57 75 92 127 92 140
6
March 31, 2000 -------------------------------- Pro Actual Pro Forma As (unaudited) Forma(4) Adjusted(5) ----------- -------- ----------- Balance Sheet Data: Current assets................................. $ 5,020 $ 5,320 $33,141 Property and equipment, net.................... 34,874 34,874 34,874 Total assets................................... 45,503 45,803 73,624 Current liabilities............................ 20,161 34,850 12,206 Long-term debt, less current portion........... 7,399 7,399 -- Total shareholders' equity..................... 17,817 387 57,710
- -------- (1) On January 1, 1998, we granted warrants to purchase 604,890 shares of common stock at an exercise price of $0.0010 per share to David Moss, our Vice President--Operations. These warrants expire on December 31, 2007. In connection with the grant of these warrants, we recognized compensation expense of $3,055,000 in 1998 representing the excess of the estimated fair value of the shares over the exercise price. In 1999 our existing shareholders committed to give 49,500 shares of their stock to a director for services to us. For the year ended December 31, 1999 we recorded stock related compensation expense of $720,000 for this commitment, based upon the estimated fair value of the shares to be given. On April 13, 2000 we granted 25,000 warrants to purchase common stock at an exercise price equal to the initial public offering price to the law firm of Levy, Small & Lallas for legal services provided to us in connection with this offering. These warrants will be issued and vest only upon the close of this offering and expire one year from the close of this offering. (2) We executed license agreements with two developers of CD technology effective June 1, 1996 and October 1, 1996, respectively. The agreements set forth royalty rates payable to the licensors for the license to manufacture and sell CDs. We reached settlements totaling $70,000 for CD sales occurring before the effective dates of the agreements. Because of the settlement amounts, our prior estimates of royalty liabilities were overstated by approximately $3,770,000 (of which $300,000 related to 1994 and $3,470,000 related to 1995) and the adjustment to the accruals was made in 1996. The original estimates for royalty liabilities were recorded in cost of sales in 1994 and 1995. (3) We have been exempt from paying federal income taxes and have paid certain state income taxes at a reduced rate because of our S Corporation status. Upon the completion of this offering, our S Corporation status will terminate. Pro forma statement of income data reflect the income tax expense recordable had we not been exempt from paying taxes under the S Corporation election. Because of the termination of our S Corporation status, we will be required to record a one-time, non-cash charge against historical earnings for additional deferred taxes based upon the increase in the effective tax rate from our S Corporation status (1.5%) to C Corporation status (approximately 40%). This charge will occur in the quarter during which our S Corporation status is terminated. If this charge was recorded at March 31, 2000, the amount would have been approximately $2.7 million. (4) The pro forma balance sheet reflects (i) an accrual for the distribution of retained earnings of approximately $14.7 million to our current shareholders, including an amount totaling approximately $7.9 million for the purpose of paying income taxes on S Corporation earnings and (ii) the recording of additional deferred taxes of approximately $2.7 million based on the increase in the effective tax rate upon our anticipated change from an S Corporation to a C Corporation. (5) Adjusted for pro forma adjustments discussed above and to give effect to the receipt and application of the estimated net proceeds of this offering, including a deduction of $472,500 to be paid to Averil Capital Markets Group, Inc., a company controlled by one of our directors upon the closing of this offering, payment of the accrual for distribution of our retained earnings of approximately $14.7 million to our current shareholders and the repayment of existing bank debt of which approximately $6.7 million is included in current liabilities. 7 RISK FACTORS You should carefully consider the following risk factors, in addition to the other information in this prospectus, before purchasing shares of our common stock. Each of these risk factors could adversely affect our business, operating results and financial condition as well as adversely affect the value of an investment in our common stock. Risks Related to Our Business We do not have long-term purchase contracts with our customers and therefore our customers could stop doing business with us at any time. Generally, we do not have agreements with our customers that contain purchase commitments or guarantees for an ongoing business relationship. Accordingly, our customers could stop doing business with us at any time and we cannot guarantee an ongoing business relationship with our customers. Since we operate with virtually no backlog, if a customer stops doing business with us, we may not be able to replace the lost business with business from another existing client or a new client. To the extent we are unable to replace the business, some of our capacity would go unused, our revenues could decline and our results of operations may be adversely affected. Our focus on high volume customers results in customer concentration and increases the likelihood that losing a single customer would have an adverse impact on our revenues and results of operations. As part of our business model, we seek to replicate DVDs and CDs for high volume customers to reduce our marginal production costs. This strategy results in customer concentration and has inherent risks. For example, our top three customers, America Online, Inc., Modus Media International Holdings, Inc., and Havas Interactive, Inc. accounted for approximately 56% of our net sales for the year ended December 31, 1999. If we lose any of our large customers, our revenues may be reduced and our operating results may be adversely impacted. Additionally, the merger between America Online, Inc. and Time Warner may result in the diversion of some replication business from us to Time Warner's internal DVD and CD manufacturing operations. If DVD and/or CD prices decline, our revenues and margins may be reduced and our operating results may be adversely impacted. Since the introduction of CD media in 1982, there has been a significant growth in the CD replicating business, which has attracted numerous entrants and resulted in increased worldwide CD production capacity. As a result of this increased competition, wholesale CD prices have historically declined. If CD prices decline further we may not be able to reduce our costs or increase our volume to offset the decline in price. Additionally, if the acceptance of the DVD medium continues to grow, the DVD replicating business may attract new entrants, which may result in an increased worldwide DVD production capacity. As a result, wholesale DVD prices may decline and we may not be able to reduce our costs or increase our volume to offset the decline in price. These pricing pressures in the DVD and CD replication business could reduce our revenues and margins, which would adversely impact our operating results. We may not succeed in developing a substantial DVD customer base, which would adversely impact our growth strategy. We commenced our DVD production in the fourth quarter of 1999. Our growth strategy depends in part on our ability to attract additional DVD customers. We believe motion picture producers and distributors, computer hardware manufacturers and producers of computer software and games will primarily drive DVD sales. Although we plan to expand our customer relationships, we will be competing for DVD business with captive DVD manufacturers of major motion picture companies and we may not be successful in attracting additional DVD customers. 8 We may experience operational downtime if we are forced to move production to another facility. Since our business model is based on operating replicating facilities at a single geographic locale to achieve efficiencies associated with high volume, we will not be able to move production quickly to another facility if we experience operational downtime or capacity reduction. Earthquakes, power outages, or other events outside of our control could cause such operational downtime or capacity reduction. Any operational downtime or capacity reduction could result in the loss of major orders or customers and have a disproportionate adverse impact on our business, financial condition and results of operation. We substantially depend upon our key personnel and they would be difficult to replace. We depend on our executive officers for our success and the loss of any of these officers or key employees could disrupt our business. We depend on our key executives, including Alex Sandel, who is our Chief Executive Officer and David Moss, who is our Vice President--Operations. In addition to his management duties, Mr. Sandel also plays a key role in our sales and marketing efforts. We have entered into an employment agreement with Mr. Moss. In addition, we have purchased $3 million of "key person" life insurance on each of Messrs. Sandel and Moss, of which we are the sole beneficiary. However, in the event of the death of either of these executive officers, the proceeds of such insurance may not be sufficient to offset our loss. Because our operating results may fluctuate and are unpredictable from quarter to quarter, our share price may be adversely affected. Our net sales, net income and results of operations have fluctuated from quarter to quarter, and we expect these fluctuations to continue in the future because of many factors, including: . seasonal pattern of certain of the businesses we serve; . timing of new product releases by our customers; . commercial success of products offered by our customers; . timing of expenses incurred to obtain and support new business; and . general changes in economic and industry conditions. The demand for DVDs and CDs is usually highest in the second half of the year concurrent with the new school year and holiday gift purchases. This seasonality could result in significant quarterly variations in financial results, with the third and fourth quarters generally being the strongest. Additionally, we anticipate that demand for DVDs will be somewhat dependent on the timing of motion picture releases, with DVDs typically being released six months following the theatrical release of a motion picture. We may not be able to adequately reduce our costs on a timely basis if our revenues do not meet expectations in any given quarter. In addition, historically our product mix has been more heavily weighted to lower margin customers in the first six months of each year. If our results of operations for any period fall below the expectations of securities analysts or investors, the price of our common stock could decline. We heavily rely on our customers in the Internet and computer software industries and our operations could be impaired if demand from such industries drops. For the quarter ended March 31, 2000, approximately 78% of our net sales were to Internet service providers and computer software companies. We are dependent upon the continued growth and financial stability of the Internet and computer software industries, which may be affected by changes in any of the following: . economic conditions; . consumer trends and preferences; . sales of personal computers; . the installed base of CD-ROM and DVD drives in computers; and . sales of interactive game consoles. 9 Our sales are also dependent upon the ability of software publishers to create commercially successful content and Internet service providers continuing to market their services through the mass distribution of CDs. If we do not respond to technological change, we could lose customers and our services could become obsolete. The industries in which we compete are characterized by rapidly changing technologies. We may not be able to successfully adapt our manufacturing processes to new technologies. Additionally, we may not have the financial resources to make the capital expenditures necessary for such adaptations or be able to generate sufficient sales to recover these capital expenditures. If we fail to keep pace with rapidly changing industry technology, we will be at a competitive disadvantage and could lose customers. In addition, the electronic delivery of information through such means as the Internet or broadband online data delivery are potential future competitors of DVD and CD technology. Such technologies could potentially cause a significant shift from the utilization of DVDs and CDs to broadband and other online delivery mechanisms and render DVDs and CDs obsolete. In addition, it is possible that as the demand for DVDs increases the demand for CDs will decrease. Our future performance and profitability could be impaired if we are unable to manage growth. Our future performance and profitability will depend on a number of factors, including our ability to obtain production machinery, and recruit, motivate and retain qualified personnel. In addition, our performance will depend on whether we are able to implement enhancements to our operational and financial systems, including our reporting obligations for being a public company. Moreover, our management and our administrative and financial resources may face significant demands resulting from any future expansion, whether internally or through acquisitions. If we are unable to compete successfully against current and future competitors our revenues and operating results could be impaired. The DVD and CD replication industries are highly competitive. Our primary competitors include the following DVD and/or CD replication companies: AmericDisc; Carlton Communications PLC; Cinram International, Inc.; Denon Electronics, Inc.; Disctronics, Inc.; DOCdata N.V.; JVC Corporation; and Zomax Optical Media, Inc. A number of these companies can handle large volume requirements and offer services not currently offered by us. In addition to the above listed companies, we compete with foreign manufacturers that can operate at lower costs. To a limited extent, we compete with large captive manufacturing divisions of major music and entertainment companies. Many of our existing competitors and future potential competitors may be larger and more established and have greater financial and other resources. As a result, such competitors may respond more quickly than us to market demands or devote greater resources to the manufacture, promotion and sale of their products. Price increases and shortages of raw materials could adversely affect the volume of our sales and our profitability. We use raw materials, such as plastic and oil, in our DVD and CD manufacturing and replicating process. Although we have not experienced any material shortages in raw materials, if a shortage of raw materials were to occur, our costs could increase and we may have to delay shipments, and in either case our operating results would be adversely affected. We also depend on a small number of suppliers for many of the raw materials that we use in our business. If we were unable to continue to purchase these raw materials from our suppliers, our operating results would be adversely affected. 10 We heavily depend on licenses for DVD and CD technology and we may not be successful in obtaining and maintaining such licenses. We could incur significant loss of revenues if we are unable to obtain and maintain such licenses. We cannot guarantee that we will successfully obtain and maintain licenses for the patented technology we use. We manufacture CDs using patented technology primarily under nonexclusive licenses from U.S. Philips Corporation and Discovision Associates. These CD licenses generally provide for the payment of royalties based upon the number, type and size of CDs sold. Our license from Discovision Associates continues until the last patent covered by such license expires and our license from U.S. Philips Corporation continues until the earlier of October 1, 2006 or the expiration of the last patent covered by such license. In order to manufacture/replicate DVDs we must obtain licenses from U.S. Philips Corporation and Sony Corporation for certain patented DVD technology. We have entered into nonexclusive DVD licenses with U.S. Philips Corporation, which continue until October 1, 2009. Additionally, we believe we have finalized a nonexclusive DVD licensing agreement with Sony Corporation to use Sony Corporation's patented DVD technology. We are currently awaiting the receipt of the executed copy of this DVD licensing agreement with Sony Corporation. These DVD licenses generally provide for the payment of royalties based upon the number and type of DVDs sold. We cannot assure you neither we nor our licensors will not be sued for patent infringement and have to stop using the licensed technologies. Our operating results could be impaired by current or future environmental regulation and other legal uncertainties. Since the DVD and CD manufacturing processes involve the use of hazardous materials, we are subject to federal, state and local regulations governing the storage, use and disposal of hazardous materials. Our liability in the event of an accident or the cost of clean-up could exceed our resources or insurance coverage. Also, we may have to incur substantial expenditures as a result of environmental regulations adopted in the future, including having to engage in preventive or remedial action, having to reduce chemical exposure or dealing with waste treatment or disposal. Risks Related to this Offering and Our Common Stock The rights of our shareholders could be adversely affected because our founders control us. Upon completion of this offering, two of our founders can elect or remove all members of the board of directors and thereby control our affairs and management. Moreover, upon completion of this offering, these two founders, Alex Sandel and Jason Barzilay, will beneficially own approximately 74% (71% if the underwriters' over-allotment option is exercised in full) of our outstanding shares. As a result of such ownership, these founding shareholders, acting together, can determine the outcome of elections and other matters presented to our shareholders for approval. Such concentration of ownership may cause any of the following: . delay, defer or prevent a change in our control; . adversely affect the voting and other rights of our other shareholders; and . depress the price of our common stock. Purchasers in this offering will experience immediate and substantial dilution. If you purchase our common stock upon completion of this offering, you will experience an immediate and substantial dilution in that you will pay a price per share of common stock that substantially exceeds the value of our assets after subtracting our liabilities. In addition, you will have contributed 100% of the total to fund Future Media, but will only own 24.0% of the outstanding shares. If outstanding stock options and warrants are exercised then you will experience additional dilution. 11 Our stock price could fluctuate and we cannot assure you that the shares offered pursuant to this offering will trade at market prices in the range of the initial public offering price. The initial public offering price does not necessarily bear any relationship to our book value, assets, past operating results, financial condition or any other established criteria of value. The initial public offering price of the shares of our common stock is negotiated with the selling shareholders and the underwriters. The trading price of our common stock could be subject to wide fluctuations in response to any of the following: . variations in our operating results; . announcements relating to our business (including new product introductions by us or by our competitors); . technological trends; . securities analysts changing financial estimates; . changes in the stock price or operating performance of other companies investors may deem comparable to us; . changes in general economic conditions or the financial markets; and . changes in the manufacturing or retail industries. Sales of additional shares of our common stock into the public market may cause our stock price to fall. Upon completion of this offering, we will have 19,535,185 shares of common stock outstanding, 20,312,962 shares if the underwriters' over-allotment option is exercised in full. Of those 19,535,185 shares, a total of 5,185,185 shares, 5,962,962 shares if the underwriters exercise their over-allotment option in full, will be freely tradeable without restriction or further registration under the Securities Act of 1933, as amended, unless purchased or held by our affiliates as that term is defined in Rule 144 under the Securities Act. Pursuant to Rule 144, sales of common stock by our affiliates are subject to the volume limitations, manner of sale, and notice requirements. All of our executive officers, directors, shareholders, including the selling shareholders, and Averil Capital Markets Group, Inc. will execute lock-up agreements under which they will agree to not sell or otherwise transfer, directly or indirectly, any shares of common stock or any securities convertible into, or exercisable or exchangeable for, any shares of common stock for a period of 180 days (or one year, in the case of Averil Capital Markets Group, Inc.) after the date of this prospectus without the prior written consent of Prudential Securities Incorporated, on behalf of the underwriters. After the expiration of the 180-day period (or one year, in the case of Averil Capital Markets Group, Inc.), shares that can be sold under Rule 144 will be eligible for sale. Prudential Securities Incorporated may, in its sole discretion, at any time and without notice, release all or any portion of the shares of our common stock subject to these lock-up agreements. Sales of substantial amounts of our common stock in the public market, or the perception sales could occur, could adversely affect the prevailing market price for the common stock and could impair our ability to raise capital through a public offering of equity securities.
Number of shares Date of eligibility for resale into public market ---------------- ------------------------------------------------- 14,850,000 180 days after the date of this prospectus due to a lock-up agreement our two existing shareholders have with Prudential Securities Incorporated. 1 year after the date of this prospectus due to a lock-up agreement Averil Capital Markets Group, Inc. has with Prudential Securities Incorporated.
12 Provisions in our charter documents could deter takeover efforts or depress our stock price. Provisions of our Articles of Incorporation, Bylaws and California law could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our shareholders. The rights of the holders of common stock will be subject to, and may be adversely affected by, the rights of the holders of any preferred stock issued in the future. Our board of directors has the authority to issue up to 10,000,000 shares of preferred stock and to determine the price, rights, preferences, privileges and restrictions, including voting rights, of those shares without any further vote or action by our shareholders. Following this offering, we will not have any shares of preferred stock outstanding and we have no present intention to issue any shares of preferred stock. However, preferred stock could be issued with voting, liquidation, dividend and other rights superior to those of the common stock. An issuance of preferred stock could make it more difficult for a third party to acquire a majority of our outstanding voting stock, which may depress the market value of our common stock. Provisions of our Articles of Incorporation make it difficult for minority shareholders to obtain representation on the board of directors. Our Articles of Incorporation and California law provide cumulative voting rights of shareholders, which cease at such time we have 800 or more holders of our common stock as of the record date of our most recent annual meeting of shareholders. This provision has the effect of making it more difficult for minority shareholders to obtain representation on the board of directors once we have 800 or more shareholders. FORWARD-LOOKING STATEMENTS This prospectus includes forward-looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends affecting the financial condition of our business. These forward-looking statements are subject to a number of risks, uncertainties and assumptions about us, including, among other things: . general economic and business conditions, both nationally and in our markets; . our expectations and estimates concerning future financial performance, financing plans and the impact of competition; . anticipated trends in our business; . existing and future regulations affecting our business; . successful implementation of our business strategy; . our relationship with large customers; . fluctuations in our operating results; . increasing adoption of alternative data delivery systems; . technological trends in the DVD and CD industries; and . other risk factors described under "Risk Factors" in this prospectus. In addition, in this prospectus, the words "believe," "may," "will," "estimate," "continue," "anticipate," "intend," "expect" and similar expressions, as they relate to us, our business or our management, are intended to identify forward-looking statements. Because of these risks and uncertainties, the forward-looking events and circumstances discussed in this prospectus may not occur and actual results could differ materially from those anticipated or implied in the forward- looking statements. 13 TERMINATION OF S CORPORATION STATUS We have been treated as an S Corporation since our inception. As a result, our shareholders have been directly taxed on our earnings for federal income tax purposes instead of us. Other than a tax imposed on S Corporations by the State of California (currently 1.5% of income), our shareholders have also been responsible for state income taxes on earnings. Such taxation of our shareholders will continue through the date immediately preceding the date of termination of our S Corporation status. The termination date will occur immediately prior to the closing of this offering. On the termination date, we will become a C Corporation for tax purposes and be subject to federal and state corporate income taxes. From January 1, 2000 through the date of this prospectus we paid an aggregate of approximately $9.1 million in dividends to our shareholders for the purpose of paying S Corporation taxes for 1998 and 1999. Out of the proceeds of this offering, we expect to pay approximately $9.3 million in dividends to our shareholders, including approximately $1.8 million for the purpose of paying S Corporation taxes. Pursuant to our current loan agreement with Greyrock, we may not declare or pay any dividends or make any distribution without the prior written consent of Greyrock, except for distributions to existing shareholders for the purpose of paying income taxes on our S Corporation earnings. We have entered into a tax indemnification agreement with our existing shareholders relating to their respective income tax liabilities. The tax indemnification agreement is intended to assure we assume the taxes relating to the income we receive while we are a C Corporation and our existing shareholders assume the taxes relating to the income they received while we were an S Corporation. We will indemnify our existing shareholders if there is a final determination that they owe more taxes for a period when we were an S Corporation and such determination results in a current or future decrease in the taxes that we owe. We will also indemnify the existing shareholders for all taxes imposed upon them as the result of their receipt of an indemnification payment under the tax indemnification agreement. On the other hand, our existing shareholders will indemnify us if there is a final determination that reduces their tax liability for a period when we were an S Corporation, but increases our tax liability as a C Corporation. Any payment made by us to the existing shareholders pursuant to the tax indemnification agreement may be considered by the Internal Revenue Service or state taxing authorities to be non-deductible by us for income tax purposes. The tax indemnification agreement will continue in effect until the expiration of the relevant statutes of limitations with respect to the tax periods covered by the agreement. 14 USE OF PROCEEDS The net proceeds to us from this offering, at an assumed initial public offering price of $13.50 per share, are estimated to be approximately $57.3 million, $67.1 million if the underwriters' over-allotment option is exercised in full, after deducting the underwriting discounts and commissions and estimated offering expenses of $1,500,000. We expect to use a portion of the net proceeds to repay all existing bank debt to Greyrock Capital, a division of Banc of America Commercial Finance Corporation, in an amount estimated to be approximately $28.4 million at closing. The bank debt was used to purchase capital equipment, to pay a distribution to the existing shareholders and for general corporate purposes. The existing shareholders have personally guaranteed repayment of the bank debt and upon repayment of the loan from Greyrock, the shareholder guarantees will terminate. We also expect to use approximately $14.1 million to purchase capital equipment. We also plan to distribute $9.3 million to our existing shareholders as a distribution of the retained earnings through the closing of this offering, including an amount of approximately $1.8 million for the purpose of paying income taxes on our S Corporation earnings. Upon the closing of this offering we plan to pay $472,500 to Averil Capital Markets Group, Inc., for services rendered in connection with this offering. Averil Capital Markets Group, Inc., is a financial advisory firm founded and controlled by Diana Maranon, who is one of our directors. This amount has been deducted from the net proceeds of the offering in the calculation above. NASD members, affiliates, associated persons and related persons will not be paid, in the aggregate, ten percent (10%) or more of the gross proceeds of this offering (through repayment of debt or otherwise.) The balance of the net proceeds will be used for working capital and general corporate purposes, including potential strategic investments in companies that could add value to Future Media by increasing DVD and/or CD replication revenues. Currently, we do not have any acquisition target identified. Pending such uses, we intend to invest the net proceeds in short-term, interest bearing securities or guaranteed obligations of the United States government. We will not receive any proceeds from the sale of shares by the selling shareholders. DIVIDEND POLICY Historically we have paid cash dividends when operating as an S Corporation. However, other than paying approximately $9.3 million out of the net proceeds of this offering to our existing shareholders as a distribution of retained earnings, including an amount of approximately $1.8 million for the purpose of paying income taxes on S Corporation earnings, we have no current intention to declare or pay dividends on our common stock following our conversion to C Corporation status. Instead, we intend to follow a policy of retaining earnings to finance the growth of our business. Our board of directors will have the discretion to determine any future dividend payments and such discretion may depend on the following: our results of operations; our financial condition; contractual and legal restrictions; and other factors our board of directors deems relevant. Pursuant to our current loan agreement with Greyrock, we may not declare or pay any dividends or make any distribution without the prior written consent of Greyrock, except for distributions to existing shareholders for the purpose of paying income taxes on our S Corporation earnings. 15 DILUTION Purchasers of our common stock in this offering will experience immediate and substantial dilution in the pro forma net tangible book value of our common stock from the initial public offering price. The pro forma net tangible book value of our common stock as of March 31, 2000 was $387,000. Pro forma net tangible book value per share is equal to our total tangible assets, less total liabilities, divided by the number of shares of common stock outstanding, after giving effect to: . the distribution by us of approximately $14.7 million to our existing shareholders as a retained earnings distribution, including an amount of approximately $7.9 million for the purpose of paying income taxes on S Corporation earnings, . the recording by us of additional deferred taxes as if we were treated as a C Corporation at March 31, 2000, and . to give effect to a 1.65 for 1 stock split approved by our board of directors on April 13, 2000. After giving effect to the sale of 4,685,185 shares of common stock by us and the receipt and application of the estimated net proceeds, assuming an initial public offering price of $13.50 per share, after deducting the underwriting discounts and commissions and estimated offering expenses, including an amount of $472,500 to be paid to Averil Capital Markets Group, Inc., a company controlled by one of our directors upon the closing of this offering, our pro forma net tangible book value as of March 31, 2000 would have been approximately $57.7 million or $2.95 per share. This represents an immediate increase in net tangible book value of $2.92 per share to our current shareholders and an immediate and substantial dilution of $10.55 per share to new shareholders purchasing shares in this offering. The following table illustrates this per share dilution: Assumed initial public offering price......................... $13.50 Pro forma net tangible book value as of March 31, 2000...... $0.03 Increase attributable to new shareholders................... 2.92 ----- Pro forma net tangible book value as of March 31, 2000 after the offering................................................. 2.95 ------ Dilution to new shareholders.................................. $10.55 ======
The following table summarizes a comparison of the number of shares of common stock acquired from us, the percentage ownership of such shares, the total consideration, the percentage of total consideration and the average price per share paid by the existing shareholders and by the investors purchasing shares of common stock in this offering, before the deduction of underwriting discounts and commissions and offering expenses.
Shares Purchased Total Consideration Average ------------------ ------------------- Price Per Number Percent Amount Percent Share ---------- ------- ----------- ------- --------- Current shareholders........ 14,850,000 76.0% $ 15,000 -- % $ -- New investors............... 4,685,185 24.0% 63,250,000 100.0% $13.50 ---------- ----- ----------- ----- 19,535,185 100.0% $63,265,000 100.0% $ 3.24 ========== ===== =========== ===== ======
The foregoing tables and calculations assume no exercise of outstanding options under our stock incentive plans, no exercise of the warrants granted to David Moss and no exercise of warrants granted to Levy, Small and Lallas. At the date of this prospectus, 1,598,350 shares of common stock were subject to outstanding options under our stock incentive plans, 604,890 shares of common stock were issuable upon exercise of the warrants held by David Moss at an exercise price of $0.0010 per share and 25,000 warrants to be granted to Levy, Small & Lallas upon the closing of this offering at an exercise price equal to the initial public offering price. To the extent options or warrants are exercised, there will be further dilution to new investors. 16 CAPITALIZATION The following table sets forth our capitalization as of March 31, 2000 on . an actual basis; . on a pro forma basis to give effect to the accrual for the payment of $14.7 million to our current shareholders as a distribution of retained earnings, including approximately $7.9 million for the purposes of paying income taxes on S Corporation earnings and the recording of additional deferred taxes of approximately $2.7 million based on the increase in the effective tax rate upon our anticipated change from an S Corporation to C Corporation; and . pro forma as adjusted to reflect the pro forma adjustments and to give effect to our receipt of approximately $57.3 million in estimated net proceeds from this offering, including a deduction of $472,500 to be paid to Averil Capital Markets Group, Inc., a company controlled by one of our directors upon the closing of this offering and the application of these net proceeds, including the repayment of existing bank debt of $14.1 million at March 31, 2000, of which $7.4 million was classified as long-term debt.
At March 31, 2000 -------------------------------- Actual Pro Pro Forma (unaudited) Forma As Adjusted ----------- ------- ----------- (in thousands) Long-term debt, less current portion.......... $ 7,399 $ 7,399 $ -- ------- ------- ------- Shareholders' equity: Preferred Stock, no par value; 10,000,000 shares authorized; no shares issued or outstanding actual, pro forma or pro forma as adjusted................. -- -- -- Common Stock, no par value; 75,000,000 shares authorized; 14,850,000 shares issued and outstanding actual and pro forma; 19,535,185 shares outstanding pro forma as adjusted.................... 3,790 3,790 61,113 Notes receivable from officers.............. (4,058) (4,058) (4,058) Accumulated other comprehensive income...... 655 655 655 Retained earnings........................... 17,430 -- -- ------- ------- ------- Total shareholders' equity.............. 17,817 387 57,710 ------- ------- ------- Total capitalization.................... $25,216 $ 7,786 $57,710 ======= ======= =======
The number of issued and outstanding shares in the foregoing table excludes the following options and warrants that could result in further dilution for new investors: (a) 3,250,000 shares of common stock available for issuance pursuant to our stock incentive plans, of which 1,598,350 shares were subject to outstanding options as of the date of this prospectus; (b) 604,890 shares of common stock issuable upon exercise of warrants issued to David Moss, our Vice President--Operations, at an exercise price of $0.0010 per share; and (c) 25,000 shares of common stock issuable upon exercise of warrants issued to Levy, Small & Lallas, at an exercise price equal to the initial public offering price. 17 SELECTED FINANCIAL DATA We derived the statement of income data for the years ended December 31, 1997, 1998 and 1999 and the three months ended March 31, 1999 and 2000 and the balance sheet data as of December 31, 1998 and 1999 and March 31, 2000 presented below from our financial statements included in another part of this prospectus. The statement of income data for the years ended December 31, 1995 and 1996 and the balance sheet data as of December 31, 1995, 1996 and 1997 are derived from our audited financial statements not included in this prospectus. The financial statements as of and for the years ended December 31, 1997, 1998 and 1999 have been audited by Ernst & Young, LLP, independent auditors. The statement of income data for the three months ended March 31, 1999 and 2000 and the balance sheet data as of March 31, 2000 are unaudited but have been prepared on the same basis as our audited financial statements, and in the opinion of management, contain all adjustments, consisting only of normal recurring adjustments, necessary for the fair presentation of our operating results for these periods and our financial condition as of that date. You should read the selected financial data together with the historical financial statements and related notes to our audited reports, as well as the section included in this prospectus entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations."
Three Months Ended March 31 Year Ended December 31 (unaudited) ------------------------------------------- --------------- 1995 1996 1997 1998 1999 1999 2000 ------- ------- ------- ------- ------- ------ ------- (in thousands, except per share data) Statement of Income Data: Net sales............... $26,972 $25,814 $36,042 $43,311 $53,002 $8,675 $14,780 Cost of goods sold...... 14,821 11,972 23,132 27,304 31,938 5,865 9,342 ------- ------- ------- ------- ------- ------ ------- Gross profit............ 12,151 13,842 12,910 16,007 21,064 2,810 5,438 Selling, general and administrative expenses............... 6,093 2,537 4,214 4,232 4,201 1,072 1,593 Other general and administrative expense- stock related compensation(1)........ -- -- -- 3,055 720 -- -- Abandoned offering costs.................. -- -- -- 676 -- -- -- ------- ------- ------- ------- ------- ------ ------- Income from operations.. 6,058 11,305 8,696 8,044 16,143 1,738 3,845 Interest income......... 12 252 42 35 1 -- 8 Interest expense........ (957) (1,108) (818) (1,264) (1,404) (351) (399) Loss in equity of unconsolidated entity.. -- -- -- -- -- -- (155) Change in accounting estimate for royalties(2)........... -- 3,770 -- -- -- -- -- ------- ------- ------- ------- ------- ------ ------- Income before state income taxes........... 5,113 14,219 7,920 6,815 14,740 1,387 $ 3,299 Provision for state income taxes........... 72 223 120 102 2 1 1 ------- ------- ------- ------- ------- ------ ------- Net income.............. $ 5,041 $13,996 $ 7,800 $ 6,713 $14,738 $1,386 $ 3,298 ======= ======= ======= ======= ======= ====== ======= Earnings per share: Basic.................. $ 0.34 $ 0.94 $ 0.53 $ 0.45 $ 0.99 $ 0.09 $ 0.22 ======= ======= ======= ======= ======= ====== ======= Diluted................ $ 0.34 $ 0.94 $ 0.53 $ 0.43 $ 0.92 $ 0.09 $ 0.20 ======= ======= ======= ======= ======= ====== ======= Shares used in computing earnings per share: Basic.................. 14,850 14,850 14,850 14,850 14,850 14,850 14,850 ======= ======= ======= ======= ======= ====== ======= Diluted................ 14,850 14,850 14,850 15,672 16,026 15,859 16,124 ======= ======= ======= ======= ======= ====== ======= Pro Forma Statement of Income Data(3)(unaudited): Pro forma net income data: Income before provision for income taxes....... $14,740 $ 3,299 Pro forma income tax provision.............. 5,896 1,320 ------- ------- Pro forma net income.... $ 8,844 $ 1,979 ======= ======= Pro forma basic earnings per share.............. $ 0.55 $ 0.12 ======= ======= Pro forma diluted earnings per share..... $ 0.52 $ 0.11 ======= ======= Weighted average shares outstanding--basic..... 16,200 16,200 ======= ======= Weighted average shares outstanding--diluted... 17,136 17,435 ======= =======
18
December 31, March 31, 2000 --------------------------------------- ----------------------------------------- Actual Pro Forma 1995 1996 1997 1998 1999 (unaudited) Pro Forma (4) As Adjusted (5) ------- ------- ------- ------- ------- ----------- ------------- --------------- (in thousands, except per share data) Balance Sheet Data: Current assets.......... $10,846 $11,252 $ 8,036 $ 9,204 $ 8,253 $ 5,020 $ 5,320 $33,141 Property and equipment, net.................... 11,896 12,097 17,636 21,898 29,837 34,874 34,874 34,874 Total assets............ 22,909 24,155 25,920 31,438 41,089 45,503 45,803 73,624 Current liabilities..... 12,839 8,865 14,132 16,246 16,165 20,161 34,850 12,206 Long term debt, less current portion........ 4,750 2,129 1,755 9,085 5,327 7,399 7,399 -- Total shareholders' equity................. 5,305 13,144 9,936 5,999 19,469 17,817 387 57,710 Dividends per share..... -- 0.41 0.74 0.92 0.03 0.20
- -------- (1) On January 1, 1998, we granted warrants to purchase 604,890 shares of common stock at an exercise price of $0.0010 per share to David Moss, our Vice President--Operations. These warrants expire on December 31, 2007. In connection with the grant of these warrants, we recognized compensation expense of $3,055,000 in 1998 representing the excess of the estimated fair value of the shares over the exercise price. In 1999 our existing shareholders committed to give 49,500 shares of their stock to a director for services to us. For the year ended December 31, 1999 we recorded stock related compensation expense of $720,000 for this commitment, based upon the estimated fair value of the shares to be given. On April 13, 2000 we granted 25,000 warrants to purchase common stock at the initial public offering price to the law firm of Levy, Small & Lallas for legal services provided to us in connection with this offering. The warrants vest upon the closing of this offering and expire one year from the close of this offering. (2) We executed license agreements with two developers of CD technology effective June 1, 1996 and October 1, 1996, respectively. The agreements set forth royalty rates payable to the licensors for the license to manufacture and sell CDs. We reached settlements totaling $70,000 for CD sales occurring before the effective dates of the agreements. Because of the settlement amounts, our prior estimates of royalty liabilities were overstated by approximately $3,770,000 (of which $300,000 related to 1994 and $3,470,000 related to 1995) and the adjustment to the accruals was made in 1996. The original estimates for royalty liabilities were recorded in cost of sales in 1994 and 1995. (3) We have been exempt from paying federal income taxes and have paid certain state income taxes at a reduced rate because of our S Corporation status. Upon the completion of this offering, our S Corporation status will terminate. Pro forma statement of income data reflect the income tax expense recordable had we not been exempt from paying taxes under the S Corporation election. Because of the termination of our S Corporation status, we will be required to record a one-time, non-cash charge against historical earnings for additional deferred taxes based upon the increase in the effective tax rate from our S Corporation status (1.5%) to C Corporation status (approximately 40%). This charge will occur in the quarter during which our S Corporation status is terminated. If this charge was recorded at March 31, 2000, the amount would have been approximately $2.7 million. (4) The pro forma balance sheet reflects (i) an accrual for the distribution of retained earnings of approximately $14.7 million to our current shareholders, including an amount totaling approximately $7.9 million for the purpose of paying income taxes on S Corporation earnings and (ii) the recording of additional deferred taxes of approximately $2.7 million based on the increase in the effective tax rate upon our anticipated change from an S Corporation to a C Corporation. (5) Adjusted for pro forma adjustments discussed above and to give effect to the receipt and application of the estimated net proceeds of this offering, including a deduction of $472,500 to be paid to Averil Capital Markets Group, Inc., a company controlled by one of our directors upon the closing of this offering, repayment of the accrual for distribution of our retained earnings of approximately $14.7 million to our current shareholders and the repayment of existing bank debt of which approximately $6.7 million is included in current liabilities. 19 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis should be read in conjunction with the "Selected Financial Data" and the financial statements and related notes, which are included in this prospectus. Results of Operations Sales are generally recorded at the time of shipment. However, in certain instances, sales are recognized upon completion of an order, prior to shipment, if the risks of ownership have passed to the customer. In these circumstances, which have been insignificant at the end of reporting periods, we obtain written instructions from the customer to hold the product for future shipment. Cost of goods sold consists primarily of the following: . raw materials; . direct labor; . depreciation of plant equipment; . repairs and maintenance of plant equipment; . royalties payable on the sale of DVDs and CDs; and . rent and utilities related to the plant facility. In addition to changes in these costs, our cost of goods sold as a percentage of net sales are affected by various factors, including the following: . DVD and CD units manufactured and associated number of units sold as a percentage of our total DVD and CD production capacity in any period, which directly affects gross margin due to the high component of fixed costs inherent in our operations; . average unit prices we are able to charge for our products, which are subject to market conditions; and . raw material packaging costs and associated direct labor costs required to fulfill customer orders during any particular period. Quarterly Results The following table sets forth certain unaudited statement of income data for the last eight quarters and has been prepared on the same basis as the annual information and in management's opinion includes all adjustments necessary to present fairly the information for each of the quarters below.
Three Months Ended ------------------------------------------------------------------------------------- 1998 1999 2000 --------------------------------- ------------------------------------------ -------- June 30 September 30 December 31 March 31 June 30 September 30 December 31 March 31 ------- ------------ ----------- -------- ------- ------------ ----------- -------- (in thousands) Net sales............... $9,794 $12,025 $14,577 $8,675 $11,313 $14,960 $18,054 $14,780 Cost of goods sold...... 6,389 7,727 8,554 5,865 6,744 9,283 10,047 9,342 ------ ------- ------- ------ ------- ------- ------- ------- Gross profit............ 3,405 4,298 6,023 2,810 4,569 5,677 8,007 5,438 Selling, general and administrative expenses............... 1,146 812 1,413 1,072 1,030 888 1,211 1,593 Other general and administrative expense- stock related compensation........... -- -- -- -- -- -- 720 -- Abandoned offering costs.................. -- -- 676 -- -- -- -- -- ------ ------- ------- ------ ------- ------- ------- ------- Income (loss) from operations............. 2,259 3,486 3,934 1,738 3,539 4,789 6,076 3,845 Interest income......... 15 20 -- -- 24 28 (51) 8 Interest expense........ (317) (416) (400) (351) (330) (372) (351) (399) Loss in equity of unconsolidated entity.. -- -- -- -- -- -- -- (155) ------ ------- ------- ------ ------- ------- ------- ------- Income (loss) before state income taxes..... 1,957 3,090 3,534 1,387 3,233 4,445 5,674 3,299 Provision (benefit) for state income taxes..... 19 46 53 1 -- 1 1 1 ------ ------- ------- ------ ------- ------- ------- ------- Net income (loss)....... $1,938 $ 3,044 $ 3,481 $1,386 $ 3,233 $ 4,444 $ 5,673 $ 3,298 ====== ======= ======= ====== ======= ======= ======= =======
20 We have experienced, and expect to experience in the future, quarterly variations in revenues and earnings as a result of various factors, many of which are outside our control, including: .seasonal patterns of certain of the businesses we serve; .timing of new product releases by our customers; .commercial success of products offered by our customers; .timing of expenses incurred to obtain and support new business; and .general changes in economic and industry conditions. Typically, we experience increased demand for our products in our third and fourth quarters. Such increase is primarily due to the release of new products by our customers for the new school year and the holiday season. Operating Results The following table provides certain statement of income data expressed as a percentage of net sales for the specified periods.
Three Months Ended Year Ended December 31 March 31, ------------------------- -------------------- 1997 1998 1999 1999 2000 ------- ------- ------- --------- --------- Net sales.................... 100.0% 100.0% 100.0% 100.0% 100.0% Cost of goods sold........... 64.2 63.0 60.3 67.6 63.2 ------- ------- ------- --------- --------- Gross profit................. 35.8 37.0 39.7 32.4 36.8 Selling, general and administrative expenses..... 11.7 9.8 7.9 12.4 10.8 Other general and administrative expense-- stock related compensation.. -- 7.1 1.4 -- -- Abandoned offering costs..... -- 1.6 -- -- -- ------- ------- ------- --------- --------- Income from operations....... 24.1 18.5 30.4 20.0 26.0 Interest income.............. 0.1 0.1 -- -- -- Interest expense............. (2.2) (2.9) (2.6) (4.0) (2.7) Loss in equity of unconsolidated entity....... -- -- -- -- (1.0) ------- ------- ------- --------- --------- Income before state income taxes....................... 22.0 15.7 27.8 16.0 22.3 Provision for state income taxes....................... 0.3 0.2 -- -- -- ------- ------- ------- --------- --------- Net income................... 21.7% 15.5% 27.8% 16.0% 22.3% ======= ======= ======= ========= =========
As shown by the above table, over the last three years, as a percentage of sales our gross profit margins have increased from 35.8% in 1997 to 39.7% in 1999. In addition our selling, general and administrative expenses have decreased as a percentage of sales from 11.7% in 1997 to 7.9% in 1999. These favorable trends are a result of the fact that our business has a high percentage of fixed costs, both in costs of goods sold, which directly effects our gross profit, and in selling, general and administrative expenses. Therefore, by increasing revenues, our costs as a percentage of revenues tend to decrease resulting in higher income from operations as a percentage of sales. The amounts shown for the three months ended March 31, 2000 and 1999 are not necessarily indicative of trends that may be expected on an annual basis. These amounts are shown for informational purposes only. Three Months ended March 31, 2000 compared to March 31, 1999 Net Sales. Net sales totaled $14,780,253 for the three months ended March 31, 2000 as compared to $8,674,760 for the three months ended March 31, 1999. This represents an increase of $6,105,493 or 70.4%. This increase is the result of increased CD unit sales and DVD revenues in 2000 (for which there were none in 1999), partially offset by lower packaging revenues and lower average CD unit prices in 2000 as compared to 21 1999. During the three months ended March 31, 2000 our CD unit sales increased approximately 64.5%. This increased demand for our CD's was fulfilled by an increase in the utilization of our manufacturing equipment in 2000 as compared to 1999 and by the addition of CD manufacturing capacity subsequent to March 31, 1999. Our average CD sales price decreased approximately 5.4% in the three months ended March 31, 2000 as compared to the three months ended March 31, 1999. Our DVD revenues in the three months ended March 31, 2000 totaled $1,947,850 (of which there were none in 1999). Packaging revenues decreased to $801,935 in the three months ended March 31, 2000 from $946,937 for the same period in 1999, a decrease of $145,002 or 15.3%. Cost of Goods Sold. Cost of goods sold was $9,341,733 for the three months ended March 31, 2000 and $5,864,842 for three months ended March 31, 1999, an increase of $3,476,891 or 59.3%. Cost of goods sold as a percentage of sales decreased to 63.2% for the three months ended March 31, 2000 from 67.6% for the three months ended March 31, 1999. As a percentage of sales in 2000, our factory overhead costs decreased 2.4%, depreciation of plant equipment decreased 2.5% and shipping and other overhead decreased approximately 1%. These decreases were partially offset by increases in raw material costs of 1.3% and a net increase of .2% in royalties and other production costs as a percentage of sales. Gross Profit. Our gross profit increased as a result of our increased volume of CD and DVD units sold during the three months ended March 31, 2000 as compared to the three months ended March 31, 1999. The increased gross profit in the three months ended March 31, 2000 was also the result decreased of production expenses as a percentage of sales as discussed above. Gross profit for the three months ended March 31, 2000 was $5,438,520 or 36.8% of net sales as compared to $2,809,918 or 32.4% of net sales for three months ended March 31, 1999. Selling, General and Administrative Expenses. As a percentage of net sales, selling, general and administrative expenses decreased from 12.4% for the three months ended March 31, 1999 to 10.8% for the three months ended March 31, 2000. Selling, general and administrative expenses were $1,593,581 for three months ended March 31, 2000 as compared to $1,071,812 for the three months ended March 31, 1999, an increase of $521,769 or approximately 48.7%. This increase is the partially the result of increased salaries and related taxes ($93,991) and additional rental and moving expenses (totaling $245,000) recognized as selling, general and administrative expenses during the three months ended March 31, 2000. We incurred rental expenses for both our old and new production headquarters during the three months ended March 31, 2000 as we were operating from both during the period. We took possession of our new facility in order to make the necessary leasehold improvements and power upgrades required for our operations. We do not anticipate the additional rental and moving expenses to occur in the future. The remaining increase in selling, general and administrative expenses in the three months ended March 31, 2000 compared to the three months ended March 31, 1999 is a result of increased expenses commensurate with our increased sales. Income from Operations. As a result of the foregoing, income from operations totaled $3,844,939 for the three months ended March 31, 2000 and $1,738,106 for the three months ended March 31, 1999. This represents an increase of $2,146,833 or 123.5%. Income from operations was 26.0% of net sales for the three months ended March 31, 2000 and 20.0% of net sales for the three months ended March 31, 1999. Equity in Loss of Unconsolidated Entity. During the three months ended March 31, 2000 we recognized $155,000 as our share of the net loss of Synthonics Technologies, Inc., an investment carried on the equity method. We made this investment in late December 1999 so there is no corresponding amount for the first quarter of 1999. Interest Expense. Interest expense was $398,614 for the three months ended March 31, 2000 and $351,396 for the three months ended March 31, 1999. The increase of 13.4% in 2000 as compared to 1999 is the result of higher average interest rates, partially offset by lower average borrowings during the three months ended March 31, 2000. The weighted average interest rate on our debt was 10.8% for the three months ended March 31, 2000 and 9.6% for the three months ended March 31, 1999. 22 Income Tax Expense. We have operated as an S Corporation for federal and state income tax purposes, and accordingly we are not subject to federal taxes and subject to only a minimal percentage of state income taxes. The only provision for income taxes was the amount required for state income tax purposes. Our total income tax expense was approximately $1,000 for the three months ended March 31, 2000 and 1999 due to credits we receive for state taxes for purchases of manufacturing equipment. Net Income. Based on our S Corporation status and the factors discussed above, net income was $3,297,846 for the three months ended March 31, 2000 and $1,386,210 for the three months ended March 31, 1999. This represents an increase of $1,911,636 or 137.9% for the three months ended March 31, 2000 as compared to the three months ended March 31, 1999. Year Ended December 31, 1999 Compared to Year Ended December 31, 1998 Net Sales. Net sales totaled $53,001,871 for the year ended December 31, 1999 as compared to $43,311,180 for the year ended December 31, 1998. This represents an increase of $9,690,691 or 22.4% for the year ended December 31, 1999, as compared to the year ended December 31, 1998. This increase is a result of increased CD unit sales of approximately 26.3%, partially offset by lower packaging revenues. Our pricing is comprised of a price for the unit (CD or DVD) and a price for packaging, when our customers request this service. While our unit prices for CDs remained constant during 1999 as compared to 1998, our packaging revenues decreased by approximately $3,048,011. The additional CD unit sales during 1999 are a result of increased demand for our products with fulfillment of these orders made possible by production capacity added subsequent to 1998. In addition, we commenced production and shipment of DVDs during the fourth quarter of 1999, which added $2,718,333 to revenues for the year. Cost of Goods Sold. Cost of goods sold was $31,937,704 for the year ended December 31, 1999 and $27,304,178 for the year ended December 31, 1998. Cost of goods sold as a percentage of sales was approximately 60.3% for the year ended December 31, 1999 as compared to 63.0% for the year ended December 31, 1998. As a percentage of sales in 1999, our raw materials costs decreased 4.8% and shipping costs decreased 0.7%, partially offset by increases in depreciation expense of 1.3%, factory overhead of 1.9% and royalties of 0.5%. Gross Profit. Gross profit for the year ended December 31, 1999 was $21,064,167 or 39.7% of net sales as compared to $16,007,002 or 37.0% of net sales for the year ended December 31, 1998. Our gross profit increased because our volume of CD and DVD units sold increased, in line with our business model, as a result of the increased production capacity we added during 1999. Selling, General and Administrative Expenses. As a percentage of net sales, selling, general and administrative expenses decreased from 9.8% for the year ended December 31, 1998 to 7.9% for the year ended December 31, 1999. Selling, general and administrative expenses were $4,200,969 for the year ended December 31, 1999 as compared to $4,232,741 for the year ended December 31, 1998, a decrease of $31,772 or approximately 0.8%. This decrease is the net result of reduced amounts paid for consulting fees (approximately $396,000), taxes (sales taxes paid on materials used in production) and licenses (approximately $107,000) and miscellaneous items (approximately $147,000), offset by higher amounts paid for salaries and related benefits (approximately $486,000) and office related expenses (approximately $132,000) in 1999. Other General and Administrative Expense--Stock Related Compensation. In 1999 our existing shareholders committed to give 49,500 shares of their stock to a director for services to us. For the year ended December 31, 1999 we recorded compensation expense of $720,000 for this commitment, based upon the estimated fair value of the shares to be given. On January 1, 1998, we granted warrants to purchase 604,890 shares of stock at $0.0010 per share to one of our officers, with the warrants expiring on December 31, 2007. In connection with these warrants, we recognized compensation expense for $3,055,000 in 1998 representing the excess of the estimated fair value of the shares over the exercise price. 23 Income from Operations. Income from operations totaled $16,143,198 for the year ended December 31, 1999 and $8,043,528 for the year ended December 31, 1998. This represents an increase of $8,099,670 or 100.7% for the year ended December 31, 1999, as compared to the year ended December 31, 1998. Income from operations was 30.4% of net sales for the year ended December 31, 1999 and 18.5% of net sales for the year ended December 31, 1998. Excluding the stock related compensation expense in 1999 and 1998 and abandoned offering costs recognized in 1998, income from operations would have been 16,863,198 or 31.8% of net sales in 1999 and $11,774,261 or 27.2% of net sales in 1998. As a result, income from operations in 1999 as compared to 1998 would have increased $5,088,937 or 43.2%. Interest Expense. Interest expense was $1,403,694 for the year ended December 31, 1999 and $1,263,861 for the year ended December 31, 1998. The increase of 11.1% in 1999 as compared to 1998 is the net result of higher average borrowings during 1999, partially offset by lower average interest rates. Our weighted average interest rate on our debt was 10.1% for the year ended December 31, 1999 and 10.4% for the year ended December 31, 1998. Income Tax Expense. We have operated as an S Corporation for federal and state income tax purposes, and accordingly we are not subject to federal taxes and subject to only a minimal percentage of state income taxes. The only provision for income taxes was the amount required for state income tax purposes. Our total income tax expense was $2,000 for the year ended December 31, 1999 due to our S Corporation status and credits we receive for state taxes for purchases of manufacturing equipment. Net Income. Based on our S Corporation status and the factors discussed above, net income was $14,738,174 for the year ended December 31, 1999 and $6,712,633 for the year ended December 31, 1998. This represents an increase of $8,025,541 or 119.6% for the year ended December 31, 1999 as compared to the year ended December 31, 1998. Year Ended December 31, 1998 Compared to Year Ended December 31, 1997 Net Sales. Net sales for the year ended December 31, 1998 totaled $43,311,180 compared to net sales for the year ended December 31, 1997, which totaled $36,042,427. This increase of $7,268,753, or 20.2%, is attributable to an increase in the number of CDs sold of approximately 55.9%, offset by lower average CD sales prices for the year ended December 31, 1998 compared to 1997. Our pricing is comprised of a price for the unit (CD) and a price for packaging, when our customers request this service. Our average unit price declined in 1998 as compared to 1997 by approximately 14.8%. In addition, our packaging revenues decreased by $1,384,468 in 1998 from the amounts in 1997. The additional unit sales during 1998 are a result of increased demand for our products with fulfillment of these orders made possible by production capacity added subsequent to 1997. Cost of Goods Sold. Cost of goods sold for the year ended December 31, 1998 totaled $27,304,178 or 63.0% of net sales, compared to $23,132,442 or 64.2% of net sales for the year ended December 31, 1997. As a percentage of net sales, increases in cost of sales in the year ended December 31, 1998 were related to increases in royalties of 2.2% and depreciation of production equipment of 1.3%, offset by decreases in factory overhead of 2.3%, raw material costs of 1.0% and obsolescence reserves of 1.4%. Gross Profit. Because of the foregoing, gross profit for the year ended December 31, 1998 was $16,007,002, as compared to $12,909,985 for the year ended December 31, 1997, an increase of $3,097,017 or 24.0%. As a percentage of net sales, gross profit was 37.0% in 1998 as compared to 35.8% in 1997. Selling, General and Administrative Expenses. Selling, general and administrative expenses were $4,232,741 for the year ended December 31, 1998 and $4,214,033 for the year ended December 31, 1997. This represents an increase of $18,708 or less than 1.0% in 1998 over 1997. As a percentage of net sales, selling, general and administrative expenses decreased from 11.7% for the year ended December 31, 1997 to 9.8% for the year ended December 31, 1998. 24 Income from Operations. Because of the above items, income from operations was $8,043,528 for the year ended December 31, 1998 and $8,695,952 for the year ended December 31, 1997, a decrease of $652,424 or 7.5%. As a percentage of net sales, income from operations was 18.6% in 1998 and 24.1% in 1997. Excluding the stock warrant compensation expense and abandoned offering costs recognized in the year ended December 31, 1998, income from operations would have been $11,774,261 or 27.2% of net sales. This represents an increase of $3,078,309 or 35.4% of the amount in 1997. Interest Expense. Interest expense totaled $1,263,861 for the year ended December 31, 1998 and $817,998 for the year ended December 31, 1997. This increase in 1998 of $445,863, or 54.5%, is a result of higher average borrowings in 1998 as compared to 1997. The weighted average interest rate on our debt was 10.4% for the year ended December 31, 1998 and 10.5% for the year ended December 31, 1997. Income Tax Expense. We have operated as an S Corporation for federal and state income tax purposes, and accordingly we were not subject to federal taxes and we were only subject to a minimal percentage (1.5% of pretax income) of state income taxes. The only provision for income taxes was the amount required for state income tax purposes. Net Income. Because of the items discussed above, net income was approximately $6,712,633 for the year ended December 31, 1998 and was approximately $7,800,159 for the year ended December 31, 1997, a decrease of $1,087,526 or 13.9%. Liquidity and Capital Resources Historically we have funded our operations and capital expenditures through cash flow from operations, borrowings under our lines of credit and favorable terms from our equipment vendors for the purchase of equipment used in our manufacturing operations. In February 1997, we entered into a credit agreement with Greyrock Capital, a division of Banc of America Commercial Finance Corporation ("Greyrock"), which was amended in January 1998 and further amended in April 1998, July 1998, June 1999 and January 2000. The credit agreement currently provides: . receivable loans based on 80% of our eligible receivables; . equipment loans based on 90% of the net purchase price of new equipment purchased and delivered subsequent to June 1999; and . additional revolving loans. Under the credit agreement we are allowed to borrow the lower of $30,000,000, or an amount equal to 80% of our eligible receivables and up to $15,000,000 of equipment loans plus the unpaid balance of the revolving loans. The credit agreement had an original maturity date of February 28, 1998 and provided for automatic renewals. In January 2000, the maturity date was extended to June 30, 2001, and continues to provide for automatic renewals. The credit agreement is secured by accounts receivable, equipment, inventory and other assets and is personally guaranteed by our existing shareholders. Unlike a typical revolving loan or line of credit, loans under the Greyrock credit agreement are advanced at Greyrock's sole discretion. Accordingly, there can be no guarantee that funds will be available under this credit agreement in the future. To date Greyrock has never refused our request for a loan. The credit agreement also includes, among others, various negative covenants, including the prohibition to merge or consolidate with another corporation, make any loans of money or assets, redeem, retire, purchase or otherwise acquire any of our stock and make any change in our capital structure which would have a material adverse effect on our ability to pay our obligations under the credit agreement without Greyrock's prior written consent. We obtained permission from Greyrock for the loans and advances to related parties that are described in the Related Party Transactions in this Prospectus. We are in compliance with the terms of the credit agreement. We do not pay any commitment fees for the unused portion of the credit facility. Borrowings under receivable loans bear interest at the prime rate (8.5% at December 31, 1999 and 9.0% at March 31, 2000) plus 2.0% per annum; however, the interest rate will not be less than 7.0% per annum. At 25 December 31, 1999 there was a total of $1,852,303 borrowed under the receivable loans. At March 31, 2000 there was a total of $1,919,620 borrowed under the receivable loans. Under the amendment of April 1998, the revolving loans were for up to $15,000,000, payable in monthly principal installments of $312,500 through the earlier of the date the credit agreement terminates, or is terminated, or April 2002. In addition, this amendment disallowed any distributions to shareholders except for the purpose of paying income taxes on S corporation earnings. The revolving loans bear interest at the prime rate (8.5% at December 31, 1999 and 9.0% at March 31, 2000) plus 2.0% per annum; however the interest rate will not be less than 7.0% per annum. The outstanding balance of the revolving loans was $9,062,500 at December 31, 1999 and $8,125,000 at March 31, 2000. Under the amendment of June 1999, amounts borrowed under the equipment loans are to be repaid in 48 equal monthly payments of principal through the earlier of the earlier of the date the credit agreement terminates, or is terminated or the date such equipment loans have been repaid in full. The equipment loans bear interest at the prime rate (8.5% at December 31, 1999 and 9.0% at March 31, 2000) plus 2.0% per annum; however, the interest rate will not be less than 7.0% per annum. At December 31, 1999 no amounts had been borrowed under the equipment loans. At March 31, 2000 there was $4,782,500 borrowed under the equipment loans. Historically, we have funded our capital requirements with cash flows from operations and borrowings under our credit arrangements. Cash flows provided from operating activities were $10,843,926 in 1998, $23,046,306 in 1999 and $7,645,147 in the three months ended March 31, 2000. In 1998, operating cash flows were provided primarily by net income ($6,712,633) plus the effect of non-cash expenses of stock related compensation expense ($3,055,000) and depreciation and amortization ($2,860,789), partially offset by increases in receivables ($1,347,486) and net decreases in payables and accrued liabilities ($603,293). In 1999 operating cash flows were provided primarily by net income ($14,738,174) plus the effect of non-cash expenses of stock compensation expense ($720,000) and depreciation and amortization ($4,368,177), decreases in accounts receivable ($713,144) and net increases in accounts payable and accrued liabilities ($2,012,586). In the three months ended March 31, 2000 operating cash flows were provided primarily by net income ($3,297,846) plus the effect of non-cash expenses of depreciation and amortization ($1,149,803), decreases in accounts receivable ($3,321,310) and increases in payables and accrued liabilities ($1,640,154). Our cash flows from operations were used to partially fund our investing and financing activities. We spent a total of $6,731,862 in 1998, $17,378,635 in 1999 and $5,266,358 in the three months ended March 31, 2000 for investing activities. Of this amount, $6,751,862, $15,226,235 and $5,266,358 was spent for property and equipment used in our operations for the years ended December 31, 1998 and 1999 and the three months ended March 31, 2000, respectively. In 1999, we made cash investments totaling $2,152,400 in two companies with whom we entered into strategic alliances. We made a $1,652,400 investment in Lions Gate Entertainment, which allowed us to align ourselves with a motion picture production company which distributes DVDs from films in its library and new releases. Additionally we made a $500,000 investment in Synthonics Technologies, Inc. in the form of a convertible note. We used a total of $4,112,064 in 1998, $5,667,671 in 1999 and $2,198,789 in the three months ended March 31, 2000 in financing activities. These amounts were primarily the result of the net amounts received from long-term debt ($11,321,000 in 1998, $0 in 1999 and $4,130,000 in the three months ended March 31, 2000) offset by loans to officers ($0 in 1998, $1,428,000 in 1999 and $2,630,000 in the three months ended March 31, 2000), distributions to shareholders ($13,704,000 in 1998, $560,000 in 1999 and $2,975,000 in the three months ended March 31, 2000) and repayments of long-term debt and capital lease obligations ($2,855,807 in 1998, $3,768,668 in 1999 and $1,129,229 in the three months ended March 31, 2000). As of the date of this prospectus, we have entered into purchase orders for equipment to be used in our operations requiring future payments totaling approximately $9.4 million. On March 1, 2000 we entered into a 26 lease agreement with a company owned by our President. The lease is for a period of thirteen years and requires monthly base rent payments of $53,843, subject to annual increases based on the consumer price index. At the end of both the fifth and tenth year the monthly rental will be adjusted to fair market value as of those dates. Out of the net proceeds of this offering, we anticipate investing approximately $14,100,000 in capital equipment. This new equipment will expand our capacity for replication of DVDs and CDs. It should be noted, however, the purchase of equipment is subject to many factors, including but not limited to future demand for our product. Therefore, no assurance can be given we will purchase equipment as described above, and actual equipment purchased may vary significantly from our projections. We believe cash flows from operations, net proceeds from this offering, together with available funds under the credit agreement, will be sufficient to support our operating and capital expenditures for the next twelve months. However, long-term capital requirements depend on many factors, including, but not limited to, the rate at which we expand our business, whether internally or through acquisitions and strategic alliances. To the extent the funds generated from the sources described above are insufficient to fund our activities in the short or long term, we will be required to raise additional funds through public or private financings. No assurance can be given additional funds will be available on terms acceptable to us. Seasonality The demand for DVDs and CDs is usually highest in the second half of the year, concurrent with the new school year and holiday gift purchases. This seasonality could result in significant quarterly variations in financial results, with the third and fourth quarters generally being the strongest. Impact of Recently Issued Accounting Standards Effective in 2001, accounting for gains and losses resulting from changes in the value of derivatives would be changed depending on the use of the derivative and whether they qualify for hedge accounting. The adoption of this new requirement is not expected to have a material impact on our financial position or results of operations. Inflation Prices for raw materials used in the production of DVDs and CDs had not changed substantially as a percentage of sales since 1996, and in certain instances decreased during the year 1999. Since November 1999 the price we pay for optical grade polycarbonate plastic has increased approximately 10% per pound due to the change in oil prices. In addition, some of our other manufacturing and selling, general and administrative costs have continued to increase (primarily in the aggregate and sometimes as a percentage of net sales) since the beginning of 1996. As our general CD selling price has been relatively unchanged over the last two years, we have been unable to pass these costs on to our customers. Despite this trend we have remained profitable by increasing net sales. Impact of Year 2000 In 1999, we completed our remediation and testing of systems. Because of those planning and implementation efforts, we experienced no significant disruptions in mission critical information technology and non-information technology systems and those systems have successfully responded to the Year 2000 date change. We did not incur any significant expenses during 1999 in connection with remediating our systems. We are not aware of any material problems resulting from Year 2000 issues, either with our products, internal systems, or the products and services of third parties. We will continue to monitor our mission critical computer applications and those of our suppliers and vendors throughout the year 2000 to ensure any latent Year 2000 matters arising are addressed promptly. Qualitative and Quantitative Disclosures About Market Risk We are exposed to market risk related to changes in interest rates. There are currently no risks related to foreign currency exchange rates and we do not use derivative financial instruments, swaps, commodity investments or hedging. Our interest expense is sensitive to changes in the prime rate. Due to the nature of our debt, we have concluded that there is no material market risk exposure. 27 INDUSTRY OVERVIEW The projections discussed in this Industry Overview section include industry projections, and any growth rates discussed are industry growth rates and do not reflect our growth rates over the same period. The Digital Versatile Disc (DVD) and Compact Disc (CD) are among the most popular optical media for content delivery and are widely used in the distribution of movies, music, application and edutainment software, publishing content and Internet/online promotional materials. The wide acceptance of DVD and CD as a content delivery media has fueled the growth of the replication industry. The first commercial application of CD technology was storage and playback of pre-recorded music, or CD-Audio, which was adopted as an international standard in 1982, and introduced to the consumer market in 1983. The CD-ROM entered the market in 1991, providing cost-effective storage and retrieval of any combination of data, text, graphics, audio and video. The DVD entered commercial distribution in December 1996. DVDs are currently capable of storing up to 13 times as much data as CDs and are suitable for high quality playback of film and video, multi-channel surround sound audio and interactive media. An important advantage of DVD players and DVD-ROM drives, which should speed their market penetration, is their compatibility with CD-Audio and CD-ROMs. This compatibility feature of DVD players and DVD-ROM drives is expected to increase consumer acceptance of DVD technology. Unlike the introduction of CDs, when consumers were reluctant to purchase CD players because they would be required to spend substantial amounts on new music collections, consumers will be able to acquire the DVD players and DVD-ROM drives without making their CDs obsolete. During the past decade, CDs have become one of the most popular formats in audio and portable data storage and retrieval markets. Since its introduction, the popularity of DVDs has grown rapidly and the DVD is increasingly becoming a standard format for video. DVDs and CDs can be replicated faster than traditional tape storage mediums at a comparable cost. In addition, consumer acceptance of the DVD and CD formats is due in part to the following combination of advantages over other mass storage formats: . Higher storage capacity / longer play time; . Greater portability and ease of storage; . Higher quality presentation including crisper sounds and sharper video; . Longer life as a result of lack of degradation; and . Random accessibility of data. CD-ROM. According to Infotech, CD-ROM disc units sold in the United States by CD-ROM replicators have grown at a compound annual growth rate of 34.0% from approximately 443 million units in 1996 to approximately 1.066 billion units in 1999. The consumer market has emerged within the past several years and its substantial growth is expected to help sustain CD-ROM unit sales in the next few years. Infotech estimates that total worldwide CD-ROM disc units sold will continue to increase through the year 2001. CD-ROM is well suited to applications involving the storage of large amounts of information in a form that can be distributed to a diverse user population. CD-ROM was developed in the late 1980s and was initially limited to business and professional applications such as library references and parts catalogs. In the 1990s, the increasingly widespread presence of personal computers (PCs) and CD-ROM drives has created a thriving consumer market for CD-ROM applications. Infotech estimates that in the United States, the installed base of CD-ROM drives will grow from approximately 60.4 million in 1996 to approximately 338.8 million by 2004 representing a compounded annual growth rate of 24.1%. In addition, CD-ROM discs can be played on DVD-ROM drives. This rapidly growing installed base of CD-ROM drives, as well as the growth in the installed base of DVD-ROM drives, expands the potential consumer market for publishers of CD-ROM software, data and entertainment products. 28 DVD. DVD is becoming the accepted new medium for home video distribution. Unlike videocassettes, DVD-Video experiences no image or sound degradation with normal use and offers greater storage capacity, indexing, random access and lower manufacturing costs. DVD is capable of holding a full length motion picture with up to three spoken languages, three foreign language subtitles and multi-channel, digital surround sound. Added features such as multilingual voice tracks, soundtrack albums, director's notes, out takes, story-based games and other CD applications may be available with the higher storage capacity afforded with DVDs. The home video market, both rental and purchased videos, has been served primarily by pre-recorded videotape (VHS). We believe the DVD-Video format will surpass the VHS format in the pre-recorded video market over time. Infotech estimates the following: . The installed base of DVD-Video players in the United States will increase from approximately 300,000 in 1997 to 39.6 million in 2004, representing a compounded annual growth rate of approximately 100.9%. Infotech estimates the worldwide installed base of DVD-Video players will reach 96.7 million players by 2004. . DVD-Video disc units sold in the United States by replicators will increase from 3.4 million units in 1997 to approximately 991.0 million units in 2004, representing a compounded annual growth rate of 124.9%. . In the United States, more than 5,000 DVD-Video titles are currently available and the number of titles will approach 42,500 by the end of 2004. In addition to the growth in home video, Infotech projects that DVD-ROM drive shipments in the United States will increase from approximately 125,000 in 1997 to 134.2 million in 2004, representing a compounded growth rate of 171.0%. Also, the next generation of game consoles being manufactured by Sega, Nintendo, Sony and Microsoft will be DVD-based. Consequently, there will be pressure on some software game manufacturers to produce higher-capacity software games in the DVD format. We believe that certain of our software game customers will supplement their CD business in this area. Infotech estimates that DVD-ROM disc units sold by replicators in the United States will increase from approximately 520,000 in 1997 to 589.0 million in 2004, representing a compounded growth rate of 173.1%. Growth of Internet Usage and E-Commerce As the number of Internet users has increased the functionality of the Internet has expanded to a medium that enables complex business-to-business communications and commerce. The Internet and related online technologies are revolutionizing the way businesses and consumers communicate, share information and conduct business. We believe CDs and DVDs will play an important role in the expansion of the Internet and online commerce. Specifically, we believe CDs, and potentially DVDs, will function as an important marketing medium for integrating Internet or online strategies with traditional commerce, distribution and communication channels, such as "bricks and mortar" stores, mail order catalogs, television sales and retail-based kiosks. DVDs and CDs have special features, in addition to those discussed above, which particularly enhance their use in connection with the Internet and e-commerce programs. These include the following: . The ability of a DVD or CD to direct or link consumers to a website; and . The increased ability to include special promotional or customer brand information in the form of graphics, audio, video and other data. In fact, certain of our Internet and e-commerce customers, most notably America Online, have already adopted a technique of mass-mailing CDs for marketing purposes as a cost effective alternative to other methods of advertising. 29 BUSINESS We are an independent manufacturer/replicator of Digital Versatile Discs (DVD) and Compact Discs (CD). We target our sales to companies in industries including Internet/online, film and entertainment, edutainment software, publishing and computer hardware. We have successfully implemented our business model, which consists of the following elements: . High volume customers: We believe our customer base is comprised of some of the highest volume customers of DVDs and CDs often requiring production runs in excess of 25,000 units. . High replication capacity: Since inception we have continued to add new equipment and believe we are one of the largest, in terms of manufacturing capacity, independent manufacturers/replicators of DVDs and CDs in the United States. . Low cost structure: We achieve economies of scale through our optimally designed facility at a single locale, our dedication to maximizing machine uptime and our flat organizational structure. . Superior turnaround service: We are dedicated to providing superior turnaround service, as short as a few hours, by maintaining high throughput mastering technologies and high DVD/CD graphic printing capacity and by efficiently managing operational workflow. Our customers include America Online, Inc., Modus Media International Holdings, Inc., Havas Interactive, Inc., GT Interactive Software, Lions Gate Entertainment, infoUSA Inc., Interplay Entertainment Corp., Juno Online Services, Inc. and a major motion picture distributor. Of these customers, America Online, Modus Media and Havas Interactive each accounted for 10% or more of our revenues for the year ended December 31, 1999. In order to achieve significant cost efficiencies we focus on customers requiring high volume production runs and have designed our business processes to support them. We are thereby able to achieve lower overall unit costs and therefore we believe we are less vulnerable to competitive pricing pressures and have greater flexibility in the pricing of our products and services. Due to our technologically advanced equipment, plant design, in-house engineering capabilities and workflow techniques, we believe we are one of the most efficient high volume, low cost independent DVD and CD manufacturers in the industry. As a result of these factors, as well as our self-sufficient engineering, repair and maintenance capabilities, we believe we are able to provide superior turnaround service. This is not only a fundamental selling advantage but also helps foster long-term relationships with our high volume customers. Based upon our strong business model, we believe we are well positioned to capitalize on the anticipated growth in the DVD market, the continuing growth in the CD-ROM market, as well as the growing use of CDs in connection with marketing of Internet, e-commerce and other distribution channels. Operating Approach We believe that our operating approach distinguishes us from our competitors and that the effectiveness of our operating approach has been proven through the growth in our targeted customer base, the retention of our customers and our demonstrated long-term financial performance. Our focused operating approach is based on the following principles. High Capacity Manufacturing Capabilities at a Single Locale. We maintain all of our production and mastering facilities within two buildings, aggregating approximately 112,000 square feet, in Valencia, California. With our current equipment configuration, we have current production capacity of approximately 150 million CDs per year and 30 million DVDs per year. Prior to the end of 2000 we plan to purchase additional replicating machines which will be convertible between DVD and CD. With the purchase of this equipment we will increase our production capacity to 220 million CDs or 150 million CDs and 60 million DVDs. By aggregating our production capacity in a single locale, we can maintain high product yield rates, manage costs and facilitate overall profitability. In addition, we believe we can more closely administer our daily production schedule and quickly respond to unanticipated time sensitive customer requests. Because of our fast turnaround times, we are able to fulfill the replication needs of a national customer base from our 30 Valencia, California facility. We believe we have one of the most efficient facilities in the industry. As compared to others in the industry, our manufacturing facilities are relatively new and were designed to facilitate high volume production. We believe our sales per employee, operating income per employee, operating margins and yield rates historically have been among the highest in the industry. Optimally Designed Manufacturing Facilities. Our manufacturing facilities have been engineered to provide optimal efficiency. The layout of our facilities, coupled with redundant operating systems, has allowed us to efficiently manage operational workflow and to maximize factory throughput. We are able to complete and control all mastering, replication, printing and packaging functions internally without dependence on outside subcontractors. As a result, we believe we have established faster turnaround times for customer orders than most others in the industry. Self-Sufficient Repair, Maintenance and Engineering Capabilities. We operate 24 hours a day, seven days a week, and have staff engineers on the production floor at all times to monitor and maintain a smooth production flow. In order to maximize our machine uptime, we maintain a full machine shop with substantial spare parts inventory for our manufacturing equipment. Our engineering talent, coupled with our investment in spare parts inventory, has allowed us to develop a high degree of self-sufficiency, resulting in higher productivity. We also maintain a close technical working relationship with each of our equipment vendors. Technologically Advanced Manufacturing Equipment. To implement our business model, we have always invested in the most advanced, high volume equipment available. As of December 31, 1999, we have invested approximately $39.1 million in our mastering, replication, printing and packaging equipment. We expect to invest approximately $18.0 million toward the purchase of new equipment during 2000, including $14.1 million of the net proceeds of this offering. Marketing Our Services Directly to Senior Management. Since our business model requires us to attract customers with large annual replication requirements, the selection of the replication vendor by our customers usually has higher visibility and importance at the executive levels. Consequently, we are able to more precisely target our prospective customers and minimize the use of field sales personnel. Alex Sandel, who has extensive relationships in the computer hardware and software industries, spearheads our sales and marketing effort. As a result, we are able to actively target and market our services at the executive level. A strong sales team with substantial experience in the CD replicating business and extensive industry knowledge and contacts supports Mr. Sandel. In addition to our sales team, we plan to utilize the relationships of the members of our board of directors to increase our visibility and penetration with both DVD and CD customers. Growth Strategy In order to foster our continued growth in line with our business model, we plan to pursue the following opportunities. Capitalize on the Continuing Growth of DVD. We commenced our DVD production in the fourth quarter of 1999. In order to continue our participation in this growing market, we have purchased and plan to purchase additional machines that will significantly increase our DVD manufacturing capacity. Through a direct sales effort targeting motion picture production companies, post production and authoring houses and existing edutainment customers, we intend to pursue a marketing strategy targeted at senior executives similar to the one we have successfully implemented in the CD-ROM market. We believe that our location in Southern California, as well as our independence from large entertainment companies, will provide an advantage in obtaining business from independent motion picture production companies as well as overflow work from the major motion picture production companies having captive replicating facilities. We have made and intend to continue to make strategic investments, where appropriate, in selected companies that either currently or in the future may have high volume DVD replication requirements. By making this type of strategic investment, we have the ability to negotiate a long-term exclusive DVD replication agreement. 31 Expand our Position as a Low Cost CD-ROM Manufacturer. Our penetration of the marketplace for CDs is focused on the CD-ROM market with a significant presence among computer software developers and Internet/online providers. Because of our success as a low cost, high volume replicator, we believe we are well positioned to address the growth in the market for CD-ROM. We believe we can offer our customers cost effective CD manufacturing services with turnaround times among the shortest in the industry. In addition to maintaining our existing customer base, we intend to use the contacts of our board of directors and our senior executives' direct selling efforts to expand our customer base to other companies with high volume replicating needs. Stimulate CD Demand through Targeted Internet-Related Marketing Programs. The rise of the Internet and related services has caused various industries to re- examine traditional distribution methods, such as "bricks and mortar" retail stores, direct mail catalogs, television sales and retail-based kiosks, and their connection to online users. This has caused both business-to-business and business-to-consumer companies to alter their marketing and distribution programs in order to address changing market trends caused by growing Internet commerce. In Europe, the CD has been a significant marketing tool, often distributed as inserts to magazines or other publications. In our market, some of our largest customers, such as America Online and Juno, are using CDs as marketing tools. We believe CDs, and potentially DVDs, will play an increasingly important role in the marketing strategy of many e-commerce and catalog companies. CDs are relatively inexpensive to both manufacture and mail. As compared to paper based catalogs, creating an updated or subsequent version of catalogs on CDs and DVDs is generally easier and less expensive. CDs and DVDs also provide interactive functionality and an entertaining means of advertising. Certain of our Internet and e-commerce customers, most notably America Online, have already adopted a technique of mass-mailing CDs for marketing purposes as a cost effective alternative to other methods of advertising. In order to capitalize on this market need, our objective is to assist companies in establishing and producing marketing programs enhancing, promoting and integrating their e-commerce businesses utilizing CDs and DVDs. We will focus on promoting our business through three principal avenues: . the digital production and distribution of product catalogs through CDs and, in the future, DVDs; . e-commerce programs capitalizing on the convergence of traditional retail, catalog, kiosk and online formats through various CD-based applications; and . marketing programs utilizing the CD as an advertising medium used to drive customers to a targeted online destination by either new or existing retailers and e-tailers. 32 Customers We service a broad range of high volume DVD and CD customers. The following table summarizes the principal market segments within DVD and CD-ROM and our market orientation, our current customer base and our estimate of the growth potential of the DVD and CD markets. Customers who are affiliated with us have been identified with an asterisk (*).
Estimated Estimated Selected CD-ROM DVD Market Segment Customers Demand(1) Demand(1) -------------- -------------------------- ---------- --------- (All CD customers except where DVD is indicated) Online Providers These customers are large America Online High Low users due to the continued and growing prevalence of Internet and online services. These customers are attractive to us due to their less seasonal and higher volume requirements. Internet Marketing These customers include Synthonics Technologies* High High "bricks and mortar," direct mail catalog, kiosk and online companies. They are looking to promote their e-commerce presence and integrate it with other distribution channels. The DVD and CD formats can stimulate new customer growth and also connect to the current customer base. Film/Entertainment One of the largest users of A major motion picture Not High DVD products. We are distributor/DVD applicable positioned to penetrate this Lions Gate Entertainment*/ market segment based upon our DVD capacity and rapid turnaround capabilities. Edutainment Software This segment is one of the Havas Interactive High High mass-market segments most GT Interactive appropriately suited to our Interplay speed and quality Encore capabilities. These companies are expected to be large volume users driven by edutainment, games and application software. Microsoft Authorized Replicators and Turnkey Manufacturers These replicators are Modus Media High High authorized by Microsoft to Zomax assemble and distribute Banta operating systems, applications and manuals to computer manufacturers. These companies outsource a significant portion of their CD requirements. Publishing Publishing companies are a infoUSA/CD and DVD High Medium large and increasing user of Ziff/Davis the DVD and CD formats given the continued transition from print to electronic media. This segment is expected to continue to grow because of the low cost of storing a high volume of printed product on DVD or CD. Computer Hardware & Peripherals This is a substantial market 3dfx High Medium sector in which we have a Toshiba demonstrated track record; we Fountain Technology intend to continue to aggressively pursue PC and peripheral manufacturers.
- -------- (1) "High" demand for CD-ROM refers to market segments where the replication and distribution of CDs is either directly a part of the product, such as in software games, or an integral part of the sales and marketing process, as in some online providers. "High" demand for DVD refers to market segments were the DVD format is not only a part of the product or integral part of the sales and marketing process, but also provides additional value added as a result of its enhanced capabilities over the CD-ROM format. Conversely, "low" demand and "medium" demand reflect reduced importance of the format based upon the above criteria. 33 Currently, approximately 40 customers account for substantially all of our net sales. Our top three customers, America Online, Modus Media and Havas Interactive, accounted for approximately 32%, 14% and 10%, respectively, of our net sales for the year ended December 31, 1999. We have expanded our customer base aggressively since our founding in July 1994 primarily due to the focused efforts of our senior management and sales team. We plan to continue expanding and diversifying our customer base in order to reduce our dependence on any one customer and to optimize our production capacity. Specifically, we plan to further expand and diversify our customer base beyond our current presence by further penetrating the Internet, film/entertainment, and publishing industries. Our current customer base is characterized primarily by customers requiring production runs that are annual and ongoing, less cyclical in nature and less time-sensitive, such as America Online and customers with substantial annual production requirements tied to seasonal consumer purchasing trends and product announcement cycles such as Havas Interactive and GT Interactive. To the extent we are successful in our efforts to promote DVD and CD business within the film/entertainment industry or through Internet related marketing programs, we will attract and acquire customers with substantial production requirements revolving around film releases, retail cycles and other planned marketing events. Our large capacity allows us to manage the competing demands of our customers on a daily basis. We work closely with customers to monitor the actual production schedule and the product quality and service delivered. Our business is based primarily on purchase orders. Due to our fast turnaround time, high capacity and strong customer service support, we believe that we have been able to develop excellent relationships with our customers. However, we do not have any significant backlog and we do not typically enter into supply contracts with our customers. As part of our effort to secure certain DVD business, we recently invested $1.7 million in Lions Gate Entertainment, a Canadian production and distribution film and entertainment studio, in order to become affiliated with and establish relationships within the entertainment industry. In December 1999, we purchased 648 units of Lions Gate, each unit consisting of a 5.25% convertible redeemable preferred shares and 425 common share purchase warrants, which at the time represented a less than 5% ownership percentage in Lions Gate on a fully diluted basis. In addition, assuming price and quality are in line with industry standards, we have obtained the right to replicate primarily all of the DVD needs of Lions Gate for a period of two years. Sales and Marketing Our sales and marketing effort is tailored to a customer base consistent with our business model. We have targeted customers who require and depend upon high volume DVD and CD manufacturing capacity. We maintain a focused sales and marketing effort led by Alex Sandel and supported by a strong sales staff who have significant experience in the replication industry. Our sales and marketing efforts are focused on expanding our reach across the United States, across a broader industrial base, to customers in the Internet/online area and to the future users of DVDs and CDs. These efforts are supported by relationships and contacts of our board of directors and sales and marketing team. Develop DVD Customer Base. We believe DVD technology is positioned to become the new medium for home video and the high-capacity medium for software distribution and high-capacity computer games. Home Video: We anticipate DVD demand will continue to grow in the motion picture industry, the primary area utilizing the DVD format today. We intend to broaden our sales and marketing efforts in this industry through relationships certain of our directors have with leading motion picture producers and distributors. In order to further stimulate our growth and broaden our relationships within the entertainment industry, and where appropriate, we intend to continue making strategic investments in selected companies that can direct their DVD replication requirements exclusively to us. As an example, we recently invested $1.7 million in Lions Gate Entertainment, a Canadian production and distribution film and entertainment studio. As part of the investment, we received exclusive rights to all DVD 34 replication needs of Lions Gate for the next three years, assuming price and quality are in line with acceptable industry standards. Additionally, we are marketing to independent post-production companies that provide DVD authoring services to the motion picture industry because of the long-term relationships they have with the movie studios and, in certain cases, the autonomy to independently select the services of DVD replicators. Software Distribution and Computer Games: DVD-ROM drives are becoming increasingly popular. Furthermore, home video game companies, such as Sony, Nintendo and Sega, are introducing home video game consoles that are compatible with the DVD format. Microsoft has also announced its plans to introduce a DVD compatible game console. With this large installed base, which is projected to continue to grow, we believe there will be a growing demand for high-capacity computer games playable on the DVD format. In addition, some of our current customers in the software publishing industry are moving selected product titles to the DVD format. We will be well- positioned to attract future DVD business from our current computer hardware and software customers as a result of our strong relationships and demonstrated performance with these customers. Stimulate CD Demand through Targeted Internet-Related Marketing Programs. As a result of the increasing popularity of the Internet, many companies now have to integrate an Internet strategy with their traditional retail and direct mail marketing strategies. We believe CDs, and potentially DVDs, will play an increasingly important role as part of the marketing strategy of many e- commerce and catalog companies. When a CD or DVD is used as a catalog or promotional tool in the Internet e-commerce space, we believe it will generate high-volume demand. In order to capitalize on this market, our objective is to assist companies to establish and produce marketing programs enhancing, promoting and integrating their e-commerce businesses utilizing CDs and DVDs. We will focus on three principal areas: Targeted Internet Marketing Programs: We believe the CD format is well suited for driving customer traffic to designated online sites because it is less expensive than other advertising media, it can be targeted to an intended audience, it can deliver a dynamic, interactive advertising message and it can deliver to the customer software that currently cannot be delivered via the Internet due to file size concerns. The most notable example of this use, which involves our leading customer, is that of America Online. We are identifying and marketing to our current customers as well as potential customers this technique in stimulating growth in CDs. E-Commerce Programs: The introduction of online and digital capabilities has also introduced new and more engaging ways in which retailers and e- tailers can interact with their customers. There will be application programs that interactively promote commerce. These types of interactive programs may require CDs and DVDs as a program medium. Digital Catalog Business: In order to respond to an increasingly "digital" consumer as well as the increasing popularity of online e- commerce, many direct mail catalog companies are considering various changes to their traditional distribution programs. One possible alternative is the partial or total substitution of the traditional paper- based catalog with a CD or DVD catalog. By following this approach, a company can appeal to the new and growing base of online consumers, "link" and drive traffic to its website, interact with customers in a more entertaining way, and more effectively integrate a customer with its online capabilities. Many customers and potential customers interested in CD or DVD marketing programs lack the knowledge and resources to internally develop and execute these programs. We will oversee the coordination of the overall production process of these programs. We intend to outsource the creative, graphic and production services necessary to implement the above programs. Where the customer handles creative programming, we will carry out our replicating and packaging functions upon delivery of a master from the customer. By following this model, we can stimulate growth in our main business, the replication of DVDs and CDs, while maintaining our core high volume business model. 35 Broader Industry Coverage for CDs. Our marketing efforts have been historically targeted toward companies in the computer hardware and software industries, and we intend to further penetrate these areas. As a result of the rise of the Internet, we will also continue to focus on online service providers and other related companies. Because of our efficiency, high capacity, fast turnaround time and independence within the replicating industry, we have obtained overflow work from other CD replicators that do not have sufficient internal capacity. We only accept orders from replicators who provide such work on a year-round basis. Our main marketing thrust is to attract new customers whose usage patterns are driven by fundamentals that counterbalance the seasonal usage patterns of the computer hardware and software market segments. We believe this strategy helps to balance capacity demands and thereby moderate seasonal fluctuations. Suppliers We seek to reduce costs and enhance quality by purchasing from a limited number of suppliers. We do not maintain any material long-term contracts with our suppliers. However, all raw materials needed to manufacture our products are readily available from multiple suppliers at competitive prices. The principal raw materials used to manufacture DVDs are optical grade polycarbonate, aluminum, nickel, ultraviolet-curable lacquers and ink. Also, certain types of DVDs require a minimal amount of gold. The principal raw materials used to manufacture CDs are the same as those used for manufacturing DVDs, except for gold. Warehousing and Distribution We primarily use common carriers to ship products to customers throughout the United States. We also deliver products by truck directly to a small number of customers who demand direct shipping. To meet the needs of customers distant from our facility, we ship unpackaged or "spindled" DVDs and CDs directly to the customer or its distribution facility. If required, we have relationships with packaging companies in other parts of the United States that would be able to handle individual customer fulfillment needs. We currently believe that this strategy is superior to building multiple manufacturing facilities. The cost to ship unpackaged DVDs or CDs to a packaging company is lower than the investment required to construct, operate and maintain multiple manufacturing facilities. Also, by aggregating our production capacity in a single locale, we believe we can optimize our production capacity, maintain high product yield rates, manage costs and facilitate overall profitability. In addition, we believe we can more closely administer our daily production schedule and quickly respond to large volume, unanticipated time sensitive customer requests. Because of our low-cost structure and fast turnaround times, we are able to fulfill the replication needs of a national customer base from our Valencia, California facility. Seasonality and Backlog Our peak sales activity normally occurs in the four-month period from August through November, as hardware manufacturers and software developers introduce new products before the back-to-school and holiday season. Typically, DVDs and CDs are produced and shipped as orders are received and we operate with virtually no backlog during most of the year. As a result, net sales in any quarter generally are dependent on orders shipped in that quarter. However, we believe focusing our marketing efforts on a more diversified customer base will help reduce the effects of seasonal cycles of our business. For example, to the extent we are successful in our efforts to promote DVD and CD business within the film/entertainment industry or through Internet related marketing programs, we will attract and acquire customers with substantial production requirements revolving around film releases, retail cycles and other planned marketing events, which are not as seasonal as our computer hardware and software customers. Competition The DVD and CD replication industries are highly competitive. We believe that the principal competitive factors in the DVD replicating industry are price, quality, turnaround time, capacity and service and relationships with studios, with price and quality being the most important. We believe the factors listed above 36 are also critical in the CD replicating industry, with price and turnaround time typically being the most important. We believe that we compete favorably with respect to each of these factors in both DVD and CD replicating and that the quality of our products and services, our low cost manufacturing operations, our ability to accommodate tight delivery schedules, and our flexibility in production create significant competitive advantages. The replication industry can be divided into two categories: companies that are affiliated with and are captives of large entertainment companies (music and motion pictures), and independent companies, such as us, that have no affiliation. We compete more directly with the independent replicators, which include: AmericDisc, Carlton Communications PLC, Cinram International, Inc., Denon Electronics, Inc., Disctronics, Inc., DOCdata N.V., JVC Corporation, and Zomax Optical Media, Inc. In addition to the above listed companies, we also compete with foreign manufacturers that can operate at lower costs than us. We do not typically compete directly with captive manufacturers. In some instances, we provide replication services to them to cover their overflow work caused by their own capacity constraints. These captive replicators include the following: Sony Music Entertainment, Inc., Polygram Holdings, Inc., Warner Advanced Media Operations and Warner Music Group (both divisions of Time Warner, Inc.), Bertelsmann Music Group and Capitol-EMI Music. Many of the independent replicators are manufacturers of DVDs and CDs but also other pre-recorded multimedia products including video cassettes, audio cassettes and audio CDs. In addition, certain of these independent replicators consider themselves full outsource service providers offering such services as call center operations, customer support, warehousing inventory management, distribution and fulfillment. We concentrate on providing high volume, low cost DVD and CD replication along with mastering, packaging and fulfillment services which are essential to our customers needs. We believe we distinguish ourselves from our competitors through our strict focus on those replication and affiliated services necessary to meet our customers' requirements for high capacity manufacturing and quick turnaround of DVDs and CDs. We believe we compete favorably with respect to price, quality, turnaround time, capacity and service with our competitors who are independent replicators as well as companies that are captives of large entertainment companies. However, companies that are captives of large entertainment companies as well as some of the independent replicators may have greater resources at their disposal than we do. We may also face indirect competition from broadband online service providers, such as telephone, cable and wireless service providers. However, we believe online delivery of data will not, for the foreseeable future, be a practical alternative for consumers due to significant time and hardware storage requirements to download the capacity of a DVD or CD. DVD and CD Manufacturing Process The DVD and CD manufacturing process consists of three stages. Pre-production. Pre-production of DVDs and CDs consists of three distinct processes: pre-mastering, mastering and electroplating. Through these processes, metal stampers are created which contain tracks with pits and lands holding data in a digital format. The metal stampers are then mounted in the proper injection molding equipment to produce either DVDs or CDs. Pre- production begins with receipt of the customer's data, which is supplied in any number of approved input media. The mastering process forms the master image of the DVD or CD from which the polycarbonate replicas are molded. Mastering begins with the preparation of a glass substrate, which is coated with a thin photo resist layer and placed on a computer-controlled laser beam recorder. The laser exposes a series of areas in the photo-resist layer on the glass plate as the data is transferred from a playback device. Chemicals etch the exposed areas of photo resist layer, producing a series of microscopic "pits" and "lands," or physical representations of the digital information. The glass substrate is then developed and then initialized to produce the glass master. 37 An electroplating unit is then used to electroplate the glass master with nickel vanadium to create the metal master (commonly referred to as the metal "father"). The metal father is then separated from the glass master and electroplated a second time to create an inverted impression on a metal "mother." A further electroplating process is used to produce several stampers from the metal mother. The nickel-plated stampers are punched, polished and mounted in the proper injection molding machine to replicate DVDs or CDs. Replication and Printing. CD replication uses a fully integrated in-line process, which incorporates injection molding machines, metallizing equipment, protective coating machinery and inspection equipment. To begin, optical grade polycarbonate plastic is heated and injected under high pressure into the mold cavity of the machine against the metal stamper. The molding process creates a clear polycarbonate disc with pits on one side containing all of the digitized data. In order to make the disc readable by reflected laser light, a thin layer of reflective aluminum is deposited onto the disc surface by a metallizing machine. A clear protective coating is then applied to the disc by a spin coating device in order to protect the disc from scratches and oxidation and to serve as a base for printing on the disc. An in-line inspection device is used to scan each disc for physical flaws. Thereafter, the disc is ready for label printing, the final step of production. The DVD production process is essentially the same as the CD production process, except that DVD replication entails the use of a special substrate- bonding machine, which is integrated into the replication line itself. In addition, the replication process is slightly different from the production of other CD formats in that each replication line has two presses, which produce two polycarbonate substrates, each one-half the thickness of a standard CD. Information is molded onto a layer or multiple layers of a substrate depending on the specific data requirements. The two substrates are bonded together to form a DVD. A DVD-5 contains 4.7 gigabytes of data molded onto one layer of the polycarbonate substrate. A DVD-10 contains 9.4 gigabytes of data molded into both polycarbonate substrates. A DVD-9 contains approximately 8.5 gigabytes of data molded onto both polycarbonate substrates, one of which is semi- transparent. The semi-transparent layer contains a thin layer of reflective material, usually gold. Post-Production Services. Post-production services primarily involve printing, packaging, fulfillment and distribution, including confectionering, stickering, cellophaning, shrink-wrapping, spine printing, bundling and other services. We maintain equipment to provide for most customer-requested packaging configurations and use temporary labor to manage labor intensive packaging requests. Currently the standard packaging configuration is the jewel box with customer supplied print material on the bottom and top of the box. The jewel box is typically shrink-wrapped for protection. DVD and CD Licenses. We manufacture CDs using patented technology primarily under nonexclusive licenses from U.S. Philips Corporation covering CD-A, CD- ROM, CDV, CD-i and Enhanced Music CD systems for the territory comprised of the United States of America, its territories and possessions and Discovision Associates covering patents relating to the design, manufacture, and sale of optical disc products, compact discs and CD-ROM discs for the territory comprised of the United States of America and Canada and their territories and possessions. Every CD we manufacture is covered by both the U.S. Philips Corporation licenses and the Discovision Associates licenses. These CD licenses generally provide for the payment of royalties based upon the number, type and size of CDs sold. Our license from Discovision Associates continues until the last patent covered by such license expires and our license from U.S. Philips Corporation continues until the earlier of October 1, 2006 or the expiration of the last patent covered by such license. These licenses are standard for the industry and most replicators enter into substantially similar agreements. In order to manufacture/replicate DVDs we must obtain licenses from U.S. Philips Corporation and Sony Corporation for certain patented DVD technology. We have entered into a nonexclusive DVD license with U.S. Philips Corporation covering the use of DVD Video Disc and DVD ROM Disc Patents, for the territory comprised of the United States of America, its territories and possessions. We have also entered into a nonexclusive DVD license with U.S. Philips Corporation covering the use of AC-3 technology developed by 38 Dolby Laboratories for the territory comprised of the United States of America, its territories and possessions. Every DVD we manufacture is covered by each of these licenses we have from U.S. Philips Corporation. These licenses from U.S. Philips Corporation continue until October 1, 2009. Additionally, we believe we have finalized a nonexclusive DVD licensing agreement with Sony Corporation to use Sony Corporation's patented DVD technology. We are currently awaiting the receipt of the executed copy of this DVD licensing agreement with Sony Corporation. These DVD licenses generally provide for the payment of royalties based upon the number and type of DVDs sold. Employees At March 31, 2000, we had 140 full-time employees, including 3 engaged in sales and marketing, 13 engaged in general administration and finance and 124 engaged in DVD and CD replicating/manufacturing. In addition, we use temporary employees in varying numbers throughout the year, who are primarily engaged in packaging. We rely on our ability to vary the number of part-time and temporary employees in order to respond to fluctuating market demand for our packaging services. None of our employees are covered by a collective bargaining agreement. We believe we have a good relationship with our employees. Properties Our executive offices and manufacturing, sales and marketing operations are located at 24811 Avenue Rockefeller, Valencia, California, where we lease approximately 83,000 square feet of space. This lease expires on December 31, 2013. Our mastering facilities are located near our executive offices at 24833 Anza Drive, Valencia, California, in leased facilities occupying an aggregate of approximately 28,500 square feet of space. This lease expires on May 31, 2007. We are currently negotiating the release from our lease for the property located 25136 Anza Drive in Valencia, and we do not believe that this will result in any material out-of-pocket costs to us. We believe that our new facilities will be adequate to meet our projected needs for the foreseeable future. Legal Proceedings We are not involved in any pending, nor are we aware of any threatened, legal proceedings which we believe could reasonably be expected to have a material adverse effect on our business, operating results or financial condition. 39 MANAGEMENT Directors and Executive Officers The following table sets forth certain information with respect to our directors and executive officers as of February 15, 2000:
Name Age Position - ---- --- -------- Alex Sandel.................. 57 Chairman of the Board, Chief Executive Officer and President David Moss................... 39 Vice President--Operations Louis L. Weiss............... 49 Chief Financial Officer, Principal Accounting Officer and Secretary Sanford R. Climan(1)(2)...... 44 Director Mark Dyne(1)(2).............. 39 Director Diana Maranon................ 41 Director Jason Barzilay............... 47 Director Martin Schuerman(1).......... 34 Director
- -------- (1) Member of the Audit Committee. (2) Member of the Compensation Committee. Directors are elected at each annual meeting of shareholders and hold office until the following annual meeting and their successors are duly elected and qualified. Our Bylaws presently provide the number of directors shall not be less than five nor more than nine, with the exact number to be fixed from time to time by resolution of our board of directors. The current number of directors is fixed at seven. The remaining directors may fill any vacancy on the board of directors, including a vacancy resulting from an increase in the size of the board of directors. The board of directors cannot decrease the number of directors or shorten the term of any incumbent director. The board of directors appoints the executive officers and subject to employment contracts, such officers serve at the discretion of the board of directors. Alex Sandel is one of our co-founders and he has served as our Chairman of the Board, Chief Executive Officer and President since we were founded in June 1994. Mr. Sandel was one of the original founders of Packard Bell Electronics (1986), an innovative PC manufacturer that was first to market PCs via traditional consumer electronics retail outlets. Mr. Sandel served as a director of Packard Bell Electronics since its inception until 1999. Mr. Sandel is also a principal shareholder in Argoguest, Inc., an incubator focused on investing in early stage Israeli-based Internet and Internet enabling technology companies. From December 1994 through December 1997, Mr. Sandel served as a director and President of Cal Circuit Abco II, Inc., a distributor of computer memory products. From 1983 until December 1994, Mr. Sandel served as a director and President of Cal Circuit Abco, Inc. which operated as a distributor of computer memory and peripheral components to the personal computer industry. In December 1994, certain assets of Cal Circuit Abco, Inc. were spun off to form Cal Circuit Abco II, Inc., and Mr. Sandel served as President and a director of Cal Circuit Abco, II, until 1997. Also in December 1994, Cal Circuit Abco, Inc. changed its name to Reveal Computer Products Inc. and continued operating under the management of Jason Barzilay until it filed for bankruptcy in 1996. Mr. Sandel has founded, managed and held engineering positions with several companies over the past thirty years. He was educated at the Israeli Institute of Technology, Haifa, Israel. While continuing his education in the United States, he received his BSEE from California State College, Pomona, California (1969) and MSOR from the University of Southern California (1974). David Moss has served as our Vice President--Operations since our founding in June 1994. From May 1993 through May 1994, Mr. Moss served as Vice President and General Manager of ASR Recording, a 40 manufacturer of CDs. From April 1991 through April 1993, Mr. Moss served as director of manufacturing at Denon Digital, also a manufacturer of CDs. Mr. Moss has worked in the CD and other media replication business for 15 years. He has a B.A. degree in Production and Operation Management and a B.A. degree in Computer Science, both from California State University at Northridge. Louis L. Weiss joined us in May 1998 as Chief Financial Officer and Principal Accounting Officer. From December 1996 through April 1998, Mr. Weiss served as Chief Financial Officer of P.D.I. Industries, Inc., a pharmaceuticals distributor. From January 1996 through September 1996, Mr. Weiss served as Chief Financial Officer of Cardkey Industries, a manufacturer of keycards for building security systems. From June 1992 through December 1995, Mr. Weiss served as President of LLW Associates, a financial consulting firm founded by Mr. Weiss. Mr. Weiss is a Certified Public Accountant (inactive status) and he has a B.B.A. and M.B.A. from the University of Wisconsin. Sanford R. Climan has served as a Director since August 1998. Mr. Climan is Managing Director of Entertainment Media Ventures (EMV), a Los Angeles-based venture capital fund focused on investment in the areas of technology, media, and the Internet. From October 1995 through May 1997, Mr. Climan was Executive Vice President and President of Worldwide Business Development for Universal Studios, Inc., where he oversaw corporate international strategy and the following Universal Studios operating units: Consumer Products; Home Video; Pay Television; New Media; Spencer Gifts and Strategic Marketing. From June 1997 through February 1999 and from June 1986 to September 1995, Mr. Climan was a member of the senior management team at Creative Artists Agency, a leading talent and literary representation firm, working with both talent and corporate clients. Prior to joining CAA, Mr. Climan held executive positions at various entertainment companies, working in general management capacities, as well as overseeing areas of motion picture and television production and distribution. Mr. Climan serves as a director of a number of public and private companies. Mr. Climan received his B.A. from Harvard College, a M.S. in Health Policy and Management from the Harvard School of Public Health and his M.B.A. from Harvard Business School. Mark Dyne has served as a Director since August 1998. Since October 1996, Mr. Dyne has served as Chairman of the Board of Directors and as Chief Executive Officer of Brilliant Digital Entertainment, Inc., a production and development studio producing digital entertainment. Currently, Mr. Dyne is a Director of Ozisoft Pty. Limited, a company he founded in 1982. From November 1998 through January 2000, Mr. Dyne was Chief Executive Officer of Virgin Interactive Entertainment. From June 1995 through May 1997, Mr. Dyne served as an executive officer of Sega Enterprises (Australia) Pty., Ltd., a theme park developer, which operated the $70 million interactive indoor theme park in Darling Harbor in Sydney, Australia. Moreover, currently, Mr. Dyne is Chairman of the Board of Directors of Tag-It Pacific, Inc., a manufacturer of buttons, tags and other apparel trim products, and a director of Talent Connection.com, an entertainment portal. Diana Maranon has served as a Director since August 1998. Ms. Maranon is the President and Managing Director of Averil Capital Markets Group, Inc., a financial advisory firm, and a member of the National Association of Securities Dealers. Ms. Maranon serves as a director of Brilliant Digital Entertainment, Inc. Before founding Averil Capital Markets Group, Inc., in 1994, Ms. Maranon was a Vice President with Wasserstein Perella & Co., Inc., an investment banking firm, with whom she started in 1988. From 1985 to 1988, Ms. Maranon practiced securities law with Skadden Arps Slate Meagher & Flom, LLP. Ms. Maranon received J.D. and M.B.A. degrees from the University of California at Los Angeles and is a member of the California Bar. Jason Barzilay is one of our co-founders and served as a Director from our founding until 1998. In April 2000, Mr. Barzilay rejoined our Board as a Director. Mr. Barzilay was one of the original founders of Packard Bell Electronics, an innovative PC manufacturer that was first to market PCs via traditional consumer electronics retail outlets. Mr. Barzilay served as a Director of Packard Bell Electronics from its inception in 1986 until 1999. In 1996 Mr. Barzilay founded Argoquest, Inc., a private venture capital firm. Mr. Barzilay serves as a Director to a number of companies that are part of Argoquest, Inc.'s portfolio of start-up companies. In 1983, Mr. Barzilay co- founded Cal Circuit Abco, Inc., a distributor of computer memory and peripheral components to the personal computer industry. In December 1994, Cal Circuit Abco, Inc. changed its name to 41 Reveal Computer Products, Inc. Mr. Barzilay served as Chief Executive Officer and President of Reveal Computer Products from 1992 until it filed for bankruptcy in 1996. Martin Schuermann has served as a Director since April 2000. From 1995 to 1999, Mr. Schuermann was the Managing Director of CLT-UFA Los Angeles and US Representative CLT-UFA, S.A., Europe's largest TV-company with interests in 22 television channels with 120 million daily viewers and 18 radio stations with an estimated 25 million daily listeners. From 1994 to 1995 Mr. Schuermann was a producer with Paramount Pictures (International Co-Productions). From 1992 to 1994 he was the Executive Vice President for Don Johnson Productions at Paramount Pictures. Mr. Schuermann is a member of the Supervising Board of INTERTAINMENT AG, a leading media company that is listed on Germany's "Neuer Market" stock exchange. Board Committees The board of directors will maintain an audit committee and a compensation committee. The audit committee will review the scope of our audits, the engagement of our independent auditors and their audit reports. The members of the audit committee are Sanford Climan, Mark Dyne and Martin Schuermann. The compensation committee will evaluate our compensation policies and administer our stock option plan. The members of the compensation committee are Sanford Climan and Mark Dyne. Director Compensation We intend to pay non-employee directors fees of $1,500 for each meeting personally attended and $500 for each telephonic meeting attended. In addition, our directors are eligible to receive grants under our stock incentive plans. As of the date of this prospectus, our current non-employee directors have received options to purchase a total of 346,500 shares of our common stock. On August 31, 1998 we granted options to 4 non-employee directors to purchase an aggregate of 297,000 shares of our common stock at $7.21 per share. These options vest over a three or four year period and will expire on August 31, 2001 and 2002. On April 13, 2000 we granted an option to a non-employee director to purchase an aggregate of 49,500 shares of our common stock at a price equal to the initial sales price for the shares sold pursuant to this offering assuming the closing of this offering occurs prior to July 2000. These options vest over a four year period and will expire on April 13, 2004. Our directors are also reimbursed for their reasonable travel expenses incurred in attending board or committee meetings. In 1999, our shareholders committed to give 49,500 shares of their stock to Mark Dyne for advisory services he has provided to us, including customer development. These shares were valued at approximately $720,000. We have entered into an engagement agreement with Averil Capital Markets Group, Inc., a financial advisory firm founded and controlled by Diana Maranor, who is also one of our directors. As consideration for services rendered in connection with this offering, we have agreed to pay Averil Capital Markets Group. Inc. a cash payment of 0.75% of the gross proceeds raised upon consummation of this offering and warrants to purchase shares of our common stock equivalent to 0.25% of the gross proceeds raised at an exercise price equal to 110% of the initial public offering price. The number of warrants to be issued will be based on a compensation value of $175,000, will vest upon the closing of this offering and will expire three years from the closing of this offering. Compensation Committee Interlocks and Insider Participation We did not have a compensation committee for the fiscal year ended December 31, 1999. Our board of directors made all decisions regarding executive compensation for the fiscal year ended December 31, 1999. No interlocking relationship exists between any member of our compensation committee and any member of any other company's board of directors or compensation committee. 42 Executive Compensation The following table presents both cash and noncash compensation paid or to be paid by us to each of our executive officers who received compensation for the year ended December 31, 1999 in excess of $100,000: Summary Compensation Table
Annual Compensation Year Ended ---------------- Name and Principal Position December 31 Salary Bonus - --------------------------- ----------- -------- ------- Alex Sandel, Chief Executive Officer and President....................................... 1999 $540,000 -- David Moss, Vice President--Operations........... 1999 $461,561 $52,000 Louis Weiss, Chief Financial Officer............. 1999 $228,894 --
Employment Agreements with Executive Officers David Moss has an employment agreement with us. According to his agreement, he is entitled to a salary of $395,000 per year subject to automatic annual increases of six percent. The compensation committee can make further salary increase adjustments to Mr. Moss' agreement if they choose to do so. In addition, the compensation committee can grant bonus compensation to Mr. Moss including stock option grants to purchase shares of our common stock. During the term of his employment agreement we will pay 100% of the premium on term life insurance having a face value payable on the death of Mr. Moss of no less than $1,000,000. If Mr. Moss' employment is terminated without cause, he will be entitled to severance pay at his then-current annual salary, including the automatic annual increases of six percent, through the expiration of his employment agreement plus a lump sum payment of $1,000,000. Mr. Moss' employment agreement is effective August 26, 1998 through August 26, 2003, subject to extension through August 26, 2006 upon our written consent and Mr. Moss' written consent. Fiscal Year-End Option Values
Number of Securities Value of Unexercised Underlying Unexercised In-The-Money Options and Options and Warrants Warrants at Fiscal Year- at Fiscal Year-End End Name Exercisable/Unexercisable Exercisable/Unexercisable - ---- ------------------------- ------------------------- Alex Sandel, Chief Executive Officer and President................ 113,025/339,075 $758,398/$2,275,193 David Moss, Vice President--Operations.... 664,703/179,437 $8,567,360/$1,204,022 Louis Weiss, Chief Financial Officer........ 35,063/105,187 $235,272/$705,805
Stock Plan We adopted a stock incentive plan in May 1998. Each of our executive officers, other employees, non-employee directors or consultants is eligible to be considered for the grant of awards under our 1998 stock incentive plan. A maximum of 1,598,350 shares of common stock may be issued under our 1998 stock incentive plan. If any award expires or terminates for any reason, then the common stock subject to that award will again be available for issuance under our 1998 stock incentive plan. We also adopted a stock incentive plan in April 2000. Each of our executive officers, other employees, non-employee directors or consultants is eligible to be considered for the grant of awards under our 2000 stock incentive plan. A maximum of 1,651,650 shares of common stock may be issued under our 2000 stock incentive plan. If any award expires or terminates for any reason, then the common stock subject to that award will again be available for issuance under our 2000 stock incentive plan. Our board of directors or a committee of two or more non-employee directors appointed by the board of directors will administer our 1998 and 2000 stock incentive plans. The administrator will have full and final 43 authority to select the executives and other employees to whom awards will be granted. Additionally, the administrator will have the full and final authority to grant the awards and to determine the terms and conditions of the awards and the number of shares to be issued. Awards. Our 1998 and 2000 stock incentive plans authorize the administrator to enter into both incentive and non-statutory options. An award under the 1998 or 2000 stock incentive plan may permit the recipient to pay the entire purchase price of the shares by delivering previously owned shares of our capital stock. Plan Duration. Our board of directors adopted our 1998 stock incentive plan on May 7, 1998 and on the same day our shareholders approved the plan. Our 1998 stock incentive plan was subsequently amended on August 25, 1998. Our shareholders approved the amendment on the same day. As of the date of this prospectus, our board of directors has granted options covering an aggregate of 1,598,350 shares of our common stock to our directors, officers and employees, with a weighted average exercise price of $7.74 per share pursuant to the 1998 stock incentive plan. The options pursuant to the 1998 stock incentive plan will typically vest in four equal annual installments commencing on the first anniversary of the date of grant. We have granted all of the shares available under our 1998 stock incentive plan and any future grant will be pursuant to our 2000 stock incentive plan. Our board of directors adopted our 2000 stock incentive plan on April 13, 2000. The 2000 stock incentive plan was approved by the shareholders on the same day and has not since been amended. 1,651,650 shares of our common stock are reserved for issuance pursuant to the 2000 stock incentive plan. As of the date of this prospectus, our board of directors has not granted any options pursuant to this plan. The options pursuant to the 2000 stock incentive plan will typically vest in four equal annual installments commencing on the first anniversary of the date of grant. Any award duly granted on or prior to April 13, 2010 may be exercised or settled in accordance with its terms. No award may be granted on or after April 13, 2010. Amendments. The administrator may amend or terminate our 1998 and 2000 stock incentive plans at any time and in any manner. However, no recipient of any option may be deprived of any of his or her rights under the option as a result of any amendment or termination without his or her consent. Shareholder approval is required to increase the number of shares available for issuance under our 1998 our 2000 stock incentive plans. Form S-8 Registration. We intend to file a registration statement under the Securities Act to register the 1,598,350 shares of our common stock reserved for issuance under our 1998 stock incentive plan, 1,651,650 shares of our common stock reserved for issuance under our 2000 stock incentive plan and the 604,890 shares issuable upon David Moss' exercise of his warrants. The registration statement is expected to be filed shortly following the date of this prospectus and will become effective immediately upon filing with the Securities and Exchange Commission. Shares issued under our 2000 stock incentive plan after the effective date of this registration statement generally will be available for sale to the public without restriction, except for the 180-day lock-up provisions and except for shares issued to our affiliates, which will remain subject to the volume and manner of sale limitations of Rule 144. See "Shares Eligible for Future Sale." Limitation of Liability and Indemnification Matters Our Articles of Incorporation include a provision eliminating the personal liability of our directors to us and to our shareholders for monetary damages for breach of the director's fiduciary duties in certain circumstances. This limitation has no effect on a director's liability for any of the following: . for acts or omissions involving intentional misconduct or a knowing and culpable violation of law; . for acts or omissions a director believes to be contrary to our best interest or to the best interest of our shareholders; . for acts or omissions involving the absence of good faith on the part of the director; . for any transaction from which a director derived an improper personal benefit; 44 . for acts or omissions showing a reckless disregard for the director's duty to us or to our shareholders in circumstances in which the director was aware, or should have been aware, in the ordinary course of performing a director's duties, of a risk of serious injury to us or to our shareholders; . for acts or omissions constituting an unexcused pattern of inattention amounting to abdication of the director's duty to us or to our shareholders; . under Section 310 of the California Corporations Code (concerning contracts or transactions between a director and us); or . under Section 316 of the California Corporations Code (concerning director's liability for improper dividends, loan and guarantees). This limitation of liability does not apply to a director acting in his capacity as an officer. Further, this limitation of liability provision does not affect the availability of injunctions and other equitable remedies available including injunctive relief or recession. Our Articles of Incorporation and Bylaws provide indemnification of our directors and executive officers and discretionary indemnification of our other officers and employees and other agents to the fullest extent permitted by law. Pursuant to this provision, our Bylaws provide for indemnification of our directors, officers and employees. In addition, we may provide indemnification to persons whom we are not obligated to indemnify. The Bylaws also allow us to enter into indemnity agreements with individual directors, officers, employees and other agents. We have entered into indemnification agreements designed to provide the maximum indemnification permitted by law with all our directors and executive officers. These agreements, together with our Bylaws and Articles of Incorporation, may require us, among other things, to indemnify these directors against certain liabilities that arise by reason of their status or service as directors (other than liabilities resulting from willful misconduct of a culpable nature), to advance expenses to them as they are incurred, provided they undertake to repay the amount advanced if it is ultimately determined by a court that are not entitled to indemnification, and to obtain directors' and officers' insurance if available on reasonable terms. We maintain director and officer liability insurance. Section 317 of the California Code, our Bylaws and our indemnification agreements with our directors and executive officers make provision for the indemnification of officers, directors and other corporate agents in terms sufficiently broad to indemnify such persons, under certain circumstances, for liabilities (including reimbursement of expenses incurred) arising under the Securities Act. Insofar as indemnification for liabilities arising under the Securities Act may be permitted to our directors, officers, and controlling persons pursuant to the foregoing provisions, or otherwise, we have been advised 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. 45 RELATED PARTY TRANSACTIONS General Shareholder Transactions We have been treated as an S Corporation since our inception. We distributed an aggregate of approximately $28.2 million in dividends, of which approximately $24.2 million were cash dividends to our shareholders from January 1, 1997 through March 1, 2000. These dividends were paid to our shareholders to pay their income taxes ($10.1 million), and as a return of their investment ($18.1 million). We intend to pay dividends aggregating approximately $9.3 million to our shareholders prior to the closing of this offering as a distribution of retained earnings, including an amount of approximately $1.8 million for the purpose of paying income taxes on 2000 S Corporation earnings. Our current shareholders have personally guaranteed repayment of the Greyrock bank debt. Upon completion of this offering and the application of the net proceeds to repay the loan from Greyrock, the shareholder guarantees will terminate. See "Use of Proceeds." Our current shareholders have entered into a tax indemnification agreement with us relating to their respective income tax liabilities. See "Termination of S Corporation Status." Loans to Officers, Directors and Shareholders In January 2000, we loaned $2,630,000 to Alex Sandel for the partial payment for the purchase of shares of our stock from a former shareholder. The loan is evidenced by a note bearing interest at our borrowing rate from Greyrock (prime plus 2%). If we have no borrowings outstanding from Greyrock the note bears interest at prime plus 1%. As of April 30, 2000 we have accrued $86,370 interest under this note. We expect this note to be repaid in full prior to or concurrently with the closing of this offering. During 1999, we made non-interest bearing loans to Alex Sandel totaling $1,427,000 and interest bearing loans totaling $1,075,000 (interest accrued at our borrowing rate from Greyrock, at prime plus 2%). These loans were repaid in their entirety during 1999 except for interest accrued, totaling approximately $72,000, which was subsequently forgiven by our board of directors. In December 1999, we made advances totaling $2,500,000 to Jason Barzilay, one of our shareholders for the purpose of investment in Argoquest. This amount was repaid before the end of 1999. During 1999, we also made a loan of $1,000,000 to a company owned by Alex Sandel and Jason Barzilay for the purpose of investment in Argoquest, which was repaid before the end of the year. Interest on these loans totaling $7,520 accrued at our borrowing rate from Greyrock. In connection with the warrants to purchase 604,890 shares of our common stock, for an exercise price of $.0010 per share, issued to David Moss, our Vice President--Operations, we loaned him a total of $1,428,000 in 1999 under promissory notes bearing compound interest at the rate of 4.6% per annum, in order to allow him to pay the federal and state taxes due as a result of the receipt of the warrants. The unpaid principal balance and any accrued but unpaid interest shall be due and payable on the earlier of: (1) January 1, 2006; or (2) the fifteenth day following the date of delivery of written demand for payment made at any time after the later of (a) the closing of a liquidity event (which includes this offering), or (b) if applicable, the expiration of any lock-up period imposed in connection with such liquidity event on our common stock held by David Moss. During July 1998 we made advances totaling $1,500,000 to Beny Alagem, a shareholder at that time. These advances were repaid in August 1998. Business Relationships with Officers, Directors and Shareholders From November 1999 through February 2000, we made rental payments on a new facility totaling $172,000 to a company owned by Alex Sandel, our president and majority shareholder. In March 2000 we entered into a lease agreement through December 31, 2013 with this company. The lease calls for monthly base rent of $52,843, with annual increases based on the Consumer Price Index. In addition, at the end of the fifth and tenth years the monthly base rent is to be adjusted to fair market value as determined by the parties. We 46 believe the lease, including the amount of the lease payments, is on terms similar with those currently prevailing in the market and no less favorable than would be obtained with an independent third party. In December 1999, we invested $500,000 in Synthonics Technologies, Inc., a company which owns various patents in 3D modeling, in return for a note convertible into 11,518,096 shares of Synthonics common stock, which at the time represented approximately 38% of Synthonics outstanding shares. In addition, we agreed to replicate and package up to 2 million CDs without charge to Synthonics and establish a catalog entity to develop and produce 3D interactive digital catalogs on behalf of Synthonics for its customers. At the time of the investment, Diana Maranon, one of our directors, was a member of the board of directors of Synthonics. Our agreement with Synthonics grants us exclusive rights to all DVD and CD replication needs of Synthonics for a period of five years, assuming price and quality are in line with industry standards. Since September 1997, Averil Capital Markets Group, Inc., a financial advisory firm founded and controlled by Diana Maranon, has performed various services for us including investigation of strategic and financing alternatives. As consideration for these services rendered, we have paid Averil Capital Markets Group, Inc. approximately $186,184, including expenses. As consideration for services rendered in connection with this offering, we have agreed to pay Averil Capital Markets Group, Inc. a cash payment of 0.75% of the gross proceeds raised upon consummation of this offering and warrants to purchase shares of our common stock equivalent to 0.25% of the gross proceeds raised by the Company at an exercise price equal to 110% of the initial public offering price. The warrants given to Averil Capital Markets Group, Inc. will become exercisable on the first anniversary of this offering. We have entered into an indemnification agreement with Averil Capital Markets Group, Inc. pursuant to which we will indemnify Averil Capital Markets Group, Inc. and Ms. Maranon against any amounts these parties may become obligated to pay in connection with Ms. Maranon's service as one of our directors and her consulting services to us. We lease one of our two facilities in Valencia, California, from Bascal Properties II, a partnership owned by our existing shareholders. This lease expires in May 2007 and currently provides for a monthly base rent of $20,000, with periodic adjustments based on the consumer price index. We believe this lease is at prevailing market rates for similar properties. Rental payments to Bascal Properties II were $240,000 for the year ended December 31, 1999, $240,000 for the year ended December 31, 1998 and $140,000 for the year ended December 31, 1997. In June 1997, we loaned approximately $1.9 million to Bascal Properties II. This loan bore interest at prime plus two percent and was repaid in full in September 1997. On November 1, 1997, we entered into a Purchase and Sale Agreement with Packard Bell NEC. The Packard Bell NEC Agreement governed our relationship with Packard Bell NEC with respect to the procedures for ordering, pricing and delivering products, as well as product warranties. Pursuant to the Packard Bell NEC Agreement, Packard Bell NEC agreed to purchase from us substantially all of its United States requirements for CDs, so long as the pricing, terms, conditions and quality of the CDs being sold by us were at least as favorable as those available from any other third party supplier. The Packard Bell NEC Agreement expired in November 1999. At the time this agreement was entered into, our current shareholders owned a significant minority interest in Packard Bell NEC and Alex Sandel was a director of Packard Bell NEC. Historically, significant portions of our net sales have been to Packard Bell NEC. Our net sales to Packard Bell NEC were approximately $554,000 for the year ended December 31, 1999, $5.3 million for the year ended December 31, 1998, $12.1 million for the year ended December 31, 1997, $14.2 million for the year ended December 31, 1996 and $20.9 million for the year ended December 31, 1995. Such sales represented approximately 1.0% of our net sales for the year ended December 31, 1999, 12.4% of our net sales for the year ended December 31, 1998, 33.5% of our net sales for the year ended December 31, 1997, 55.3% of our net sales for the year ended December 31, 1996 and 65.8% of our net sales for the year ended December 31, 1995. At December 31, 1999, accounts receivable from Packard Bell NEC were approximately $23,000, or 0.3% of total trade receivables as of such date. 47 We had net sales to Reveal Computer Products (formerly named Cal Circuit Abco, Inc. prior to December 1994), a re-packager of computer peripherals managed by Jason Barzilay and controlled by our current and former shareholders, amounting to $35,000 for the year ended December 31, 1996 and $4,212,000 for the year ended December 31, 1995. At the time we sold products to Reveal Computer Products we expected to receive all amounts due from Reveal Computer Products. During the second quarter of 1996, we wrote off accounts receivable balances of $1,559,000 due from Reveal Computer Products. Moreover, from June 1995 to November 1995, we loaned an aggregate of approximately $3.3 million to Reveal Computer Products bearing interest at prime plus three percent. At the time we made the loans to Reveal Computer Products, we expected that Reveal Computer Products would be able to repay such amounts. We determined this amount was uncollectible and reserved for it at December 31, 1995. We ultimately wrote off such amount in 1996, the same year Reveal Computer Products entered bankruptcy and ceased operations. On October 8, 1996 an involuntary Chapter 7 petition was filed against Reveal Computer Products. A Consent to Entry of Order Relief under Chapter 7 was filed and entered on November 25, 1996. In September 1998, as part of Reveal's bankruptcy proceeding, the bankruptcy trustee instituted an action against us and Jason Barzilay seeking to recover certain alleged preferential transfers from Reveal. In April 2000, the allegations against us were dismissed. Jason Barzilay settled the trustee's claim without acknowledgement of any wrongdoing. Other than our decision to forgive interest on certain loans made to our shareholders, we believe that the terms of the foregoing transactions were no less favorable to us than we would expect to negotiate with an unrelated third party. Future transactions with related parties will require the approval of our disinterested directors and will be on terms no less favorable to us than those that could be obtained from unrelated third parties. 48 PRINCIPAL AND SELLING SHAREHOLDERS The following table presents information regarding the beneficial ownership of our common stock as of May 1, 2000, and as adjusted to reflect our sale of shares of our common stock and the selling shareholders sale of our common stock offered by this prospectus, for: . each person who is known to us to be the beneficial owner of more than 5% of our outstanding common stock; . each of our directors; and . the named executive officers as a group. The address of each person listed is in care of us, at 24811 Avenue Rockefeller, Valencia, California 91355, unless otherwise provided below such person's name.
Shares Beneficially Shares Beneficially Owned Prior to Owned After the Offering(1) Offering --------------------- Number of ---------------------- Number of Percent of Shares Number of Percent of Name of Beneficial Owner Shares Class Offered Shares Class - ------------------------ ---------- ---------- --------- --------- ---------- Alex Sandel(2)........... 10,126,050 67.2% Jason Barzilay........... 4,950,000 33.3% David Moss(3)............ 724,515 4.7% Louis Weiss(4)........... 70,125 * 70,125 * Sanford R. Climan(4)(5).. 49,500 * 49,500 * Mark Dyne(4)(6).......... 12,375 * 61,875(9) * Diana Maranon(4)(7)...... 12,375 * 12,375 * Martin Schuermann........ -- * -- * All of the directors and executive officers as a group (eight persons)(8)............. 15,944,940 100.0%
- -------- * Less than one percent. (1) Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission that deem shares to be beneficially owned by any person who has or shares voting or investment power with respect to such shares. Shares of common stock under warrants or options currently exercisable or exercisable within 60 days of the date of this offering are deemed outstanding for purposes of computing the percentage ownership of the person holding such warrants or options but are not deemed outstanding for computing the percentage ownership of any other person. Unless otherwise indicated, the persons named in this table have sole voting and sole investment power with respect to all shares shown as beneficially owned, subject to community property laws where applicable. (2) Includes 239,250 shares of common stock, which may be purchased upon exercise of options that are currently exercisable. (3) Includes 604,890 shares of common stock, which may be purchased upon exercise of warrants that are currently exercisable and 119,625 shares of common stock, which may be purchased upon exercise of options that are currently exercisable. (4) Represents shares of common stock, which may be purchased upon exercise of options that are currently exercisable. (5) Mr. Climan's address is c/o Entertainment Media Ventures, LLC, 828 Moraga Drive Second Floor, Los Angeles, California 90049. (6) Mr. Dyne's address is c/o Brilliant Digital Entertainment, Inc., 6355 Topanga Canyon Boulevard, Suite 513, Woodland Hills, California 91367. (7) Ms. Maranon's address is c/o Averil Capital Markets Group, Inc., 2029 Century Park East, Suite 1900, Century City, California 90067. (8) Includes 1,108,140 shares of common stock, which may be purchased upon exercise of warrants and options that are currently exercisable. (9) Includes 49,500 shares to be given by the existing shareholders to Mr. Dyne. 49 DESCRIPTION OF CAPITAL STOCK We are authorized to issue 75,000,000 shares of our common stock, no par value and 10,000,000 shares of preferred stock, no par value. As of March 1, 2000, there were 14,850,000 shares of our common stock outstanding and there were two holders of record of the common stock. Currently, there are no shares of preferred stock outstanding. The following statements are brief summaries of our capital stock. Common Stock The holders of common stock are entitled to one vote for each share held of record on all matters on which the holders of common stock are entitled to vote and have cumulative voting rights with respect to the election of directors. The right to cumulate votes will automatically cease as of the first record date of our annual meeting of shareholders where we have at least 800 holders of our equity securities. The holders of our common stock are entitled to receive dividends in proportion to their ownership when, as and if declared by our board of directors out of legally available funds. In the event of our liquidation, dissolution or winding up, the holders of common stock are entitled subject to the rights of holders of preferred stock issued by us, if any, to share proportionally in all assets remaining available for distribution to them after payment of liabilities and after provision is made for each class of stock, if any, having preference over the common stock. The holders of common stock have no preemptive or conversion rights and they are not subject to further calls or assessments by us. Our common stock does not have any redemption or sinking fund provisions. The outstanding shares of our common stock are, and the common stock issuable pursuant to this offering will be, when issued, fully paid and nonassessable. Preferred Stock Our board of directors has the authority to issue the authorized and unissued preferred stock in one or more series and our board of directors may determine the designations, rights and preferences of the preferred stock. Accordingly, and without the need for shareholder approval, our board of directors has the power to issue preferred stock with dividend, liquidation, conversion, voting or other rights, which adversely affect the voting power or other rights of the holders of our common stock. In the event of issuance, and under certain circumstances, we could use our preferred stock as a way of discouraging, delaying or preventing an acquisition or a change in our control. We do not currently intend to issue any shares of our preferred stock. Warrants We have granted to David Moss warrants to purchase 604,890 shares of our common stock. The warrants granted to David Moss expire on December 31, 2007 and are exercisable for $0.0010 per share. None of the warrants granted to David Moss will have any voting rights, dividend rights or preferences until such time as they are exercised for shares of our common stock. Effective upon the closing of this offering, we will grant to Averil Capital Markets Group, Inc. warrants to purchase shares of our common stock equivalent to 0.25% of the gross proceeds raised in this offering with an exercise price equal to 110% of the initial public offering price. The warrants granted to Averil Capital Markets Group, Inc. expire five years after they are granted. See "Certain Relationships and Related Transactions." We intend to grant warrants to purchase 25,000 shares of our common stock to Levy, Small and Lallas for legal services rendered to us in connection with this offering. The warrants to be granted Levy, Small and Lallas are contingent upon the closing of this offering, will be granted at the initial public offering price and will expire one year from the close of this offering. Possible Anti-Takeover Effect of Certain Charter Provisions The holders of our common stock are currently entitled to one vote for each share held of record on all matters submitted to a vote of the shareholders other than the election of directors, in which event any holder may demand cumulative voting. Under cumulative voting, the holders of common stock are entitled to cast for each share held the number of votes equal to the number of directors to be elected, which is currently seven. A holder may cast all of his or her votes for one nominee or distribute them among any number of nominees for 50 election. Our Amended and Restated Articles of Incorporation provide that the shareholders' right to cumulative voting will terminate when we become a "listed corporation" within the meaning of Section 301.5 of the California General Corporation Law. Under Section 301.5 of the California General Corporation Law we will be a "listed corporation" when our shares are qualified for trading as a National Market security on Nasdaq if we have at least 800 shareholders as of the record date for the most recent annual meeting of shareholders. We presently expect that upon consummation of this offering, our common stock will be qualified for trading on Nasdaq and we will have at least 800 shareholders. The absence of cumulative voting may have the effect of limiting the ability of minority shareholders to effect changes in our board of directors and, as a result, may have the effect of deterring hostile takeovers or delaying or preventing changes in control or management of Future Media. Transfer Agent Our transfer agent and registrar for our common stock is U.S. Stock Transfer Corporation. 51 SHARES ELIGIBLE FOR FUTURE SALE Prior to this offering, there has been no public market for our common stock. We cannot predict the effect, if any, that future sale of shares, or the availability of shares for future sale, will have on the prevailing market price for our common stock. Sales of substantial amounts of our common stock in the public market following this offering, or the perception that these sales may occur, could adversely affect the prevailing market prices for our common stock. See "Risk Factors--Sales of additional shares of our common stock into the public market may cause our stock price to fall." Upon completion of this offering, we will have 19,535,185 shares of our common stock outstanding, 20,312,962 shares if the underwriters' over-allotment option is exercised in full. Of those shares, a total of 5,185 185 shares, 5,962,962 shares if the underwriters' over-allotment option is exercised in full, will be freely tradable without restriction or further registration under the Securities Act, unless purchased or held by our "affiliates" as that term is defined in Rule 144. All of our executive officers, directors and shareholders, including the selling shareholders have signed lock-up agreements under which they agreed not to sell or otherwise transfer, directly or indirectly, any shares of common stock or any securities convertible into, or exercisable or exchangeable for, any shares of common stock for a period of 180 days from the date of this prospectus without the prior written consent of Prudential Securities Incorporated. These lock-up agreements do not prevent us from granting additional options under our stock incentive plan. After the expiration of the 180-day period, shares that can be sold under Rule 144 will be eligible for sale. Prudential Securities Incorporated may, in its sole discretion, at any time and without notice, release all or any portion of the securities subject to these lock-up agreements.
Number of shares Date of eligibility for resale into public market ---------------- ------------------------------------------------- 14,850,000 180 days after the date of this prospectus due to a lock-up agreement our two existing shareholders have with Prudential Securities Incorporated.
In general, under Rule 144 as currently in effect, any person who has beneficially owned restricted securities for at least one year would be entitled to sell within any three-month period a number of shares that does not exceed the greater of: .1% of the then outstanding shares of common stock; or . the average weekly trading volume in the common stock during the four calendar weeks immediately preceding the date on which the notice of the sale on Form 144 is filed with the Securities and Exchange Commission. Within 90 days after the date of this prospectus, we intend to file a Registration Statement on Form S-8 covering an aggregate of approximately 3,250,000 shares of common stock, including the 1,598,350 shares of common stock which will then be subject to outstanding options and 604,890 shares of common stock underlying the warrants granted to David Moss. Additionally, we have agreed to file a Registration Statement on Form S-3 covering the shares of common stock underlying the warrants to be granted to Averil Capital Markets Group, Inc., and Levy, Small & Lallas, after these warrants become exercisable. After the effective date of the Form S-8, shares of common stock issued upon exercise of options granted pursuant to our stock incentive plan and upon exercise of the warrants granted to David Moss will be available for sale in the public market. However, these shares will remain subject to Rule 144 volume limitations applicable to our affiliates and to the lock-up agreements. Shares of common stock issuable upon exercise of the warrants to be granted to Averil Capital Markets Group, Inc. will become exercisable subject to Rule 144 volume limitations, one year after the date these warrants were granted or the filing of the related Form S-3, whichever occurs first. 52 UNDERWRITING We and the selling shareholders have entered into an underwriting agreement with the underwriters named below, for whom Prudential Securities Incorporated and CIBC World Markets Corp. are acting as representatives. We and the selling shareholders are obligated to sell, and the underwriters are obligated to purchase, all of the shares offered on the cover page of this prospectus, if any are purchased. Subject to conditions of the underwriting agreement, each underwriter has severally agreed to purchase the shares indicated opposite its name:
Number of Underwriters Shares - ------------ --------- Prudential Securities Incorporated.................................... CIBC World Markets Corp. ............................................. --------- Total............................................................... 4,685,185 =========
The underwriters may sell more shares than the total number of shares offered on the cover page of this prospectus and they have, for a period of 30 days from the date of this prospectus, an over-allotment option to purchase up to 777,777 additional shares from us. If any additional shares are purchased, the underwriters will severally purchase the shares in the same proportion as per the table above. The representatives of the underwriters have advised us and the selling shareholders that the shares will be offered to the public at the offering price indicated on the cover page of this prospectus. The underwriters may allow a concession not in excess of $ per share to selected dealers and such dealers may reallow a concession not in excess of $ per share to certain other dealers. After the shares are released for sale to the public, the representatives may change the offering price and the concessions. The representatives have informed us and the selling shareholders that the underwriters do not intend to sell shares to any investor who has granted them discretionary authority. We and the selling shareholders have agreed to pay to the underwriters the following fees, assuming both no exercise and full exercise of the underwriters' over-allotment option to purchase additional shares:
Total Fees ------------------------------------------- Fee Without Exercise of Full Exercise of Per Share Over-Allotment Option Over-Allotment Option --------- --------------------- --------------------- Fees paid by us......... $ $ $ Fees paid by the selling shareholders........... $ $ N/A
We have also agreed to pay Averil Capital Markets Group, Inc. a cash payment of 0.75% of the gross proceeds and to grant Averil Capital Markets Group, Inc. a warrant to purchase shares of our common stock equivalent to 0.25% of the gross proceeds raised at an exercise price equal to 110% of the public offering price. The warrant will become exercisable on the first anniversary of this offering. However, the warrant and the underlying shares of our common stock are restricted from sale, transfer, assignment, pledge or hypothecation for a period of one year from the date of this offering. The warrant is deemed underwriting compensation under Rule 2710 of the NASD Conduct Rules. In addition, we estimate that we will spend approximately $1.5 million in expenses for this offering, including those of the selling shareholders. We have agreed to indemnify the underwriters against certain liabilities, including liabilities under the Securities Act, or contribute to payments that the underwriters may be required to make in respect of these liabilities. We, our officers and directors, and all shareholders including our selling shareholders and Averil Capital Markets Group, Inc. have entered into lock-up agreements pursuant to which we and they have agreed not to offer or sell any shares of common stock or securities convertible into or exchangeable or exercisable for shares of common stock for a period of 180 days (or one year, in the case of Averil Capital Markets Group, Inc.) from 53 the date of this prospectus without the prior written consent of Prudential Securities Incorporated, on behalf of the underwriters. Prudential Securities Incorporated may, at any time and without notice, waive the terms of the lock- up agreements specified in the underwriting agreement. Prior to this offering, there has been no public market for our common stock. The public offering price, negotiated among Future Media, the selling shareholders, and the representatives is based upon various factors such as our financial and operating history and condition, our prospects, the prospects for the industry we are in and prevailing market conditions. Prudential Securities Incorporated, on behalf of the underwriters, may engage in the following activities in accordance with applicable securities rules: . Over-allotments involving sales in excess of the offering size, creating a short position. Prudential Securities Incorporated may elect to reduce this short position by exercising some or all of the over-allotment option. . Stabilizing and short covering; stabilizing bids to purchase the shares are permitted if they do not exceed a specified maximum price. After the distribution of shares has been completed, short covering purchases in the open market may also reduce the short position. These activities may cause the price of the shares to be higher than would otherwise exist in the open market. . Penalty bids permitting the representatives to reclaim concessions from syndicate members which sold shares received in the offering and that were purchased in the stabilizing or short covering transactions. One of the factors considered at the time of the allocation of the shares is the history of investors in selling quickly the shares received in prior offerings. Any stabilization or short covering activities and the imposition of penalty bids might have an effect on the price of the shares, which may be higher than the price that may otherwise exist in the open market. Such activities, which may be commenced and discontinued at any time, may be effected on the Nasdaq National Market, in the over-the-counter market or otherwise. Each underwriter has represented that it has complied and will comply with all applicable laws and regulations in connection with the offer, sale or delivery of the shares and related offering materials in the United Kingdom, including: . the Public Offers of Securities Regulations 1995; . the Financial Services Act 1986; and . the Financial Services Act 1986, (Investment Advertisements) (Exemptions) Order 1996 (as amended). We have asked the underwriters to reserve up to 200,000 shares for sale at the same offering price directly to our officers, directors, employees and other business affiliates or related third parties. The number of shares available for sale to the general public in the offering will be reduced to the extent such persons purchase the reserved shares. The reserved shares will not be subject to lock-up agreements except to the extent such shares are sold to our officers and directors and NASD members, affiliates, associated persons or related persons who are subject to Rule 2710 of the NASD Conduct Rules. Prudential Securities Incorporated facilitates the marketing of new issues online through its PrudentialSecurities.com division. Clients of Prudential AdvisorSM, a full service brokerage firm program, may view offering terms and a prospectus online and place orders through their financial advisors. 54 LEGAL MATTERS Our counsel, Troop Steuber Pasich Reddick & Tobey, LLP, Los Angeles, California, has rendered an opinion that the common stock offered by us, upon its sale will be duly and validly issued, fully paid and non-assessable. Gibson, Dunn & Crutcher LLP, Los Angeles, California, has acted as counsel to the underwriters in connection with certain legal matters relating to this offering. EXPERTS Ernst & Young LLP, independent auditors, have audited our financial statements at December 31, 1998 and 1999, and for each of the three years in the period ended December 31, 1999, as set forth in their report. We have included our financial statements in the prospectus and elsewhere in the registration statement in reliance on Ernst & Young LLP's report, given on their authority as experts in accounting and auditing. WHERE YOU CAN FIND MORE INFORMATION We have filed with the Securities and Exchange Commission in Washington, D.C., a registration statement under the Securities Act with respect to this offering. This prospectus does not contain all of the information set forth in such registration statement and the exhibits thereto. With respect to any contract or other document filed as an exhibit to such registration statement, reference is made to the exhibit for a complete description of the matter involved, and each such statement is qualified in its entirety by such reference. For further information about us and the shares offered, please review the registration statement and the exhibits. A copy of the registration statement, including the exhibits, may be inspected without charge at the Securities and Exchange Commission's principal office in Washington, D.C., and copies of all or any part thereof may be obtained from the Public Reference Section of the Securities and Exchange Commission at 450 Fifth Street, N.W., Washington, D.C. 20549, upon payment of certain prescribed rates. When this offering is consummated, we will become subject to the informational requirements of the Securities Exchange Act and will file reports and other information with the Securities and Exchange Commission in accordance with its rules. These reports and other information concerning us may be inspected and copied at the public reference facilities referred to above as well as some of the regional offices of the Securities and Exchange Commission. The Securities and Exchange Commission maintains a web site, which contains reports, proxy and information statements and other information regarding issuers that file electronically with the Securities and Exchange Commission at http://www.sec.gov. 55 INDEX TO FINANCIAL STATEMENTS
Page ---- Report of Ernst & Young LLP, Independent Auditors........................ F-2 Balance Sheets at December 31, 1998 and December 31, 1999................ F-3 Statements of Income for years ended December 31, 1997, 1998 and 1999.... F-4 Statements of Shareholders' Equity for years ended December 31, 1997, 1998 and 1999........................................................... F-5 Statements of Cash Flows for years ended December 31, 1997, 1998 and 1999.................................................................... F-6 Notes to Financial Statements for December 31, 1997, 1998 and 1999....... F-7 Condensed Consolidated Balance Sheets at December 31, 1999 and March 31, 2000 (unaudited)........................................................ F-18 Condensed Consolidated Statements of Income for the three months ended March 31, 1999 and 2000 (unaudited)..................................... F-19 Condensed Consolidated Statement of Shareholders' Equity for the three months ended March 31, 2000 (unaudited)................................. F-20 Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 1999 and 2000 (unaudited)............................... F-21 Notes to Condensed Consolidated Financial Statements for March 31, 2000 (unaudited)............................................................. F-22
F-1 Report of Independent Auditors The Board of Directors Future Media Productions, Inc. We have audited the accompanying balance sheets of Future Media Productions, Inc. as of December 31, 1998 and 1999 and the related statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. 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 financial statements referred to above present fairly, in all material respects, the financial position of Future Media Productions, Inc. as of December 31, 1998 and 1999 and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. /s/ Ernst & Young LLP Los Angeles, California February 25, 2000, except as to Note 11, as to which the date is April 13, 2000 F-2 FUTURE MEDIA PRODUCTIONS, INC. BALANCE SHEETS
December 31 ----------------------- 1998 1999 ----------- ----------- Assets Current assets: Accounts receivable (net of allowance for doubtful accounts of $163,000 in 1998 and $265,778 in 1999).............................................. $ 8,035,270 $ 7,202,126 Inventories......................................... 726,774 766,868 Prepaid expenses.................................... 433,497 284,101 Deferred income taxes............................... 8,000 -- ----------- ----------- Total current assets.................................. 9,203,541 8,253,095 Property and equipment, net........................... 21,898,093 29,837,448 Investments........................................... -- 2,852,400 Other assets.......................................... 336,268 145,845 ----------- ----------- Total assets.......................................... $31,437,902 $41,088,788 =========== =========== Liabilities and Shareholders' Equity Current liabilities: Bank overdraft...................................... $ 517,258 $ 370,489 Line of credit...................................... 1,616,537 1,852,303 Accounts payable--trade............................. 2,648,974 2,762,457 Accounts payable--capital equipment................. 4,449,059 1,530,356 Accrued expenses--royalties......................... 2,213,294 4,101,760 Accrued expenses.................................... 1,032,631 1,043,268 Deferred revenue.................................... -- 700,000 Deferred income taxes............................... -- 40,500 Current portion of long-term debt................... 3,756,987 3,757,698 Current portion of capital lease obligations........ 11,666 5,938 ----------- ----------- Total current liabilities............................. 16,246,406 16,164,769 Long-term debt, less current portion.................. 9,084,805 5,327,108 Capital lease obligations, less current portion....... 17,479 11,525 Deferred income taxes................................. 90,000 116,000 Commitments Shareholders' equity: Preferred stock, no par value: Authorized shares--10,000,000..................... Issued and outstanding shares--none............... -- -- Common stock, no par value: Authorized shares--75,000,000..................... Issued and outstanding shares--14,850,000......... 3,070,000 3,790,000 Retained earnings................................... 2,929,212 17,107,386 Note receivable from officer........................ -- (1,428,000) ----------- ----------- Total shareholders' equity............................ 5,999,212 19,469,386 ----------- ----------- Total liabilities and shareholders' equity............ $31,437,902 $41,088,788 =========== ===========
The accompanying notes to the financial statements are an integral part of these statements. F-3 FUTURE MEDIA PRODUCTIONS, INC. STATEMENTS OF INCOME
Year Ended December 31 ------------------------------------- 1997 1998 1999 ----------- ----------- ----------- Net sales to unaffiliated companies.... $23,974,131 $37,962,123 $52,448,072 Net sales to related parties........... 12,068,296 5,349,057 553,799 ----------- ----------- ----------- Total net sales........................ 36,042,427 43,311,180 53,001,871 Cost of goods sold..................... 23,132,442 27,304,178 31,937,704 ----------- ----------- ----------- Gross profit........................... 12,909,985 16,007,002 21,064,167 Selling, general and administrative expenses.............................. 4,214,033 4,232,741 4,200,969 Other general and administrative expense--stock related compensation... -- 3,055,000 720,000 Abandoned offering costs............... -- 675,733 -- ----------- ----------- ----------- Income from operations................. 8,695,952 8,043,528 16,143,198 Other income (expense): Interest income...................... 42,105 35,189 670 Interest expense..................... (817,998) (1,263,861) (1,403,694) ----------- ----------- ----------- Other income (expense), net.......... (775,893) (1,228,672) (1,403,024) ----------- ----------- ----------- Income before provision for state income taxes.......................... 7,920,059 6,814,856 14,740,174 Provision for state income taxes....... 119,900 102,223 2,000 ----------- ----------- ----------- Net income............................. $ 7,800,159 $ 6,712,633 $14,738,174 Earnings per share: Basic................................ $ 0.53 $ 0.45 $ 0.99 =========== =========== =========== Diluted.............................. $ 0.53 $ 0.43 $ 0.92 =========== =========== =========== Shares used in computing earnings per share: Basic................................ 14,850,000 14,850,000 14,850,000 =========== =========== =========== Diluted.............................. 14,850,000 15,672,174 16,025,686 =========== =========== =========== Pro forma net income data (Notes 1 and 7, unaudited): Income before provision for income taxes............................... $ 7,920,059 $ 6,814,856 $14,740,174 Pro forma income tax provision....... 3,161,100 2,725,942 5,896,070 ----------- ----------- ----------- Pro forma net income................. $ 4,758,959 $ 4,088,914 $ 8,844,104 Pro forma basic earnings per share... $ 0.55 =========== Pro forma diluted earnings per share............................... $ 0.52 =========== Weighted average shares outstanding-- basic............................... 16,199,758 =========== Weighted average shares outstanding-- diluted............................. 17,135,628 ===========
The accompanying notes to the financial statements are an integral part of these statements. F-4 FUTURE MEDIA PRODUCTIONS, INC. STATEMENTS OF SHAREHOLDERS' EQUITY
Note Common Stock Receivable --------------------- from Retained Shares Amount Officer Earnings Total ---------- ---------- ----------- ------------ ------------ Balance at January 1, 1997................... 14,850,000 $ 15,000 $ -- $ 13,129,440 $ 13,144,440 Dividends, $0.74 per share.................. -- -- -- (11,009,020) (11,009,020) Net income.............. -- -- -- 7,800,159 7,800,159 ---------- ---------- ----------- ------------ ------------ Balance at December 31, 1997................... 14,850,000 15,000 -- 9,920,579 9,935,579 Dividends, $0.92 per share.................. -- -- -- (13,704,000) (13,704,000) Issuance of stock warrants............... -- 3,055,000 -- -- 3,055,000 Net income.............. -- -- -- 6,712,633 6,712,633 ---------- ---------- ----------- ------------ ------------ Balance at December 31, 1998................... 14,850,000 3,070,000 -- 2,929,212 5,999,212 Dividends, $0.03 per share.................. -- -- -- (560,000) (560,000) Loan to officer......... -- -- (1,428,000) -- (1,428,000) Contribution of capital................ -- 720,000 -- -- 720,000 Net income.............. -- -- -- 14,738,174 14,738,174 ---------- ---------- ----------- ------------ ------------ Balance at December 31, 1999................... 14,850,000 $3,790,000 $(1,428,000) $ 17,107,386 $ 19,469,386 ========== ========== =========== ============ ============
The accompanying notes to the financial statements are an integral part of these statements. F-5 FUTURE MEDIA PRODUCTIONS, INC. STATEMENTS OF CASH FLOWS
Year Ended December 31 --------------------------------------- 1997 1998 1999 ----------- ------------ ------------ Operating activities Net income............................ $ 7,800,159 $ 6,712,633 $ 14,738,174 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization....... 1,949,838 2,860,789 4,368,177 Stock related compensation expense.. -- 3,055,000 720,000 Provision for bad debts............. 955,243 120,000 120,000 Loss on disposals of property and equipment.......................... 20,959 57,058 -- Deferred income taxes............... 17,000 22,000 74,500 Changes in operating assets and liabilities: Accounts receivable................ (3,195,350) (1,347,486) 713,144 Inventories........................ 1,523,072 (92,276) (40,094) Prepaid expenses................... (121,019) (123,088) 149,396 Other assets....................... 279,437 (92,411) 190,423 Other receivables.................. -- 275,000 -- Accounts payable................... (850,930) 941,330 113,483 Accrued expenses................... 39,622 408,583 10,637 Accrued expenses--royalties........ 3,090,416 (1,953,206) 1,888,466 ----------- ------------ ------------ Net cash provided by operating activities........................... 11,508,447 10,843,926 23,046,306 Investing activities Capital expenditures.................. (3,641,686) (6,751,862) (15,226,235) Purchases of investments.............. -- -- (2,152,400) Proceeds from disposals of property and equipment........................ -- 20,000 -- ----------- ------------ ------------ Net cash used in investing activities........................... (3,641,686) (6,731,862) (17,378,635) Financing activities Net borrowings (repayments) on line of credit............................... (103,316) 1,352,893 235,766 Net payments on bank overdraft........ (914,366) (226,150) (146,769) Proceeds from long-term debt.......... 6,537,612 11,321,000 -- Repayments on long-term debt.......... (6,700,928) (2,844,843) (3,756,986) Note receivable from officer.......... -- -- (1,428,000) Payments on capital lease obligations.......................... (14,221) (10,964) (11,682) Dividends paid to shareholders........ (6,671,542) (13,704,000) (560,000) Advances to related parties........... (1,900,000) (1,500,000) (6,002,000) Repayments on advances to related parties.............................. 1,900,000 1,500,000 6,002,000 ----------- ------------ ------------ Net cash used in financing activities........................... (7,866,761) (4,112,064) (5,667,671) Net change in cash and cash equivalents.......................... -- -- -- Cash and cash equivalents at beginning of period............................ -- -- -- ----------- ------------ ------------ Cash and cash equivalents at end of period............................... $ -- $ -- $ -- =========== ============ ============ Supplemental disclosures of cash flow information: Cash paid during the period for: Interest........................... $ 817,998 $ 1,121,507 $ 1,403,749 State income taxes................. $ 107,000 $ 61,500 $ 1,800 Supplemental disclosure of non-cash transactions
During the year ended December 31, 1997, the Company distributed $11,009,020 to shareholders consisting of a $4,337,478 reduction of notes receivable due from shareholders and cash payments of $6,671,542. In 1999, the Company agreed to provide replications of two million CD's to Synthonics partially as part of the Company's investment in Synthonics (valued at $700,000). The accompanying notes to the financial statements are an integral part of these statements. F-6 FUTURE MEDIA PRODUCTION, INC. NOTES TO FINANCIAL STATEMENTS December 31, 1999 1. Business and Summary of Significant Accounting Policies Description of Business Future Media Productions, Inc. (the Company) is an independent manufacturer/replicator of digital versatile discs (DVDs) and compact disks (CDs) to companies in industries including Internet/online, film and entertainment, edutainment software, publishing and computer hardware. The majority of the Company's business is targeted at high volume customers in these markets. The Company operates in one business segment. Estimates and Assumptions The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions affecting the reported amounts in the financial statements and accompanying notes. Actual results could differ from those estimates, although management does not believe differences would materially affect the Company's financial position or results of operations. Concentration of Credit Risk The Company manufactures and distributes DVDs and CDs principally to companies in the Internet/online, film and entertainment, edutainment software, publishing and computer hardware industries throughout the United States. The Company grants credit to its customers and does not require collateral. Credit evaluations are performed periodically as needed. Concentrations of sales and credit exist and are described in Note 5. Cash Equivalents The Company considers all highly liquid investments with maturities of three months or less when purchased to be cash equivalents. Inventories Inventories are stated at the lower of cost (determined on a first-in, first- out basis) or market. Property and Equipment Property and equipment is stated at cost and depreciated over its useful life ranging from three to ten years using the straight-line method. Maintenance and repairs are charged to expense as incurred and costs of additions and betterments increasing useful lives are capitalized. Amortization of leased property is computed by the straight-line method over the lesser of the asset life or, life of the lease. Income Taxes The Company has elected to be taxed under the S Corporation provisions of the Internal Revenue Code which provides, in lieu of corporate income taxes, the shareholders separately account for their pro rata share of the Company's items of income, deductions, losses and credits. Therefore, these statements do not include any provision for corporate federal income taxes. Similar provisions apply for California income tax reporting; however, California tax law provides for a 1.5% rate on taxable income at the corporate level. Accordingly, the income tax provision consists of 1.5% tax due on the California taxable income of the Company offset by certain manufacturing credits. F-7 FUTURE MEDIA PRODUCTIONS, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) December 31, 1999 In connection with the closing of the proposed public offering, the Company's S Corporation status will terminate and the Company will be taxed thereafter as a C Corporation. The pro forma statements of income reflect a provision for federal and state income taxes as if the Company was a C Corporation for the periods presented. Upon conversion to a C Corporation, the Company will establish a net deferred tax liability with an accompanying increase to income tax expense. If this charge were recorded at December 31, 1999, the amount would have been approximately $2,700,000 (unaudited), consisting primarily of timing differences related to depreciation. Immediately prior to the closing of the proposed public offering, the Company will enter into a tax indemnification agreement with the existing shareholders relating to respective income tax liabilities. The tax indemnification agreement is intended to assure the Company assumes taxes for the related income giving rise to such taxes and the existing shareholders assume taxes for which they have received the related income giving rise to such taxes. Revenue Recognition Revenues are recorded when products are shipped or orders are completed under purchase orders or contracts and are due to be shipped but awaiting instructions from the customer of the shipping destination. Revenues related to the latter have been insignificant at the end of reporting periods. Royalty Agreements The Company has license agreements with certain companies for the use of their patented technology covering DVDs and CDs manufactured by the Company in North America. The Company accrues for royalties based on units sold and royalty expense is included as a component of cost of goods sold. Stock-Based Compensation The Company accounts for employee and director stock options using the intrinsic value method. Generally, the exercise price of the Company's employee stock options equals or exceeds the market price of the underlying stock on the date of grant and no compensation expense is recognized. If the option price is less than fair value, the Company records compensation expense over the vesting period of the stock option. Options granted to non-employees are accounted for using a fair value method. The Company has disclosed the pro forma material effects of using the fair value method of all options in its financial statements. Earnings Per Share Basic earnings per share has been computed by dividing net income by the weighted average number of common shares outstanding for the periods presented. Diluted earnings per share has been computed by dividing net income by securities or other contracts to issue common stock as if these securities were exercised or converted to common stock. F-8 FUTURE MEDIA PRODUCTIONS, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) December 31, 1999 The following table sets forth the calculation for basic and diluted earnings per share for the periods presented:
Year Ended December 31 --------------------------------- 1997 1998 1999 ---------- ---------- ----------- Earnings: Net income............................. $7,800,159 $6,712,633 $14,738,174 ========== ========== =========== Shares: Weighted average shares for basic earnings per share.................... 14,850,000 14,850,000 14,850,000 Stock options and warrants............. -- 822,174 1,175,686 ---------- ---------- ----------- Weighted average shares for diluted earnings per share.................... 14,850,000 15,672,174 16,025,686 ========== ========== ===========
Pro Forma Earnings Per Share (unaudited) The Company is currently taxed as an S Corporation for federal income and California franchise tax purposes. Accordingly, the provision for income taxes for the periods presented reflect primarily state income tax. The pro forma unaudited earnings per share information is calculated as if the Company had been subject to tax as a C Corporation and for the effect of share equivalents in the amount of 1,349,758 shares for expected dividends to shareholders for the most recent period presented. Long-Lived Assets The Company reviews for the impairment of long-lived assets and certain identifiable intangibles whenever events or changes in circumstances indicate the carrying amount of any asset may not be recoverable. An impairment loss would be recognized when the estimated undiscounted future cash flows expected to result from the use of the asset and its eventual disposition is less than the carrying amount. If impairment is indicated, the amount of the loss to be recorded is based upon an estimate of the difference between the carrying amount and the fair value of the asset. Fair value is based upon discounted estimated cash flows expected to result from the use of the asset and its eventual disposition and other valuation methods. The Company has identified no such impairment losses. Comprehensive Income There were no significant items of comprehensive income and no impact of these items on the Company's results of operations for the years ended December 31, 1997, 1998 and 1999, and therefore no further disclosures related to this matter have been made. Newly Issued Accounting Standards Effective in 2001, accounting for gains or losses resulting from changes in the value of derivatives would be changed depending on the use of the derivative and whether they qualify for hedge accounting. The adoption of this new requirement is not expected to have a material impact on the financial position or results of operations of the Company. F-9 FUTURE MEDIA PRODUCTIONS, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) December 31, 1999 Reclassifications Certain reclassifications have been made to the December 31, 1997 and 1998 financial statements to conform to the presentation in 1999. 2. Inventories Inventories consisted of the following:
December 31 ------------------- 1998 1999 --------- --------- Raw materials........................................... $ 604,972 $ 668,515 Work-in process and finished goods...................... 121,802 98,353 --------- --------- $ 726,774 $ 766,868 ========= =========
3. Property and Equipment Property and equipment, net, consisted of the following:
December 31 -------------------------- 1998 1999 ------------ ------------ Plant equipment......... $ 27,799,629 $ 39,057,036 Computer equipment and software............... 95,736 237,871 Office furniture and equipment.............. 83,564 83,558 Automotive equipment.... 71,080 96,865 Leasehold improvements.. 815,912 1,698,122 Leased property under capital leases......... 57,540 57,540 ------------ ------------ 28,923,461 41,230,992 Less accumulated depre- ciation and amortiza- tion................... (7,025,368) (11,393,544) ------------ ------------ $ 21,898,093 $ 29,837,448 ============ ============
4. Investments Investments in affiliates where the Company owns more than 20% but not in excess of 50% of the investees' outstanding equity where the Company is not deemed to be able to exercise controlling influence are recorded under the equity method. Investments in affiliates where the Company owns less than 20% of the investees' outstanding equity where the Company is not deemed to be able to exercise controlling influence are recorded under the cost method. Under the equity method, investments are carried at acquisition cost and adjusted for the proportionate share of the affiliates' earnings or losses. Under the cost method, investments are recorded at acquisition cost and adjusted to fair value based on the investment classification. On December 21, 1999, the Company purchased, through an underwriting, 648 units of Lions Gate Entertainment, a Canadian motion picture production and distribution company. Each unit was purchased for $2,550 or a total of $1,652,400. Each unit consists of one 5.25% Convertible Redeemable Preferred Stock and 425 warrants. Each share of preferred stock is convertible into 1,000 shares of common stock and each warrant entitles the holder to purchase one share of Lions Gate common stock at $5.00 per share. In connection with this investment, assuming price and quality are in line with industry standards, the Company obtained the right to replicate primarily all of the DVD needs of Lions Gate for a period of two years. The closing quoted market value per share of Lions Gate on February 28, 2000 was $2.625. The warrants expire January 2004. This investment has been accounted for under the cost method and classified as available-for-sale. Future changes in market valuation for this investment will be recognized as a separate component of shareholders' equity. F-10 FUTURE MEDIA PRODUCTIONS, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) December 31, 1999 On December 23, 1999, the Company paid in cash $500,000 to Synthonics Technologies, Inc. (Synthonics) in return for a note receivable convertible into 11,518,096 shares of Synthonics common stock, which at the time represented 38% of Synthonics outstanding shares. The Company agreed to replicate and package up to two million CDs without charge to Synthonics and establish a catalog company to develop and produce 3D interactive digital catalogs on behalf of Synthonics for its customers. A member of Synthonics Board of Directors is also a member of the Company's Board of Directors. The investment in Synthonics totaling $1,200,000 (including an amount of $700,000 as the fair market value of the replication services to be performed), will be accounted for under the equity method. 5. Related Party Transactions and Major Customers During the years ended December 31, 1997 and 1998, a significant portion of the Company's revenue activity consisted of sales to one affiliated company, which at the time was partially owned by the shareholders of the Company. Net sales to this affiliate, an original manufacturer of personal computers, were $12,068,296, $5,349,057 and $553,799 for the years ended December 31, 1997, 1998 and 1999, respectively, and represented 33.5%, 12.4% and 1.0% of the Company's net sales, respectively. At December 31, 1998 and 1999, accounts receivable from this affiliate were $614,538 and $23,103, or 7.5% and 0.3% of total trade receivables, respectively. Net sales to the Company's top two unaffiliated customers in 1997 and 1998 and top three unaffiliated customers in 1999 were 35.4%, 47.6% and 55.6% of total net sales, respectively, including one customer in 1999 which represented 32.1% of total net sales. Accounts receivable in the aggregate from these significant customers at December 31, 1998 and 1999 were $1,457,142, or 17.9% and $2,434,045, or 32.5% of total trade receivables, respectively. During the year ended December 31, 1997, the Company wrote off accounts receivable balances due from related parties in the aggregate of $670,263, none of which related to the receivables from the affiliated company discussed above. A director of the Company performed services for the Company including investigation of strategic and financing alternatives. As consideration for such services, the Company paid to the director $25,000, $101,184 and $0, including out of pocket expenses during the years ended December 31, 1997, 1998 and 1999. The Company has committed, upon consummation of an offering, to a cash payment to the director of 0.75% of the gross proceeds of an offering and additional equity securities, warrants, or other participating interests in the Company representing 0.25% of the consideration raised in value, priced in accordance with a Black-Scholes option model, with a minimum amount of warrants issuable pursuant to this transaction not to be less than $50,000 in value. After the end of the year, the Company paid a non-refundable retainer of $60,000 to this director, which will be credited against any transaction fees payable pursuant to the offering. During the year ended December 31, 1999, the Company made non-interest bearing loans totaling $1,427,000 and interest bearing loans totaling $1,075,000 (interest accrued at the Company's borrowing rate with its major lender) to its president. These loans were repaid in their entirety during 1999 except for interest accrued, totaling approximately $72,000, which was subsequently forgiven by the Company's Board of Directors. After the end of 1999, the Company loaned $2,630,000 to this officer with interest at the Company's borrowing rate with its major lender. During 1999, advances totaling $2,500,000 were made to one of the Company's shareholders. This amount was repaid before the end of 1999. In addition, a loan totaling $1,000,000 was made during 1999 to a company partially owned by the Company's president and this shareholder. This amount was repaid prior to the end of 1999. In July 1998 advances totaling $1,500,000 were made to a shareholder. These advances were repaid in August 1998. F-11 FUTURE MEDIA PRODUCTIONS, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) December 31, 1999 In connection with stock warrants issued to an officer of the Company (see Note 9), the Company loaned an officer a total of $1,428,000 under promissory notes bearing compound interest at the rate of 4.6% per annum. The unpaid principal balance and any accrued but unpaid interest shall be due and payable on the earlier of: (1) January 1, 2006; or (2) the fifteenth day following the date of delivery by the Company to Maker of written demand therefore made at any time after the later of (a) the closing of a Liquidity Event (as defined), or (b) if applicable, the expiration of any lock-up period imposed in connection with such Liquidity Event on the common stock of the Company, or any successor to the Company, held by Maker. In 1999, the Company made payments in lieu of lease payments on a new production facility to a company owned by the Company's president. Such payments during the year totaled $86,000. Subsequent to December 31, 1999, the Company expects to enter into a multi-year lease agreement with this company. Lease payments are expected to be negotiated at rates commensurate with commercial terms charged for similar properties in the area with increases based on the Consumer Price Index. 6. Financing In February 1997, the Company entered into a credit agreement (Credit Agreement) with a lender, which was amended in January 1998 and further amended in April 1998, July 1998, June 1999 and January 2000. The Credit Agreement currently provides loans based on 80% of the Company's eligible receivables (as defined) (Receivable Loans), loans based on 90% of the net purchase price of new equipment purchased and delivered subsequent to June 1999 (Equipment Loans) and additional revolving loans (Revolving Loans). Under the Credit Agreement the Company is allowed to borrow the lesser of $30,000,000 or an amount equal to 80% of the Company's eligible receivables (as defined), $15,000,000 of Equipment Loans plus the unpaid balance of the Revolving Loans. The Credit Agreement had an original maturity date of February 28, 1998 and provided for automatic renewals. In January 1998, the agreement was amended to have an original maturity of April 30, 1998 and in January 2000 the maturity date was extended to June 30, 2001, and continues to provide for automatic renewals. Borrowings under Receivable Loans bear interest at the prime rate (8.5% at December 31, 1999) plus 2.0% per annum; however, the interest rate will not be less than 7.0% per annum. Outstanding borrowings under the Receivable Loans amounted to $1,616,537 at December 31, 1998 and $1,852,303 at December 31, 1999. The Credit Agreement is secured by accounts receivable, equipment, inventory and other assets and is personally guaranteed by the shareholders of the Company. Interest expense related to the Receivable Loans for the years ended December 31, 1997, 1998 and 1999 was $234,778, $116,959 and $274,833, respectively. Under the amendment of April 1998, the Revolving Loans were for an amount of $15,000,000, which is payable in monthly principal installments of $312,500 through (i) the earlier of the date the Credit Agreement terminates, or is terminated, or (ii) April 2002. The Revolving Loans bear interest at the prime rate (8.5% at December 31, 1999) plus 2.0% per annum; however, the interest rate will not be less than 7.0% per annum. The outstanding balance of the Revolving Loans was $12,812,500 and $9,062,500 at December 31, 1998 and 1999, respectively. As part of the Credit Agreement, the Revolving Loans are collateralized by accounts receivable, equipment, inventory and other assets and is personally guaranteed by the shareholders of the Company. Under the amendment of June 1999, amounts borrowed under the Equipment Loans are to be repaid in 48 equal monthly payments of principal through the earlier of (i) the earlier of the date the Credit Agreement terminates, or is terminated or (ii) the date such Equipment Loans have been repaid in full. The Equipment Loans bear interest at the prime rate (8.5% at December 31, 1999) plus 2.0% per annum; however, the interest rate will not be less than 7.0% per annum. At December 31, 1999 no amounts had been borrowed under the Equipment Loans. F-12 FUTURE MEDIA PRODUCTIONS, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) December 31, 1999 The Credit Agreement also includes, among others, various negative covenants, including the prohibition to merge or consolidate with another corporation, make any loans of money or assets, redeem, retire, purchase or otherwise acquire any of the Company's stock and make any changes in the Company's capital structure which would have a material adverse impact on the Company's ability to repay its obligations under the Credit Agreement without the lender's prior written consent. The Company is in compliance with all terms of the Credit Agreement. The Company obtained permission from the lender for the loans and advances to related parties. Subsequent to the closing of the offering described in Note 11, the Company anticipates renegotiating the terms under the Credit Facility, including maturity dates, covenants, interest rates and personal guarantees. Future maturities of long-term debt are as follows: Year ended December 31: 2000........................................................... $ 3,757,697 2001........................................................... 3,758,480 2002........................................................... 1,568,629 ----------- $ 9,084,806 ===========
Interest expense incurred for long-term debt was $579,123, $1,142,893 and $1,125,167 for the years ended December 31, 1997, 1998 and 1999, respectively. The Company's weighted average interest rate on its debt was 10.5%, 10.4% and 10.1% for the years ended December 31, 1997, 1998 and 1999, respectively. 7. Income Taxes The provision (benefit) for state income taxes is as follows:
Year Ended December 31 ---------------------------- 1997 1998 1999 --------- -------- --------- Current........................................ $ 102,900 $ 80,223 $ (72,500) Deferred....................................... 17,000 22,000 74,500 --------- -------- --------- $ 119,900 $102,223 $ 2,000 ========= ======== =========
As described in Note 1 to the financial statements, the Company is currently an S Corporation for federal income and California franchise tax purposes under Subchapter S of the Internal Revenue Code and the corresponding provisions of the California statute. In connection with the closing of the proposed public offering as discussed in Note 11, the Company's S Corporation status will terminate and the Company will be taxed as a C Corporation. This will result in the establishment of a provision for income taxes and deferred tax liability of approximately $2,700,000 (unaudited) upon the closing date. The following unaudited pro forma income tax information has been determined as if the Company operated as a C Corporation for the periods presented:
Year Ended December 31 -------------------------------- 1997 1998 1999 ---------- ---------- ---------- Federal tax provision..................... $2,460,000 $2,115,600 $4,598,935 State income taxes net of federal benefit.................................. 701,100 602,800 1,297,135 ---------- ---------- ---------- Total pro forma income tax provision...... $3,161,100 $2,718,400 $5,896,070 ========== ========== ==========
F-13 FUTURE MEDIA PRODUCTIONS, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) December 31, 1999 The difference between actual income tax expense and the U. S. Federal statutory income tax rate is as follows:
Year Ended December 31 --------------------------- 1997 1998 1999 ------- ------- ------- Statutory rate................................. 34.0 % 34.0 % 34.0 % State tax provision............................ 1.5 1.5 1.5 Manufacturers credit........................... -- -- (1.5) S Corporation status........................... (34.0) (34.0) (34.0) ------- ------- ------- Effective tax rate............................. 1.5 % 1.5 % 0.0 % ======= ======= =======
The difference between the unaudited pro forma income tax expense and the U.S. Federal statutory income tax rate is as follows:
Year Ended December 31 --------------------------- 1997 1998 1999 ------- ------- ------- Statutory rate................................. 34.0 % 34.0 % 34.0 % State tax provision............................ 6.0 6.0 6.0 Manufacturers credit........................... -- -- (1.3) Other.......................................... (0.1) -- 1.3 ------- ------- ------- Effective tax rate............................. 39.9 % 40.0 % 40.0 % ======= ======= =======
Deferred income tax assets and liabilities are computed for those differences having future tax consequences using the currently enacted tax laws and rates. Income tax expenses equal the current tax payable or refundable for the period, plus or minus the net change in the deferred tax asset and liabilities accounts. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of our deferred tax assets and liabilities are as follows:
December 31 -------------------- 1998 1999 --------- --------- Bad debt allowance..................................... $ 2,400 $ 4,000 Other.................................................. 5,600 9,000 Credit carryovers...................................... -- 43,000 --------- --------- Total deferred assets.................................. 8,000 56,000 Depreciation........................................... (90,000) (116,000) Other.................................................. -- (96,500) --------- --------- Total deferred liabilities............................. (90,000) (212,500) --------- --------- Net deferred tax liabilities........................... $ (82,000) (156,500) ========= ========= Balance sheet classification: Current deferred tax assets.......................... $ 8,000 $ -- Current deferred tax liabilities..................... -- 40,500 Long-term deferred tax liabilities................... 90,000 116,000
F-14 FUTURE MEDIA PRODUCTIONS, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) December 31, 1999 8. Commitments The Company leases two office and manufacturing facilities in Valencia, California, under operating leases. One of the leases expires in February 2002. The other lease expires in May 2007 and is with a company owned by the shareholders of the Company. Both leases provide for adjustments to the monthly base rent periodically, based on the Consumer Price Index. At December 31 1999, future minimum lease payments required under the lease arrangement are as follows:
Related Party Other Total ------------- -------- ---------- Year ended December 31: 2000..................................... $ 240,000 $276,638 $ 516,638 2001..................................... 240,000 273,358 513,358 2002..................................... 240,000 49,345 289,345 2003..................................... 240,000 570 240,570 2004..................................... 240,000 -- 240,000 Thereafter............................... 580,000 -- 580,000 ---------- -------- ---------- $1,780,000 $599,911 $2,379,911 ========== ======== ==========
Total rent expense pursuant to these leases was $395,672, $507,886 and $504,312 for the years ended December 31, 1997, 1998 and 1999, respectively. Rental payments to related parties were $140,000 for the year ended December 31, 1997 and $240,000 for both the years ended December 31, 1998 and 1999. Subsequent to December 31, 1999, the Company expects to enter into a multi- year lease agreement for a new production facility and negotiated a termination of its lease agreement for one of its existing facilities. The new lease is expected to be a multi-year operating lease with a company owned by the shareholders of the Company to be negotiated at rates commensurate with commercial terms charged for similar properties with periodic adjustments to the monthly base rent based on the Consumer Price Index. The Company does not expect to incur significant expenses in terminating its existing lease under the terms of the agreement with the current landlord. 9. Stockholders' Equity Stock Options In April 1998, the Company adopted a Stock Incentive Plan (Stock Plan). Each executive officer, employee, non-employee director or consultant of the Company or any of its future subsidiaries is eligible to be considered for the grant of awards under the Stock Plan. A maximum of 1,980,000 shares of common stock may be issued pursuant to awards granted under the Stock Plan, subject to certain adjustments to prevent dilution. Any shares of common stock subject to an award, which for any reason expires or terminates unexercised, are again available for issuance under the Stock Plan. The options vest generally at periods up to 5 years. The Stock Plan will be administered by the Company's Board of Directors or by a committee of two or more non-employee directors appointed by the Board of Directors. The Stock Plan authorizes the grant of nonqualified stock options, incentive stock options, stock appreciation rights, restricted stock and stock bonuses. No stock appreciation rights are outstanding at December 31, 1999. F-15 FUTURE MEDIA PRODUCTIONS, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) December 31, 1999 A summary of the Company's stock option activity, and related information is as follows:
Outstanding Stock Options ----------------------------- Weighted Average Exercise Range of Price Exercise Number of Per Prices Per Options Share Share --------- -------- ---------- Outstanding at January 1, 1998................... -- $ -- $ -- Granted........................................ 1,366,200 6.88 6.79-7.21 --------- ----- ---------- Outstanding at December 31, 1998................. 1,366,200 6.88 6.79-7.21 --------- ----- ---------- Outstanding at December 31, 1999................. 1,366,200 $6.88 $6.79-7.21 ========= ===== ========== Exercisable at: December 31, 1998.............................. -- $ -- $ -- ========= ===== ========== December 31, 1999.............................. 353,925 $6.89 $6.79-7.21 ========= ===== ==========
At December 31, 1999, 613,800 shares were available for future grant. The weighted average remaining contractual life for the outstanding options is 8.46 years at December 31, 1999. If the Company had elected to recognize compensation expense based on the fair value of the options granted at grant date for its stock-based compensation plans, the Company's net income would have been reduced by approximately $350,000 and $600,000 for the years ended December 31, 1998 and 1999, respectively, and basic and diluted earnings per share would have been $0.43 and $0.40, respectively, for the year ended December 31, 1998, and $0.95 and $0.83, respectively, for the year ended December 31, 1999. The fair value of the options is estimated using a minimum value option pricing model with the following weighted average assumptions for grants in 1998: dividend yield of 0.0%; risk free interest rate of 6.0%; and expected life of 5.0 years. Warrants On January 1, 1998, the Company granted to one of its officers warrants to purchase 604,890 shares of common stock. Each warrant provides for the purchase of one share of common stock at $.00010 per share, resulting in stock warrant compensation expense of $3,055,000 for the year ended December 31, 1998, with the warrants expiring on December 31, 2007. These warrants have no voting rights, dividend rights or preferences until such time as they are exercised for shares of common stock. As of December 31, 1999 no warrants have been exercised. Stock Related Compensation Expense In 1999, the shareholders of the Company committed to give 49,500 shares of their stock to a director for services to the Company. For the year ended December 31, 1999, the Company has recorded stock related compensation expense of $720,000 for this commitment based on the estimated fair value of the shares given, and a contribution to capital for the same amount from the shareholders. 10. Fair Value of Financial Instruments In estimating its fair value disclosures for financial statements, the Company used the following methods and assumptions: Cash and cash equivalents: The carrying amount approximates fair value. F-16 FUTURE MEDIA PRODUCTIONS, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) December 31, 1999 Accounts receivable, other receivables, accounts payable and accounts payable-equipment: The carrying amount approximates fair value. The fair value of the note receivable from officer discounted at the Company's borrowing rate is approximately $1,096,000. Line of credit and long-term debt: The carrying amounts of the Company's borrowings under its short-term revolving credit arrangements approximate their fair value. The fair values of the Company's long-term debts are estimated using discounted cash flow analyses, based on the Company's current incremental borrowing rates for similar types of borrowing arrangements. The carrying amounts of long-term debts approximate their fair values. 11. Proposed Initial Public Offering On April 13, 2000, the Company's Board of Directors authorized the filing of a registration statement with the Securities and Exchange Commission, relating to an initial public offering of up to 5,775,000 shares of the Company's unissued common stock and up to 1,155,000 shares to be sold by selling shareholders. In connection with the initial public offering, on April 13, 2000 the Board of Directors approved and effected a 1.65-for-1 stock split of the Company's common stock. All references in the accompanying financial statements to the number of shares of common stock or per share amounts have been retroactively adjusted to reflect the stock split. In addition, the Company's capital structure changed, to reflect 75,000,000 authorized shares of common stock and to reflect 10,000,000 shares of preferred stock. The Board of Directors has authority to fix the rights, preferences, privileges and restrictions, including voting rights, of these shares or preferred stock without any future vote or action by the shareholders. The S Corporation status of the Company will terminate upon the closing of the offering and, thereafter, the Company will be subject to federal and state income taxes. As a result of terminating its S Corporation status, the Company will pay a distribution of the retained earnings balance prior to closing to its shareholders. On April 13, 2000, the Company granted a total of 256,900 stock options under the Stock Plan to employees and a director. Additionally, on April 13, 2000, the Company adopted a 2000 Stock Option Plan (2000 Plan). Upon the closing of this offering there would be no new grants under the Stock Plan. The 2000 Plan provides for a maximum of 1,340,000, plus any shares reserved for issuance under the existing Stock Plan which have not been issued as of the offering. F-17 FUTURE MEDIA PRODUCTIONS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS
Pro Forma December 31, March 31, March 31, 1999 2000 2000 ------------ ----------- ----------- (Unaudited) (Unaudited) Assets Current assets: Accounts receivables (net of allowance for doubtful accounts of $265,778 in 1999 and $295,778 in 2000)............ $ 7,202,126 $ 3,850,816 Inventories............................ 766,868 877,457 Prepaid expenses....................... 284,101 291,635 Deferred income taxes.................. -- -- 300,000 ----------- ----------- Total current assets.................... 8,253,095 5,019,908 Property and equipment, net............. 29,837,448 34,874,168 Investments............................. 2,852,400 3,351,880 Other assets............................ 145,845 2,256,687 ----------- ----------- Total assets............................ $41,088,788 $45,502,643 =========== =========== Liabilities and Shareholders' Equity Current liabilities: Bank overdraft......................... $ 370,489 $ 706,699 Line of credit......................... 1,852,303 1,919,620 Accounts payable--trade................ 2,762,457 3,323,063 Accounts payable--capital equipment.... 1,530,356 2,450,520 Accrued expenses--royalties............ 4,101,760 4,238,654 Accrued expenses....................... 1,043,268 1,985,922 Deferred revenue....................... 700,000 700,000 Deferred income taxes.................. 40,500 40,500 -- Current portion of long-term debt...... 3,757,698 4,790,198 Current portion of capital lease obligations........................... 5,938 5,938 Distributions payable.................. -- -- 14,686,732 ----------- ----------- Total current liabilities............... 16,164,769 20,161,114 Long-term debt, less current portion.... 5,327,108 7,399,204 Capital lease obligations, less current portion................................ 11,525 9,613 Deferred income taxes................... 116,000 116,000 3,200,000 Commitments Shareholders' equity: Preferred stock, no par value: Authorized shares--10,000,000 Issued and outstanding--none -- -- Common stock, no par value: Authorized shares--75,000,000 Issued and outstanding--14,850,000..... 3,790,000 3,790,000 3,790,000 Accumulated other comprehensive income................................ -- 654,480 654,480 Retained earnings...................... 17,107,386 17,430,232 -- Notes receivable from officers......... (1,428,000) (4,058,000) (4,058,000) ----------- ----------- ---------- Total shareholders' equity.............. 19,469,386 17,816,712 386,480 ----------- ----------- Total liabilities and shareholders' equity................................. $41,088,788 $45,502,643 =========== ===========
The accompanying notes are an integral part of these statements. F-18 FUTURE MEDIA PRODUCTIONS, INC. CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
Three Months Ended ------------------------ March 31, March 31, 1999 2000 ----------- ----------- Net sales to unaffiliated companies................... $ 8,615,155 $14,780,253 Net sales to related parties.......................... 59,605 -- ----------- ----------- Total net sales....................................... 8,674,760 14,780,253 Cost of goods sold.................................... 5,864,842 9,341,734 ----------- ----------- Gross profit.......................................... 2,809,918 5,438,519 Selling, general and administrative expenses.......... 1,071,812 1,593,580 ----------- ----------- Income from operations................................ 1,738,106 3,844,939 Other income (expense): Interest income..................................... -- 7,521 Interest expense.................................... (351,396) (398,614) Loss in equity of unconsolidated entity............. -- (155,000) ----------- ----------- Other income (expense), net......................... (351,396) (546,093) ----------- ----------- Income before provision for income taxes.............. 1,386,710 3,298,846 Provision for income taxes............................ 500 1,000 ----------- ----------- Net income............................................ $ 1,386,210 $ 3,297,846 =========== =========== Earnings per share: Basic............................................... $0.09 $0.22 =========== =========== Diluted............................................. $0.09 $0.20 =========== =========== Shares used in computing earnings per share: Weighted average shares outstanding--basic.......... 14,850,000 14,850,000 =========== =========== Weighted average shares outstanding--diluted........ 15,859,207 16,123,995 =========== =========== Pro forma net income data: Income before provision for income taxes............ $ 1,386,710 $ 3,298,846 Pro forma income tax provision...................... 554,684 1,319,538 ----------- ----------- Pro forma net income................................ $ 832,026 $ 1,979,308 Pro forma basic earnings per share.................. $0.12 =========== Pro forma diluted earnings per share................ $0.11 =========== Weighted average shares outstanding--basic.......... 16,199,758 =========== Weighted average shares outstanding--diluted........ 17,434,725 ===========
The accompanying notes are an integral part of these statements. F-19 FUTURE MEDIA PRODUCTIONS, INC. CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (Unaudited)
Notes Accumulated Common Stock Receivable Other --------------------- from Comprehensive Retained Shares Amount Officers Income Earnings Total ---------- ---------- ----------- ------------- ----------- ----------- Balance at December 31, 1999................... 14,850,000 $3,790,000 $(1,428,000) $ -- $17,107,386 $19,469,386 Dividends at $0.20 per share.................. -- -- -- -- (2,975,000) (2,975,000) Loan to officer......... -- -- (2,630,000) -- -- (2,630,000) Comprehensive income: Net income............ -- -- -- -- 3,297,846 3,297,846 Unrealized gain in investment of Lions Gate Entertainment... -- -- -- 654,480 -- 654,480 ---------- ---------- ----------- -------- ----------- ----------- Total comprehensive income............... 3,952,326 ---------- ---------- ----------- -------- ----------- ----------- Balance at March 31, 2000................... 14,850,000 $3,790,000 $(4,058,000) $654,480 $17,430,232 $17,816,712 ========== ========== =========== ======== =========== ===========
The accompanying notes are an integral part of these statements. F-20 FUTURE MEDIA PRODUCTIONS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Three Months Ended ------------------------ March 31 March 31 1999 2000 ----------- ----------- Operating activities Net income........................................... $ 1,386,210 $ 3,297,846 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization....................... 896,774 1,149,803 Loss in equity of unconsolidated entity............. -- 155,000 Provision for bad debts............................. 30,000 30,000 Changes in operating assets and liabilities Accounts receivable................................. 4,955,472 3,321,310 Inventories......................................... 449,851 (110,589) Prepaid expenses.................................... 15,224 (7,534) Other assets........................................ (1,205,048) (2,010,843) Accounts payable.................................... (1,372,965) 560,606 Accrued expenses.................................... 84,534 942,654 Accrued expenses--royalties......................... 1,221,200 136,894 ----------- ----------- Net cash provided by operating activities............ 6,461,252 7,465,147 Investing activities Capital expenditures................................. (1,456,133) (5,266,358) ----------- ----------- Net cash used in investing activities................ (1,456,133) (5,266,358) Financing activities Net borrowings (repayments) on line of credit........ (2,905,061) 67,317 Net borrowings (payments) on bank overdraft.......... (232,824) 336,210 Proceeds from long-term debt......................... -- 4,130,000 Repayments on long-term debt......................... (939,193) (1,125,403) Notes receivable from officers....................... (365,000) (2,630,000) Payments on capital lease obligations................ (3,041) (1,913) Dividends paid to shareholders....................... (560,000) (2,975,000) ----------- ----------- Net cash used in financing activities................ (5,005,119) (2,198,789) Net change in cash and cash equivalents.............. -- -- Cash and cash equivalents at beginning of period..... -- -- ----------- ----------- Cash and cash equivalents at end of period........... $ -- $ -- =========== =========== Supplemental disclosures of cash flow information: Cash paid during the period for: Interest............................................ 483,520 398,474 State income taxes.................................. 1,500 4,200
The accompanying notes are an integral part of these statements. F-21 FUTURE MEDIA PRODUCTIONS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. Basis of Presentation The accompanying interim condensed consolidated financial statements of the Company are unaudited and include all of the accounts of the Company and its wholly owned subsidiary, Future Media Cdlogue, Inc. In the opinion of management, the unaudited financial statements have been prepared on the same basis as the Company's audited financial statements and all adjustments necessary for a fair presentation (consisting of only normal recurring adjustments) have been reflected in the interim periods presented. Due principally to the seasonal nature of some of the Company's business, results may not be indicative of results for a full year. The accompanying financial statements should be read in conjunction with the Company's financial statements for the year ended December 31, 1999 included in this Prospectus. Future Media Productions, Inc. (the Company) is an independent manufacturer/replicator of digital versatile discs (DVDs) and compact discs (CDs) to companies in industries including Internet/online, film and entertainment, edutainment software, publishing and computer hardware. The majority of the Company's business is targeted at high volume customers in these markets. 2. Future Media Cdlogue In February 2000 the Company formed a wholly owned subsidiary, Future Media Cdlogue ("Cdlogue") for the purpose of pursuing opportunities in the replication of digital catalogs. From the period of its incorporation through March 31, 2000 Cdlogue has had no revenues or expenses. 3. Property and Equipment Property and equipment, net, consisted of the following:
December 31, March 31, 1999 2000 ------------ ------------ Plant equipment......... $ 39,057,036 $ 43,989,249 Computer equipment and software............... 237,871 237,871 Office furniture and equipment.............. 83,558 108,905 Automotive equipment.... 96,865 96,865 Leasehold improvements.. 1,698,122 2,927,086 Leased property under capital leases......... 57,540 57,540 ------------ ------------ 41,230,992 47,417,517 Less accumulated depreciation and amortization........... (11,393,544) (12,543,348) ------------ ------------ $ 29,837,448 $ 34,874,168 ============ ============
4. Shareholders' Equity On January 12, 2000 the Company loaned its President $2,630,000 under a note due no later than June 30, 2000. The note bears interest at the rate charged the Company by its major lender (prime plus 2%). If the Company has no borrowings from its major lender the loan will bear interest at the prime rate plus 1%. On April 13, 2000 the Company's Board of Directors authorized and effected a 1.65 for one stock split. All references in the accompanying condensed consolidated financial statements to the number of shares of common stock and per common share amounts have been retroactively adjusted to reflect the stock split. On April 13, 2000, the Company granted stock options to a director and employees to purchase a total of 256,900 shares of common stock under the 1998 Stock Incentive Plan. These stock options vest over a four year period. F-22 FUTURE MEDIA PRODUCTIONS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (Unaudited) On April 13, 2000 the Company granted 25,000 warrants to purchase common stock to Levy, Small and Lallas for legal services in connection with the offering. The warrant will have an exercise price equal to the initial price of common stock sold in this offering. The warrants vest upon the completion of this offering and expire within one year of the close of this offering. The value of the warrants will be deducted from the proceeds of this offering. On April 13, 2000 the Company adopted a new stock option incentive plan ("the 2000 Stock Incentive Plan"). Each of our executive officers, other employees, non-employee directors or consultants are eligible to be considered for the grant of awards under the 2000 Stock Incentive Plan. A maximum of 1,340,000 shares of common stock may be issued under the 2000 Stock Incentive Plan, plus any shares reserved for issuance under the Existing Stock Plan which have not been issued as of the date of this offering. If any award expires or terminates for any reason, then the common stock subject to that award will again be available under the 2000 Stock Incentive Plan. 5. Comprehensive Income For the three months ended March 31, 1999 and 2000, comprehensive income amounted to $1,386,210 and $3,952,326, respectively. The difference between net income and comprehensive income relates to the unrealized gain the Company recorded for its available-for-sale securities on its investment in its affiliate Lions Gate Entertainment. 6. Pro Forma Information The Company is an S Corporation for income tax purposes. The pro forma unaudited March 31, 2000 information in the accompanying balance sheet reflects the distribution, in the amount of approximately $14,686,732, to shareholders upon conversion from an S Corporation and the establishment of a deferred tax liability of approximately $2,900,000, resulting in an approximately $2,700,000 reduction of retained earnings, upon conversion. In connection with the closing of a proposed public offering, the Company's S Corporation status will terminate and the Company will be taxed thereafter as a C Corporation. The pro forma condensed consolidated statements of income reflect a provision for federal and state income taxes as if the Company was a C Corporation for the periods presented. Upon conversion to a C Corporation, the Company will establish a net deferred tax liability with an accompanying increase to income tax expense. If this charge were recorded at March 31, 2000, the amount would have been approximately $2,700,000, consisting primarily of timing differences related to depreciation. The pro forma earnings per share information is calculated as if the Company had been subject to tax as a C Corporation and for the effect of share equivalents in the amount of 1,349,758 shares for expected dividends to shareholders for the most recent three month period presented. 7. Commitments The Company entered into a lease agreement for its new headquarters effective March 1, 2000, with a company owned by the Company's President. The lease expires December 31, 2013 and has an initial base rent of $53,843, subject to annual increases based on the Consumer Price Index. At the end of the fifth and tenth year of the lease the base rent is to be adjusted to fair market value on these dates as agreed to by the parties. The Company believes the lease is no less favorable than would be obtained from an independent third party. F-23 - ------------------------------------------------------------------------------- Until , all dealers effecting transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This 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. - ------------------------------------------------------------------------------- [LOGO OF FUTURE MEDIA APPEARS HERE] Prudential Volpe Technology a unit of Prudential Securities CIBC World Markets - ------------------------------------------------------------------------------- PART II INFORMATION NOT REQUIRED IN PROSPECTUS Item 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION. The following table itemizes the expenses incurred by the Registrant in connection with the issuance and distribution of the Securities being registered, other than underwriting discounts. All the amounts shown are estimates except the Securities and Exchange Commission registration fee and the NASD filing fee. Registration fee--Securities and Exchange Commission............. $ 18,480 NASD filing fee.................................................. 7,500 Nasdaq National Market fee....................................... 50,000 Accounting fees and expenses..................................... 300,000 Legal fees and expenses (other than blue sky).................... 325,000 Blue sky fees and expenses, including legal fees................. 10,000 Printing; stock certificates..................................... 200,000 Transfer agent and registrar fees................................ 10,000 Consulting fees.................................................. 472,500 Miscellaneous.................................................... 106,520 ---------- Total.......................................................... $1,500,000 ==========
Item 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS. The Registrant's Articles of Incorporation include a provision that eliminates the personal liability of its directors to the Registrant and its shareholders for monetary damages for breach of the directors' fiduciary duties in certain circumstances. This limitation has no effect on a director's liability (i) for acts or omissions that involve intentional misconduct or a knowing and culpable violation of law, (ii) for acts or omissions that a director believes to be contrary to the best interests of the Registrant or its shareholders or that involve the absence of good faith on the part of the director, (iii) for any transaction from which a director derived an improper personal benefit, (iv) for acts or omissions that show a reckless disregard for the director's duty to the Registrant or its shareholders in circumstances in which the director was aware, or should have been aware, in the ordinary course of performing a director's duties, of a risk of a serious injury to the Registrant or its shareholders, (v) for acts or omissions that constitute an unexcused pattern of inattention that amounts to an abdication of the director's duty to the Registrant or its shareholders, (vi) under Section 310 of the California Corporations Code (the "California Code") (concerning contracts or transactions between the Registrant and a director) or (vii) under Section 316 of the California Code (concerning directors' liability for improper dividends, loans and guarantees). The provision does not extend to acts or omissions of a director in his capacity as an officer. Further, the provision will not affect the availability of injunctions and other equitable remedies available to the Registrant's shareholders for any violation of a director's fiduciary duty to the Registrant or its shareholders. The Registrant's Articles of Incorporation also include an authorization for the Registrant to indemnify its agents (as defined in Section 317 of the California Code), through bylaw provisions, by agreement or otherwise, to the fullest extent permitted by law. Pursuant to this latter provision, the Registrant's Bylaws provide for indemnification of the Registrant's directors, officers and employees. In addition, the Registrant, at its discretion, may provide indemnification to persons whom the Registrant is not obligated to indemnify. The Bylaws also allow the Registrant to enter into indemnity agreements with individual directors, officers, employees and other agents. These indemnity agreements have been entered into with all directors and provide the maximum indemnification permitted by law. These agreements, together with the Registrant's Bylaws and Articles of Incorporation, may require the Registrant, among other things, to indemnify such directors against certain liabilities that may arise by reason of their status or service as directors (other than liabilities resulting II-1 from willful misconduct of a culpable nature), to advance expenses to them as they are incurred, provided that they undertake to repay the amount advanced if it is ultimately determined by a court that they are not entitled to indemnification, and to obtain directors' and officers' insurance if available on reasonable terms. The Company and certain of the Company's shareholders (the "Existing Shareholders") plan to enter into a tax indemnification agreement (the "Tax Agreement") relating to their respective income tax liabilities. Because the Company will be fully subject to corporate income taxation after the termination of the Company's S Corporation status, the reallocation of income and deductions between the period during which the Company was treated as an S Corporation and the period during which the Company will be subject to corporate income taxation may increase the taxable income of one party while decreasing that of another party. Accordingly, the Tax Agreement is intended to assure that taxes are borne by the Company on the one hand and the Existing Shareholders on the other only to the extent that such parties received the related income. The Tax Agreement generally provides that, if an adjustment is made to the taxable income of the Company for a year in which it was treated as an S Corporation, the Company will indemnify the Existing Shareholders and the Existing Shareholders will indemnify the Company against any increase in the indemnified party's income tax liability (including interest and penalties and related costs and expenses), with respect to any tax year to the extent such increase results in a related decrease in the income tax liability of the indemnifying party for that year. The Company will also indemnify the Existing Shareholders for all taxes imposed upon them as the result of their receipt of an indemnification payment under the Tax Agreement. Section 317 of the California Code and the Registrant's Bylaws make provision for the indemnification of officers, directors and other corporate agents in terms sufficiently broad to indemnify such persons, under certain circumstances, for liabilities (including reimbursement of expenses incurred) arising under the Securities Act of 1933 ("Securities Act"). Section of the Underwriting Agreement filed as Exhibit 1.1 hereto sets forth certain provisions with respect to the indemnification of certain controlling persons, directors and officers against certain losses and liabilities, including certain liabilities under the Securities Act. The Registrant maintains director and officer liability insurance. Insofar as indemnification for liabilities arising under 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. Reference is made to the following documents filed as exhibits to this Registration Statement regarding relevant indemnification provisions described above and elsewhere herein:
Exhibit Document Number -------- ------- Proposed form of Underwriting Agreement.............................. 1.1 Registrant's Amended and Restated Articles of Incorporation.......... 3.1 Registrant's Amended and Restated Bylaws............................. 3.2 Registrant's Form of Indemnification Agreement....................... 10.4 Tax Agreement........................................................ 10.5
Item 15. RECENT SALES OF UNREGISTERED SECURITIES. In April 2000, pursuant to its 1998 Stock Plan the Company issued stock options to purchase an aggregate of 256,900 shares of common stock equal to the initial sales price for the shares sold pursuant to this offering assuming the closing of this offering occurs prior to July 2000 to one of the Company's directors and 61 employees of the Company. The issuance and sale of these securities is exempt from the registration II-2 requirements of the Securities Act pursuant to Rule 701 because the offer and sale of the securities was made only to a director and employees of the Company pursuant to a compensatory benefit plan, a copy of which was provided to each respective employee or director. Also, the total number of shares underlying our options, including options granted during the previous 12 months, represented less than 15% of the total number of shares outstanding at the time of grant. The issuance of these options were also exempt from registration pursuant to Section 4(2) of the Securities Act as a transaction not involving any public offering. The options were granted to a select group of individuals and did not involve any public offer, general solicitation or general advertising. On April 13, 2000 the Company agreed to issue to Levy, Small & Lallas, LLP on the effective date of this offering, warrants to purchase 25,000 shares of the Company's common stock for a purchase price equal to the initial sales price for the shares sold pursuant to this offering. The issuance of these warrants was exempt from registration pursuant to Section 4(2) of the Securities Act as a transaction not involving any public offering. This issuance was to a single sophisticated entity and did not involve any public offer, general solicitation or advertising. In August 1998, the Company issued pursuant to its 1998 Stock Plan stock options to purchase an aggregate of 297,000 shares of common stock at $7.21 per share to four directors of the Company. The issuance and sale of these securities is exempt from the registration requirements of the Securities Act pursuant to Rule 701 because the offer and sale of the securities was made only to directors of the Company pursuant to a compensatory benefit plan, a copy of which was provided to each director. Also, the total number of shares underlying such options, including options granted during the previous 12 months, represented less than 15% of the total number of shares outstanding at the time of the grant. The issuance of these options were also exempt from registration pursuant to Section 4(2) of the Securities Act as a transaction not involving any public offering. The options were granted to a select group of individuals and did not involve any public offer, general solicitation or general advertising. In May 1998, pursuant to its 1998 Stock Plan the Company issued stock options to purchase an aggregate of 1,069,200 shares of common stock at $6.79 per share to 15 employees of the Company. The issuance and sale of these securities is exempt from the registration requirements of the Securities Act pursuant to Rule 701 because the offer and sale of the securities was made only to employees of the Company pursuant to a compensatory benefit plan, a copy of which was provided to each employee. Also, the total number of shares underlying such options, including options granted during the previous 12 months, represented less than 15% of the total number of shares outstanding at the time of the grant. The issuance of these options were also exempt from registration pursuant to Section 4(2) of the Securities Act as a transaction not involving any public offering. The options were granted to a select group of individuals and did not involve any public offer, general solicitation or general advertising. The Company has agreed to issue to Averil Capital Markets Group, Inc. warrants to purchase shares of common stock equivalent to 0.25% of the Company proceeds raised in this offering. The issuance of these warrants was exempt from registration pursuant to Section 4(2) of the Securities Act as a transaction not involving any public offering. This issuance was to a single sophisticated entity and did not involve any public offer, general solicitation or advertising. On January 1, 1998 the Company issued warrants to purchase 604,890 shares of common stock to David Moss, the Company's Vice President-Operations, for services which Mr. Moss had rendered. The issuance of these warrants was exempt from the registration requirements of the Securities Act pursuant to Rule 701 because the offer and sale of the securities was made only to a single sophisticated executive officer of the Company pursuant to a compensatory benefit plan, a copy of which was provided to the officer. Also, the total number of shares underlying such options, including options granted during the previous 12 months, represented less than 15% of the total number of shares outstanding at the time of the grant. The issuance was to a single sophisticated individual and did not involve any public offer, general solicitation or advertising. II-3 Item 16. EXHIBITS.
Exhibit Number Exhibit Description ------- ------------------- 1.1 Form of Underwriting Agreement.** 3.1 Amended and Restated Articles of Incorporation of Registrant.* 3.2 Amended and Restated Bylaws of Registrant.* 4.1 Specimen Stock Certificate of Common Stock of Registrant.* 5.1 Opinion and Consent of Troop Steuber Pasich Reddick & Tobey, LLP.* 10.1 1998 Stock Incentive Plan.* 10.2 Form of Registrant's Stock Option Certificate (Non-Statutory Stock Option).* 10.3 Form of Registrant's Stock Option Certificate (Incentive Stock Option).* 10.4 Form of Director and Officer Indemnification Agreement.* 10.5 Form of Tax Indemnification Agreement to be entered into among Registrant and the Existing Shareholders. 10.6 Employment Agreement, dated August 26, 1998, between the Registrant and David Moss.* 10.7 Warrant Agreement, dated January 1, 1998, between the Registrant and David Moss.* 10.8 Lease Agreement and Notice of Extension thereof, dated August 24, 1994 and June 13, 1996, respectively, between the Registrant and Hermann Rosen & Florence W. Rosen, Trustees.* 10.9 Lease Agreement, dated May 1, 1997, between the Registrant and Bascal Properties.* 10.10 Loan and Security Agreement dated February 26, 1997, between the Registrant and Greyrock Business Credit.* 10.11 Extension Agreement, dated January 16, 1998, between the Registrant and Greyrock Business Credit.* 10.12 Amendment to Loan Agreement, dated April 29, 1998, between the Registrant and Greyrock Business Credit.* 10.13 Extension Agreement, dated September 4, 1998, between the Registrant and Greyrock Business Credit.* 10.14 Amendment to Loan Document, dated June 17, 1999 between the Registrant and Greyrock Business Capital.* 10.15 Amendment to Loan Document, dated January 25, 2000, between the Registrant and Greyrock Business Capital.* 10.16 Comprehensive CD Disc License Agreement, dated October 1, 1996, between the Registrant and U.S. Phillips Corporation.* 10.17 Non-Exclusive Patent License Agreement for Disc Product Manufacturers, dated June 1, 1996, between the Registrant and Discovision Associates.* 10.18 Letter Agreement, dated June 15, 1998, between the Registrant and Averil Capital Markets Group, Inc.* 10.19 Engagement Agreement, dated June 15, 1998, between the Registrant and Averil Capital Markets Group, Inc.* 10.20 DVD Format and Logo License, dated January 11, 2000, between the Registrant and Toshiba Corporation.* 10.21 DVD Video Disc and DVD Rom Disc Patent License Agreement, dated October 1, 1999, between the Registrant and U.S. Philips Corporation.* 10.22 Patent License Agreement for the Use of AC-3 Technology in the Manufacture of DVD Discs, dated October 1, 1999, between Registrant and U.S. Phillips Corporation.* 10.23 Convertible Subordinated Promissory Note, dated December 22, 1999, between the Registrant and Synthonics Technologies, Inc. 10.24 Subscription Agreement for Units, between the Registrant and Lions Gate Entertainment Corporation, dated December 21, 1999.
II-4
Exhibit Number Exhibit Description ------- ------------------- 10.25 Lease Agreement for 24811 Avenue Rockefeller. 10.26 Warrant Agreement between the Registrant and Averil Capital Markets Group, Inc.** 10.27 Warrant Agreement between the Registrant and Levy, Small and Lallas.** 10.28 2000 Stock Incentive Plan.* 23.1 Consent of Troop Steuber Pasich Reddick & Tobey, LLP (included in its opinion filed as Exhibit 5.1 hereto).* 23.2 Consent of Ernst & Young LLP. 23.3 Consent of Infotech. 24.1 Power of Attorney.* 27.1 Financial Data Schedule.
- -------- *Previously filed. **To be filed by Amendment. (b) Financial Statement Schedules Report of Independent Auditors. Schedule II Valuation and Qualifying Accounts Item 17. UNDERTAKINGS. (a) The undersigned Registrant hereby undertakes to provide to the underwriter at the closing specified in the underwriting agreements, certificates in such denominations and registered in such names as required by the underwriter to permit prompt delivery to each purchaser. (b) Insofar as indemnification for liabilities arising under 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 of 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 a controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue. (c) The undersigned registrant hereby undertakes that: (1) For the 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 497(h) under the Securities Act shall be deemed to be part of this registration statement as of the time it was declared effective. (2) 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-5 SIGNATURES Pursuant to the requirements of the Securities Act, the Registrant certifies that it has reasonable grounds to believe that it meets all of the requirements for filing on Form S-1 and has duly caused this Amendment No. 2 to Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Los Angeles, State of California, on June 9, 2000. Future Media Productions, Inc. /s/ Alex Sandel By: _________________________________ Alex Sandel Chairman of the Board, Chief Executive Officer and President POWER OF ATTORNEY Pursuant to the requirements of the Securities Act of 1933, this Registration Statement has been signed by the following persons in the capacities and on the dates stated.
Signature Title Date --------- ----- ---- /s/ Alex Sandel Chairman of the Board, June 9, 2000 ______________________________________ Chief Executive Officer Alex Sandel and President /s/ Louis Weiss Chief Financial Officer, June 9, 2000 ______________________________________ Principal Accounting Louis Weiss Officer and Secretary * Director June 9, 2000 ______________________________________ Sanford R. Climan * Director June 9, 2000 ______________________________________ Mark Dyne * Director June 9, 2000 ______________________________________ Diana Maranon * Director June 9, 2000 ______________________________________ Jason Barzilay * Director June 9, 2000 ______________________________________ Martin Schuermann
* Power of Attorney *By: /s/ Alex Sandel _________________________________ Alex Sandel, Attorney-in-Fact II-6 REPORT OF INDEPENDENT AUDITORS The Board of Directors Future Media Productions, Inc. We have audited the financial statements of Future Media Productions, Inc. as of December 31, 1998 and 1999 and for each of the three years in the period ended December 31, 1999 and have issued our report thereon dated February 25, 2000 except as to Note 11, as to which the date is April 13, 2000 (included elsewhere in this Registration Statement). Our audits also included the financial statement schedule listed in Item 16(b) of this Registration Statement. The schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, the financial statement schedule referred to above as of December 31, 1998 and 1999 and for each of the three years in the period ended December 31, 1999, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. /s/ Ernst & Young LLP Los Angeles, California February 25, 2000 II-7 SCHEDULE II FUTURE MEDIA PRODUCTIONS, INC. VALUATION AND QUALIFYING ACCOUNTS ALLOWANCE FOR DOUBTFUL ACCOUNTS For the Years Ended December 31, 1997, 1998 and 1999
Charged Balance Balance at to Costs Charged at End Beginning and to Other of Description of Period Expenses Accounts Deductions(1) Period - ----------- ---------- -------- -------- ------------- -------- Column A Column B Column C Column D Column E - -------- ---------- ----------------- ------------- -------- Year Ended December 31, 1997..................... $298,439 $955,243 $ -- $1,003,682 $250,000 Year Ended December 31, 1998..................... 250,000 120,000 -- 207,000 163,000 Year Ended December 31, 1999..................... 163,000 120,000 -- 17,222 265,778 Three Months Ended March 31, 2000 (unaudited)..... 265,778 30,000 -- -- 295,778
- -------- (1) Uncollectible accounts written off, net of recoveries. EXHIBIT INDEX
Exhibit Number Exhibit Description ------- ------------------- 1.1 Form of Underwriting Agreement.** 3.1 Amended and Restated Articles of Incorporation of Registrant.* 3.2 Amended and Restated Bylaws of Registrant.* 4.1 Specimen Stock Certificate of Common Stock of Registrant.* 5.1 Opinion and Consent of Troop Steuber Pasich Reddick & Tobey, LLP.* 10.1 1998 Stock Incentive Plan.* 10.2 Form of Registrant's Stock Option Certificate (Non-Statutory Stock Option).* 10.3 Form of Registrant's Stock Option Certificate (Incentive Stock Option).* 10.4 Form of Director and Officer Indemnification Agreement.* 10.5 Form of Tax Indemnification Agreement to be entered into among Registrant and the Existing Shareholders. 10.6 Employment Agreement, dated August 26, 1998, between the Registrant and David Moss.* 10.7 Warrant Agreement, dated January 1, 1998, between the Registrant and David Moss.* 10.8 Lease Agreement and Notice of Extension thereof, dated August 24, 1994 and June 13, 1996, respectively, between the Registrant and Hermann Rosen & Florence W. Rosen, Trustees.* 10.9 Lease Agreement, dated May 1, 1997, between the Registrant and Bascal Properties.* 10.10 Loan and Security Agreement dated February 26, 1997, between the Registrant and Greyrock Business Credit.* 10.11 Extension Agreement, dated January 16, 1998, between the Registrant and Greyrock Business Credit.* 10.12 Amendment to Loan Agreement, dated April 29, 1998, between the Registrant and Greyrock Business Credit.* 10.13 Extension Agreement, dated September 4, 1998, between the Registrant and Greyrock Business Credit.* 10.14 Amendment to Loan Document, dated June 17, 1999 between the Registrant and Greyrock Business Capital.* 10.15 Amendment to Loan Document, dated January 25, 2000, between the Registrant and Greyrock Business Capital.* 10.16 Comprehensive CD Disc License Agreement, dated October 1, 1996, between the Registrant and U.S. Phillips Corporation.* 10.17 Non-Exclusive Patent License Agreement for Disc Product Manufacturers, dated June 1, 1996, between the Registrant and Discovision Associates.* 10.18 Letter Agreement, dated June 15, 1998, between the Registrant and Averil Capital Markets Group, Inc.* 10.19 Engagement Agreement, dated June 15, 1998, between the Registrant and Averil Capital Markets Group, Inc.* 10.20 DVD Format and Logo License, dated January 11, 2000, between the Registrant and Toshiba Corporation.* 10.21 DVD Video Disc and DVD Rom Disc Patent License Agreement, dated October 1, 1999, between the Registrant and U.S. Philips Corporation.* 10.22 Patent License Agreement for the Use of AC-3 Technology in the Manufacture of DVD Discs, dated October 1, 1999, between Registrant and U.S. Phillips Corporation.* 10.23 Convertible Subordinated Promissory Note, dated December 22, 1999, between the Registrant and Synthonics Technologies, Inc. 10.24 Subscription Agreement for Units, between the Registrant and Lions Gate Entertainment Corporation, dated December 21, 1999.
Exhibit Number Exhibit Description ------- ------------------- 10.25 Lease Agreement for 24811 Avenue Rockefeller. 10.26 Warrant Agreement between the Registrant and Averil Capital Markets Group, Inc.** 10.27 Warrant Agreement between the Registrant and Levy, Small and Lallas.** 10.28 2000 Stock Incentive Plan.* 23.1 Consent of Troop Steuber Pasich Reddick & Tobey, LLP (included in its opinion filed as Exhibit 5.1 hereto).* 23.2 Consent of Ernst & Young LLP. 23.3 Consent of Infotech. 24.1 Power of Attorney.* 27.1 Financial Data Schedule.
- -------- *Previously filed. **To be filed by Amendment. EX-10.5 2 0002.txt FORM OF TAX INDEMNIFICATION AGREEMENT EXHIBIT 10.5 TAX INDEMNIFICATION AGREEMENT THIS TAX INDEMNIFICATION AGREEMENT (this "Agreement") is made this ___ day of March 2000, between Future Media Productions, Inc., a California corporation (the "Company"), and Alex Sandel and Jason Barzilay (collectively, the "Shareholders") (the Company and the Shareholders are hereinafter referred to individually as a "party" and collectively as the "parties"). WHEREAS, the Company contemplates a public offering of its stock in order to raise additional equity capital for the expansion of the Company's business operations (the "Public Offering"); WHEREAS, the execution of this Agreement by the Company and the Shareholders is a condition to the closing (the "Closing") of the contemplated Public Offering; WHEREAS, from the date of its organization through the date prior to the date of the Closing, the Company has been and will continue to be an S corporation under the Internal Revenue Code of 1986, as amended (the "Code"), after which it will become a C corporation under the Code (and under the corresponding provisions of state income tax law); WHEREAS, the Company will elect under Section 1362(e)(3) of the Code to have the rules of Section 1362(e)(2) not apply for its S Termination year (as hereinafter defined), to which election the Shareholders will consent; and WHEREAS, the Company and the Shareholders wish to provide for a tax indemnification agreement in connection with the Company's termination as an S corporation. NOW, THEREFORE, the parties agree as follows: 1. DEFINITIONS 1.1 Definitions. The following terms, as used herein, have the following ----------- meanings: "C Corporation Taxable Year" means any taxable year or portion thereof during which the Company is taxable as a C Corporation. "C Short Year" means that portion of the S Termination Year of the Company defined in Section 1362(e)(1)(B) of the Code. "S Corporation Taxable Income" means the taxable income of the Company from all sources through and including the close of business on the last day of the S Short Year of the Company. "S Corporation Taxable Year" means any taxable year or portion thereof during which the Company is taxable as an S corporation. "S Short Year" means that portion of the S Termination Year of the Company defined in Section 1362(e)(1)(A) of the Code. "S Termination Year" shall have the meaning set forth in Section 1362(e)(4) of the Code. 2. TAXES 2.1 Shareholders' Filing of Tax Returns and Payment of Taxes. Each -------------------------------------------------------- Shareholder represents, covenants and agrees that: (i) such Shareholder has duly included, or shall duly include, in his own federal and state income tax returns his share of all items of income, gain, loss, deduction or credit attributable to the S Short Year of the Company or any prior period (or that portion of any period) during which the Company was an S corporation as required by applicable law; (ii) such returns have included, or shall include, his allocable share of S Corporation Taxable Income; and (iii) such Shareholder has paid, or shall pay, any and all taxes he is required to pay with respect to such allocable share of S Corporation Taxable Income for all taxable periods (or that portion of any period) during which the Company was an S corporation. 2.2 Company's Filing of Tax Returns and Payment of Taxes. The Company ---------------------------------------------------- represents, covenants and agrees that: (i) the Company is and shall be responsible for and has effected, or shall effect, the filing of all federal, state, foreign and local returns for the Company with respect to any and all taxable periods; (ii) such Company returns have included, or shall include, the Company's income from all sources for all periods covered by the returns; and (iii) the Company has paid, or shall pay, any and all taxes required to be paid by the Company for all periods covered by the returns as required by applicable law. 2.3 Company's Indemnification for Tax Liabilities. The Company hereby --------------------------------------------- indemnifies and agrees to hold each Shareholder harmless from, against and in respect of any federal and state income tax liability (including interest and penalties and any taxes resulting from payments under this Section 2.3, but reduced by the benefit received from the deduction for state income taxes paid against taxable income for federal income tax purposes), if any, incurred by such Shareholder resulting from or arising out of a final determination of an adjustment (by reason of an amended return, claim for refund, audit or otherwise) to the Company's income tax return for any S Corporation Taxable Year resulting in a current or future decrease in the Company's federal or state, as the case may be, taxable income for any C Corporation Taxable Year (by way of additional or increased deduction, credit, depreciation, amortization or other tax benefit, whether realized currently or to be realized in the future or over a period of years) and a corresponding increase in the federal or state, as the case may be, taxable income of such Shareholder with respect to such Shareholder's allocable share of S Corporation Taxable Income; provided, however, that in no event shall the Company's liability to any one of the Shareholders under this Section 2.3 exceed the amount of the income tax liability (including interest and penalties and any taxes resulting from payments under this Section 2.3) of such Shareholder arising from such increase in S Corporation Taxable Income allocated to such Shareholder. 2 2.4 Shareholder Indemnification for Tax Liabilities. ----------------------------------------------- 2.4.1 Each Shareholder hereby separately and proportionately (according to the percentage of the outstanding shares of the Company's Common Stock owned by such Shareholder during the applicable S Corporation Taxable Year from which there is a shift of S Corporation Taxable Income, as referred to herein below, pro rated by number of days of ownership in the case of partial periods of ownership) indemnifies and agrees to hold the Company harmless from, against and in respect of any federal and state income tax liability (including interest and penalties and any taxes resulting from payments under this Section 2.4.1), if any, resulting from or arising out of a final determination of any adjustment (by reason of an amended return, claim for refund, audit or otherwise) to such Shareholders' federal or state, as the case may be, taxable income resulting in a decrease in such Shareholders' S Corporation Taxable Income and a corresponding increase in the federal or state, as the case may be, taxable income of the Company; provided, however, the amount of any such indemnified tax liability shall be reduced by an amount equal to the refund of state income tax, including interest, received by the Company for state income taxes paid by the Company in respect of any taxable income shifted from an S Corporation Taxable Year to a C Corporation Taxable Year of the Company which is subject to indemnification hereunder; and provided, further, that in no event shall such Shareholder's liability under this Section 2.4.1 exceed the amount of any credit or refund of taxes and interest actually received by such Shareholder as a result of such final determination, related final determination or claim for refund. 2.4.2 Each Shareholder hereby separately and proportionately (according to the percentage of the outstanding shares of the Company's Common Stock owned by such Shareholder during the applicable taxable period ending prior to the Closing with respect to which it is determined that the Company was not an S Corporation) indemnifies and agrees to hold the Company harmless from, against and in respect of any federal and state income tax liability (including penalties, interest and any taxes resulting from the payments under this Section 2.4.2) incurred by the Company as a result of a final determination that the Company was not an S corporation for federal or state income tax purposes for any taxable period ending prior to the Closing (including a short taxable period ending the day before the Closing). 2.5 Payments. The party (or parties) providing the indemnity under -------- either Section 2.3 or Section 2.4 (the "Indemnifying Party") shall make any payment required to be paid under this Agreement to the party being indemnified under Section 2.3 or Section 2.4, respectively (the "Indemnified Party"), within thirty (30) days after the receipt of notice from the Indemnified Party that a payment is due by the Indemnified Party to the appropriate taxing authority pursuant to the applicable final determination; provided, however, that in no event shall an Indemnifying Party providing the indemnity under Section 2.4 be required to pay any such indemnified amount prior to thirty (30) days after the receipt by the Indemnifying Party of the credit or refund of taxes, if any, resulting from the corresponding applicable final determination, related final determination or claim for refund. 2.6 Subrogation. The Indemnifying Party shall be subrogated to all ----------- rights of recovery that the Indemnified Party may have against any person or organization in respect of the tax liabilities for which the Indemnifying Party is providing indemnity. Such right of subrogation shall not exceed the amount paid by the Indemnifying Party to the Indemnified Party. The Indemnified Party shall execute and deliver instruments and papers and such other items, and take such actions, 3 as are reasonably necessary to secure such rights of subrogation for the Indemnifying Party and to permit the Indemnifying Party to pursue such rights of recovery. 3. MISCELLANEOUS 3.1 Notices. All notices and other communications made in connection ------- with this Agreement shall be in writing and shall be deemed given when delivered personally or sent by facsimile transmission to the numbers indicated on the signature page hereto (if physical confirmation of transmission is retained) or on the third succeeding business day after being mailed by registered or certified mail, deposited in the United States mail, postage prepaid, return receipt requested, to the appropriate party at its, his address set forth on the signature page hereto or at such other address for such party (as shall be specified by written notice when in fact delivered pursuant hereto). 3.2 Counterparts. This Agreement may be executed in several counterparts, ------------ each of which shall be deemed an original, but all of which counterparts collectively shall constitute an instrument representing the agreement between the parties hereto. 3.3 Construction of Terms. Nothing herein expressed or implied is --------------------- intended, or shall be construed, to confer upon or give any person, firm or corporation, other than the parties hereto or their respective successors and assigns, any rights or remedies under or by reason of this Agreement. 3.4 Governing Law. This Agreement and the legal relations between the ------------- parties hereto shall be governed by and construed in accordance with the substantive laws of the State of California without regard to California choice of law rules. 3.5 Amendment and Modification. This Agreement may be amended by the -------------------------- agreement of the Company and Shareholders holding a majority of the shares of Common Stock outstanding on the date of this Agreement; provided, however, that no amendment may adversely affect any particular Shareholder in a manner not equally applicable to the other Shareholders unless such amendment is approved by such Shareholder. 3.6 Assignment. This Agreement and all of the provisions hereof shall be ---------- binding upon and inure to the benefit of the parties hereto and their respective successors and permitted assigns, but neither this Agreement nor any of the rights, interests or obligations hereunder shall be assigned by any of the parties hereto without the prior written consent of the other parties, nor is this Agreement intended to confer upon any other person except the parties, any rights or remedies hereunder; provided, however, nothing in this Section shall be construed as prohibiting an assignment of this Agreement by the Company to a successor by operation of law. 3.7 Interpretation. The title, articles and section headings contained -------------- in this Agreement are solely for the purpose of reference, are not part of the agreement of the parties and shall not in any way affect the meaning or interpretation of this Agreement. 3.8 Severability. In the event that any one or more of the provisions of ------------ this Agreement shall be held to be illegal, invalid or unenforceable in any respect, the same shall not in any respect affect the validity, legality or enforceability of the remainder of this Agreement, and the parties shall 4 use their best efforts to replace such illegal, invalid or unenforceable provisions with an enforceable provision approximating, to the extent possible, the original intent of the parties. 3.9 Entire Agreement. This Agreement embodies the entire agreement and ---------------- understanding of the parties hereto in respect of the subject matter contained herein. There are no representations, promises, warranties, covenants, or undertakings, other than those expressly set forth or referred to herein. This Agreement supersedes all prior agreements and the understandings between the parties with respect to such subject matter. 3.10 Arbitration. Any action to enforce or interpret this Agreement or to ----------- resolve disputes arising in connection with this Agreement shall be settled by arbitration in accordance with the rules of the American Arbitration Association. Any party may commence arbitration by sending a written demand for arbitration to the other parties. Such demand shall set forth the nature of the matter to be resolved by arbitration. The substantive law of the State of California shall be applied by the arbitrator to the resolution of the dispute. The Company, on the one hand, and the Shareholders, on the other hand, shall share equally all initial costs of arbitration. The prevailing party or parties shall be entitled to reimbursement of attorney fees, costs, and expenses incurred in connection with the arbitration. All decisions of the arbitrator shall be final, binding, and conclusive on all parties. Judgment may be entered upon any such decision in accordance with applicable law in any court having jurisdiction thereof. 3.11 No Third Party Benficiary; No Release of Obligations. No former ---------------------------------------------------- shareholder of the Company or other person not a party hereto is an intended third party beneficiary of this Agreement; and no former shareholder of the Company or other person not a party hereto shall in any manner be released by this Agreement from any liability or obligation whatsoever, including but not limited to any liability or obligation to the Company. IN WITNESS WHEREOF, each of the parties hereto has executed or caused this Tax Indemnification Agreement to be executed on its behalf all as of the day and year first above written. "Company" Future Media Productions, Inc., a California corporation By:___________________________________ Its:__________________________________ Address: 25136 Anza Drive Valencia, California 91355 Facsimile number: ___________________ "Shareholders" ______________________________________ Alex Sandel Address: ____________________________ ____________________________ Facsimile number: ____________________ ______________________________________ Jason Barzilay Address: ____________________________ ____________________________ Facsimile number: ____________________ 5 EX-10.23 3 0003.txt SUBSCRIPTION AGREE DTD 12/33/99 SYNTHONICS EXHIBIT 10.23 THIS SUBORDINATED CONVERTIBLE PROMISSORY NOTE AND THE SECURITIES ISSUABLE HEREUNDER HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 AND HAVE BEEN ACQUIRED FOR INVESTMENT AND NOT WITH A VIEW TO, OR IN CONNECTION WITH, THE SALE OR DISTRIBUTION THEREOF. NO SUCH SALE OR DISPOSITION MAY BE EFFECTED WITHOUT AN EFFECTIVE REGISTRATION STATEMENT RELATED THERETO OR AN OPINION OF COUNSEL FOR THE COMPANY THAT SUCH REGISTRATION IS NOT REQUIRED UNDER THE SECURITIES ACT OF 1933. - -------------------------------------------------------------------------------- $500,000.00 December 22, 1999 Los Angeles, CA SYNTHONICS TECHNOLOGIES, INC. CONVERTIBLE SUBORDINATED PROMISSORY NOTE FOR VALUE RECEIVED, Synthonics Technologies, Inc., a Utah corporation (the "Company"), promises to pay to Future Media Productions, Inc ("Holder"), at its offices at 25136 Anza Drive, Valencia, CA 91355 or such other location as is reasonably requested by Holder, the principal sum of Five Hundred Thousand $500,000.00. Interest shall accrue from the first anniversary of the date of this Note on the unpaid principal amount at the rate equal to the average rate of interest incurred by Holder on its outstanding secured borrowings, compounded annually, until paid. Such principal amount, together with accrued but unpaid interest, shall be payable on demand by the Holder after December 22, 2001 (the "Term"), unless earlier converted in accordance with Section 2 of this Convertible Note (the "Note"). 1. Payment. Payment shall be made in lawful tender of the United States and ------- shall be credited first to the accrued but unpaid interest due and the remainder applied to principal. 2. Conversion. Subject to and in compliance with the provisions of this ---------- Section 2, up to but not following the first anniversary of the date of this Note, the Note may, at the option of the Holder, be converted at any time into fully-paid and nonassessable shares of Common Stock. The number of shares of Common Stock to which the Holder shall be entitled to at any time upon conversion of the Note shall be Eleven Million, Five Hundred and Eighteen Thousand and Ninety-Six (11,518,096), subject to adjustment as provided herein. 2.1. Adjustment for Stock Splits, Stock Subdivisions or Combinations of ------------------------------------------------------------------ Shares. The number of shares of Common Stock issuable upon conversion of ------ this Note (or any shares of stock or other securities at the time issuable upon conversion of this Note) shall be proportionally increased to reflect any stock split or subdivision of the Company's Common Stock and proportionally decreased to reflect any combination of the Company's Common Stock. 2.2. Adjustment for Dividends or Distributions of Stock or Other ----------------------------------------------------------- Securities or Property. In case the Company shall make or issue, or shall ---------------------- fix a record date for the determination of eligible holders entitled to receive, a dividend or other distribution with respect to the Common Stock (or any shares of stock or other securities at the time issuable upon conversion of the Note) payable in (a) securities of the Company or (b) assets (excluding cash dividends paid or payable solely out of retained earnings), then, in each such case, the Holder of this Note on conversion hereof at any time after the consummation, effective date or record date of such dividend or other distribution, shall receive, in addition to the shares of Common Stock (or such other stock or securities) issuable on such conversion prior to such date, and without the payment of additional consideration therefore, the securities or such other assets of the Company to which such Holder would have been entitled upon such date if such Holder had converted this Note on the date hereof and had thereafter, during the period from the date hereof to and including the date of such conversion, retained such shares and all such additional securities or other assets distributed with respect to such shares as aforesaid during such period giving effect to all adjustments called for by this Section 2. 2.3. Reclassification. If the Company, by reclassification of securities ---------------- or otherwise, shall change any of the securities as to which purchase rights under this Note exist into the same or a different number of securities of any other class or classes, this Note shall thereafter represent the right to acquire such number and kind of securities as would have been issuable as the result of such change with respect to the securities that were subject to the conversion rights under this Note immediately prior to such reclassification or other change, and the number of shares of Common Stock issuable upon conversion of this Note shall be appropriately adjusted, all subject to further adjustment as provided in this Section 2. No adjustment shall be made pursuant to this Section 2.3 upon any conversion or redemption of the Common Stock which is the subject of Section 2.5. 2.4. Adjustment for Capital Reorganization, Merger or Consolidation. -------------------------------------------------------------- In case of any capital reorganization of the capital stock of the Company (other than a combination, reclassification, exchange or subdivision of shares otherwise provided for herein), or any merger or consolidation of the Company with or into another corporation, or the sale of all or substantially all the assets of the Company then, and 2 in each such case, as a part of such reorganization, merger, consolidation, sale or transfer, lawful provision shall be made so that the Holder of this Note shall thereafter be entitled to receive upon conversion of this Note, during the period specified herein, the number of shares of stock or other securities or property of the successor corporation resulting from such reorganization, merger, consolidation, sale or transfer that a holder of the shares deliverable upon conversion of this Note would have been entitled to receive in such reorganization, consolidation, merger, sale or transfer if this Note had been converted immediately before such reorganization, merger, consolidation, sale or transfer, all subject to further adjustment as provided in this Section 2. The foregoing provisions of this Section 2.4 shall similarly apply to successive reorganizations, consolidations, mergers, sales and transfers and to the stock or securities of any other corporation that are at the time receivable upon the conversion of this Note. If the per-share consideration payable to the Holder hereof for shares in connection with any such transaction is in a form other than cash or marketable securities, then the value of such consideration shall be determined in good faith by the Company's Board of Directors. In all events, appropriate adjustment (as determined in good faith by the Company's Board of Directors) shall he made in the application of the provisions of this Note with respect to the rights and interests of the Holder after the transaction, to the end that the provisions of this Note shall be applicable after that event, as near as reasonably may be, in relation to any shares or other property deliverable after that event upon conversion of this Note. 2.5. Conversion of Common Stock. In case all or any portion of the -------------------------- authorized and outstanding shares of Common Stock of the Company are redeemed or converted or reclassified into other securities or property pursuant to the Company's Certificate of Incorporation or otherwise, or the Common Stock otherwise ceases to exist, then, in such case, the Holder of this Note, upon conversion hereof at any time after the date on which the Common Stock is so redeemed or converted, reclassified or ceases to exist (the "Termination Date"), shall receive, in lieu of the number of shares of Common Stock that would have been issuable upon such conversion immediately prior to the Termination Date, the securities or property that would have been received if this Note had been converted in full and the Common Stock received thereupon had been simultaneously converted immediately prior to the Termination Date, all subject to further adjustment as provided in this Note. 3. Subordination. The indebtedness evidenced by this Note is hereby ------------- expressly subordinated, to the extent and in the manner hereinafter set forth, in right of payment to the prior payment in full of all the Company's Senior Indebtedness, as hereinafter defined. 3.1 Senior Indebtedness. As used in this Note, the term "Senior ------------------- Indebtedness" shall mean the principal of and unpaid accrued interest on (i) current or future 3 indebtedness of the Company or with respect to which the Company is a guarantor, to banks, insurance companies, lease financing institutions or other financial institutions regularly engaged in the business of lending money, which is for money borrowed (or purchase or lease of equipment in the case of lease financing) by the Company (whether or not secured) in the ordinary course of business, and (ii) any such indebtedness or any debentures, notes or other evidence of indebtedness issued in exchange for such Senior Indebtedness, or any indebtedness arising from the satisfaction of such Senior Indebtedness by a guarantor. 3.2 Default on Senior Indebtedness. If there should occur any ------------------------------ receivership, insolvency, assignment for the benefit of creditors, bankruptcy, reorganization or arrangements with creditors (whether or not pursuant to bankruptcy or other insolvency laws), sale of all or substantially all of the assets, dissolution, liquidation or any other marshaling of the assets and liabilities of the Company, or if this Note shall be declared due and payable upon the occurrence of an event of default with respect to any Senior Indebtedness, then (i) no amount shall be paid by the Company in respect of the principal of or interest on this Note at the time outstanding, unless and until the principal of and interest on the Senior Indebtedness then outstanding shall be paid in full, and (ii) no claim or proof of claim shall be filled with the Company by or on behalf of the Holder of this Note that shall assert any right to receive any payments in respect of the principal of and interest on this Note, except subject to the payment in full of the principal of and interest on all of the Senior Indebtedness then outstanding. If there occurs an event of default that has been declared in writing with respect to any Senior Indebtedness, or in the instrument under which any Senior Indebtedness is outstanding, permitting the holder of such Senior Indebtedness to accelerate the maturity thereof, then, unless and until such event of default shall have been cured or waived or shall have ceased to exist, or all Senior indebtedness shall have been paid in full, no payment shall be made in respect of the principal of or interest on this Note, unless within 180 days after the happening of such event of default, the maturity, of such Senior Indebtedness shall not have been accelerated. 3.3 Effect of Subordination. Subject to the rights, if any, of the ----------------------- holders of Senior Indebtedness under this Section 3 to receive cash, securities or other properties otherwise payable or deliverable to the Holder of this Note, nothing contained in this Section 3 shall impair, as between the Company and the Holder, the obligation of the Company, subject to the terms and conditions hereof, to pay to the Holder the principal hereof and interest hereon as and when the same become due and payable, or shall prevent the Holder of this Note, upon default hereunder, from exercising all rights, powers and remedies otherwise provided herein or by applicable law. 3.4 Subrogation. Subject to the payment in full of all Senior ----------- Indebtedness and until this Note shall be paid in full, the Holder shall be subrogated to the rights of the holders of Senior Indebtedness (to the extent of payments or distributions previously made to 4 such holders of Senior Indebtedness pursuant to the provisions of Section 3 above) to receive payments or distributions of assets of the Company applicable to the Senior Indebtedness. No such payments or distributions applicable to the Senior Indebtedness shall, as between the Company and its creditors, other than the holders of Senior Indebtedness and the Holder, be deemed to be a payment by the Company to or on account of this Note; and for the purposes of such subrogation, no payments or distributions to the holders of Senior Indebtedness to which the Holder would be entitled except for the provisions of this Section 3 shall, as between the Company and its creditors, other than the holders of Senior Indebtedness and the Holder, be deemed to be a payment by the Company to or on account of the Senior Indebtedness. 3.5 Undertaking. By its acceptance of this Note, the Holder agrees to ----------- execute and deliver such documents as may be reasonably requested from time to time by the Company or the lender of any Senior Indebtedness in order to implement the foregoing provisions of this Section 3. The provisions of this Section 3 shall bind any successors or assignees of Holder and shall benefit any successors or assigns of any lender of Senior Indebtedness, and, if the Company refinances a portion of the Senior Indebtedness with a new lender, such new lender shall be deemed a successor or assign of a lender of Senior Indebtedness for the purposes of this Section 3. This Section 3 is solely for the benefit of Holder and lenders of Senior Indebtedness and not for the benefit of the Company or any other party. The provisions of this Section 3 may be amended only by written instrument signed by Holder and the lenders of Senior Indebtedness. In the event of any legal action to enforce the rights of a party, under this Section 3, the party prevailing in such action shall be entitled, in addition to such other relief as may be granted, all reasonable costs and expenses, including reasonable attorneys' fees, incurred in such action. 4. Transfers. --------- 4.1 The Holder acknowledges that this Note has not been, and the Common Stock, when and if issued, will not be, registered under the Securities Act of 1933 (the "Securities Act"), and agrees not to sell, pledge, distribute, offer for sale, transfer or otherwise dispose of this Note or any Common Stock issued upon its conversion in the absence of (i) an effective registration statement under the Securities Act as to this Note and/or such Common Stock and registration or qualification of this Note and/or such Common Stock under any applicable Blue Sky or state securities law then in effect, or (ii) an opinion of counsel, satisfactory to the Company, that such registration and qualification are not required. Each certificate or other instrument evidencing shares of such Common Stock issued upon the conversion of this Note shall bear a legend substantially to the foregoing effect. 5 4.2 Subject to the terms and conditions of this Note and compliance with all applicable securities laws, this Note and all rights hereunder may be transferred, in whole, but not in part, (i) to the Holder's parent, subsidiary or affiliate (including the parties to that certain June 2, I999 letter agreement with the Company), (ii) to the surviving corporation in any merger or consolidation of the Holder with or into another corporation or (iii) to the purchaser of all or substantially all of the assets of the Holder, on the books of the Company maintained for such purpose at the principal office of the Company referred to above, by the Holder hereof in person, or by duly authorized attorney, upon surrender of this Note properly endorsed and upon payment of any necessary transfer tax or other governmental charge imposed upon such transfer. Other than as permitted by the immediately preceding sentence, no other transfer of this Note (or any shares of stock or other securities issued upon the exercise thereof) may be transferred shall be permitted without the prior written consent of the Company, which may be granted or withheld in its sole discretion. 4.3 Until any transfer of this Note is made in the Note register, the Company may treat the registered holder of this Note as the absolute owner hereof for all purposes; provided, however, that if and when this Note is properly assigned, the Company may (but shall not be required to) treat the bearer hereof as the absolute owner hereof for all purposes, notwithstanding any notice to the contrary. 4.4 The Company will maintain a register containing the names and addresses of the registered holders of this Note. Any registered holder may change such registered holder's address as shown on the Note register by written notice to the Company requesting such change. 4.5 In the discretion of the Company, the Company may condition any transfer of all or any portion of this Note upon the transferee's delivery to the Company of a written agreement, in form and substance satisfactory to the Company, whereby the transferee (i) makes certain standard investment representations and warranties to and for the benefit of the Company, in a form reasonably acceptable to the Company, and (ii) agrees to be bound by the transfer restrictions set forth in this Section 4. 5. Default. ------- 5.1 Events of Default. The occurrence of any of the following shall ----------------- constitute an "Event of Default" under this Note: a. Default on Senior Indebtedness. An event of default with respect to any ------------------------------ Senior Indebtedness shall occur, including without limitation the failure to pay when due any principal or interest payment on the due date thereunder; 6 b. Voluntary Bankruptcy or Insolvency Proceedings. The Company shall ---------------------------------------------- (i) apply for or consent to the appointment of a receiver, trustee, liquidator or custodian of itself or of all or a substantial part of its property, (ii) be unable, or admit in writing its inability, to pay its debts generally as they mature, (iii) make a general assignment for the benefit of its or any of its creditors, (iv) be dissolved or liquidated in full or in part, (v) become insolvent (as such term may be defined or interpreted under any applicable statute), (vi) commence a voluntary case or other proceeding seeking liquidation, reorganization or other relief with respect to itself or its debts under any bankruptcy, insolvency or other similar law now or hereafter in effect or consent to any such relief or to the appointment of or taking possession of its property by any official in an involuntary case or other proceeding commenced against it, or (vii) take any action for the purpose of effecting any of the foregoing; c. Involuntary Bankruptcy or Insolvency Proceedings. Proceedings for the ------------------------------------------------ appointment of a receiver, trustee, liquidator or custodian of Company or of all or a substantial part of the property thereof, or an involuntary case or other proceedings seeking liquidation, reorganization or other relief with respect to Company or the debts thereof under any bankruptcy, insolvency or other similar law or hereafter in effect shall be commenced and an order for relief entered or such proceeding shall not be dismissed or discharged within thirty (30) days of commencement. 5.2 Rights of Holder Upon Default. Subject to the Section 3 above, upon ----------------------------- the occurrence or existence of any Event of Default and at any time thereafter during the continuance of such Event of Default, Holder may declare all outstanding amounts payable by Company hereunder to be immediately due and payable without presentment, demand, protest or any other notice of any kind, all of which are hereby expressly waived. In addition to the foregoing remedies, upon the occurrence or existence of any Event of Default, Holder may exercise any other right, power or remedy granted to it or otherwise permitted to it by law, either by suit in equity or by action at law, or both. 6. Investment; Transfer of Securities. ---------------------------------- 6.1 Representations. Holder has been advised that this Note and the --------------- Common Stock issuable upon its conversion (collectively referred to herein as the "Securities") have not and will not be registered under the Securities Act of 1933, as amended (the "Securities Act"), nor registered or qualified under any state blue sky law, pursuant to certain exemptions from registration and qualification, and that in this connection the 7 Company is relying in part on the representations of Holder set forth in this Section 6. Holder represents and Notes that Holder: a. has a preexisting personal or business relationship with the Company; b. has such knowledge and experience in business and financial matters as to be capable of evaluating the merits and risks of an investment in the Company and has the capacity to protect his or her own interest in connection with the acquisition of the Securities; c. has the financial ability to bear the economic risk of his or her investment, has adequate means for providing for his or her current needs and foreseeable contingencies, has no need now, and anticipates no need in the foreseeable future, to sell the Securities, is able to hold the Securities for an indefinite period of time and can afford a complete loss of his or her investment (and that his or her overall commitment to investments, including this one, which are not readily marketable is not disproportionate to his or her net worth, and that this investment will not cause his or her commitment to become excessive); d. is acquiring the Securities for his or her own account, for investment purposes only, and not with a view to or for sale in connection with any resale or distribution of such Securities in violation of the Securities Act and no other person will have any direct or indirect beneficial interest in or right to the Securities; e. was not presented with or solicited by any leaflet, public promotional meeting, circular, newspaper or magazine article, radio or television advertisement or any other form of general advertising or solicitation for the purchase of the Securities; f. has had the opportunity to discuss with the officers of the Company, all material aspects of an investment in the Company, including the opportunity to ask such questions concerning the Company's business and other relevant matters as deemed necessary or desirable, and has been given all such information as has been requested, in order to evaluate the merits and risks of an investment in the Company; g. is not relying on the accuracy of any projections with respect to the Company or its operations in making any investment in the Company; 8 h. has had reasonable opportunity to seek the advice of independent counsel respecting his or her investment and the risks and the implications thereof; and i. is a resident of the state noted in his or her address line on the signature page hereto. 6.2 The representations and warranties herein contained shall be binding upon the Holder's heirs, executors, administrators, successors and assigns. 6.3 Legend. Any certificate or certificates evidencing the Securities ------ shall bear a legend substantially in the following form: THE SECURITIES EVIDENCED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 AND HAVE BEEN ACQUIRED FOR INVESTMENT AND NOT WITH A VIEW TO, OR IN CONNECTION WITH, THE SALE OR DISTRIBUTION THEREOF. NO SUCH SALE OR DISPOSITION MAY BE EFFECTED WITHOUT AN EFFECTIVE REGISTRATION STATEMENT RELATED THERETO OR AN OPINION OF COUNSEL FOR THE COMPANY THAT SUCH REGISTRATION IS NOT REQUIRED UNDER THE SECURITIES ACT OF 1933. 6.4 Transfer. No Securities shall be sold, transferred, assigned, -------- pledged, encumbered or otherwise disposed of (with or without consideration) (each a "Transfer") and the Company shall not be required to register any such Transfer unless and until all of the following events shall have occurred: a. the Securities are Transferred pursuant to and in conformity with (i) (x) an effective registration statement filed with the Securities and Exchange Commission (the "Commission") pursuant to the Securities Act, or (y) an exemption from registration under the Securities Act, and (ii) the securities laws of any state of the United States; and b. Holder has, prior to the Transfer of such Securities, and if requested by the Company, provided all relevant information to Company's counsel so that upon the Company's request, the Company's counsel is able to, and actually prepares and delivers to the Company a written opinion that the proposed Transfer (i) (x) is pursuant to a registration statement which has been filed with the Commission and is then effective, or (y) is exempt from registration under the Securities Act as then in effect, and the rules and regulations thereunder, and (ii) is either qualified or registered under any applicable state securities laws, or exempt from such 9 qualification or registration. The Company shall bear all reasonable costs of preparing such opinion. 7. Miscellaneous. 7.1 Costs. If action is instituted to collect this Note by Holder, the Company hereby agrees to pay all costs and expenses, including reasonable attorneys' fees incurred by Holder in connection with such action. 7.2 Delay. No extension of time for payment of any amount owing hereunder shall affect the liability, of the Company for payment of the indebtedness evidenced hereby. No delay by the Holder or any holder hereof in exercising any power or right hereunder shall operate as a waiver of any power or right hereunder. 7.3 Waiver and Amendment. No waiver or modification of the terms of this Note shall be valid without the written consent of the Holder; provided, however, that any such waiver or modification of Section 3 shall require the written consent of all holders of Senior Indebtedness. 7.4 Governing Law. THIS NOTE SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF CALIFORNIA AS APPLIED TO CONTRACTS ENTERED INTO BETWEEN CALIFORNIA RESIDENTS WHOLLY TO BE PERFORMED IN CALIFORNIA. 7.5 Severability. In case any provision contained herein (or part thereof) shall for any reason be held to be invalid, illegal, or unenforceable in any respect, such invalidity, illegality, or other unenforceability shall not affect any other provision (or the remaining part of the affected provision) hereof, but this Note shall be construed as if such invalid, illegal, or unenforceable provision (or part thereof) had never been contained herein, but only to the extent that such provision is invalid, illegal, or unenforceable. 7.6 Notice. Any notice or other communication required or permitted hereunder shall be in writing and shall be deemed to have been duly given on the date of service if served personally or by facsimile, or five days after the date of mailing if mailed, by first class mail, registered or certified, postage prepaid. Notices shall be addressed as follows: To Holder at: Future Media Productions, Inc. 25136 Anza Drive Valencia, CA 91355 Attention: President To Company at: Synthonics Technologies, Inc. 10 31324 Via Colonias, Suite 106 Westlake Village, CA 91362 Attention: President or to such other address as a party has designated by notice in writing to the other party in the manner provided by this Section 7.6. 7.7 Counterparts. This Note may be executed in any number of ------------ counterparts, each of which shall be an original, but all of which together shall constitute one instrument. 7.8 Entire Agreement. This Note constitutes the full and entire ---------------- understanding and agreement between the parties with regard to the subject matter hereof. 11 IN WITNESS WHEREOF, the Company has caused this Note to be duly executed and delivered by its authorized officer as of the date first above written. COMPANY: SYNTHONICS TECHNOLOGIES, INC. By: [ILLEGIBLE] ---------------------------------- HOLDER: FUTURE MEDIA PRODUCTIONS, INC. By: ---------------------------------- Title: 12 IN WITNESS WHEREOF, the Company has caused this Note to be duly executed and delivered by its authorized officer as of the date first above written. COMPANY: SYNTHONICS TECHNOLOGIES, INC. By: [ILLEGIBLE] ----------------------------------- HOLDER: FUTURE MEDIA PRODUCTIONS, INC. By: ---------------------------------- Title: ------------------------------- 13 EX-10.24 4 0004.txt SUBSCRIPTION AGREEMENT FOR UNITS EXHIBIT 10.24 LIONS GATE ENTERTAINMENT CORP. SUBSCRIPTION AGREEMENT FOR UNITS A completed and originally executed copy of this Subscription must be delivered to Yorkton Securities Inc. at the following address: BCE Place, 181 Bay Street Suite 3100 Toronto, Ontario MSJ 2T3 Attention: Nelson Smith Telephone: (416) 864-3585 Fax: (416) 864-9509 - -------------------------------------------------------------------------------- LIONS GATE ENTERTAINMENT CORP. Issue: Units issued at US$2,550 per Unit. Number of Units: 648 ----------------------------------------------------------- [NOTE: NUMBER OF UNITS AVAILABLE FOR SUBSCRIPTION IS LIMITED BY SECTION 2(B)] Total Subscription Price: US$ 1,652,400 -------------------------------------------------- Name and Residential Address of Subscriber: Name: Future Media Productions, Inc. Residential 25136 Anza Drive ------------------------------ ------------------------ Account No.: Address: Valencia, Ca. 91355 ----------------------- --------------------------- Alternate Registration Instructions: If other than in the name of the Subscriber: Name: Residential ------------------------------ ------------------------ Account No: Address: ------------------------ --------------------------- Delivery Instructions: The name and address (including contact name and telephone number) of the person to whom the certificate representing the Shares is to be delivered, other than the Subscriber: Name: Louis Weiss Address: 25136 Anza Drive ------------------------------ --------------------------- Contract Name: Valencia, Ca. 91355 --------------------- --------------------------- Telephone No.: 661-294-5575 --------------------- --------------------------- Account No. ------------------------ --------------------------- -2- SUBSCRIPTION AGREEMENT FOR UNITS THIS AGREEMENT is dated for reference the 21st day of December, 1999. ---- AMONG: LIONS GATE ENTERTAINMENT CORP., a company having an address at Suite 3123, Three Bentall Centre, 595 Burrard Street, Vancouver, B.C., V7X 1J1 (the "Issuer") AND: YORKTON SECURITIES INC., a company having an address at Suite 3100, BCE Place, 181 Bay Street, Toronto, Ontario, M5J 2T3 (the "Agent") AND: THE SUBSCRIBER WHOSE NAME AND ADDRESS APPEARS ON THE EXECUTION PAGE OF THIS AGREEMENT (the "Subscriber") WHEREAS: A. Each Unit of the Issuer ("Unit") consists of one 5.25% convertible redeemable preferred share, Series A ("Preferred Share") and 425 common share purchase warrants ("Warrants"); B. The Issuer is offering for issue and sale and the Agent is offering for sale, on a best efforts basis, the Units at a per Unit price of US$2,550 in accordance with the terms of this Agreement and an agency agreement dated December 20, 1999 between the Issuer and the Agent (the "Agency Agreement"); C. The Subscriber wishes to purchase Units of the Issuer in accordance with the terms of this Agreement; and D. In order to prevent a change of control of the Issuer and in order for the Issuer to remain "Canadian-controlled" pursuant to the Investment Canada Act, this Agreement contains certain restrictions on the Subscriber, including in respect of the number of Units which may be purchased and in respect of the acquisition of additional securities of the Issuer. -3- IN CONSIDERATION OF THE MUTUAL PROMISES CONTAINED IN THIS AGREEMENT, THE PARTIES AGREE AS FOLLOWS: 1. Definitions ----------- In this Agreement: (a) "Agency Agreement" means the agency agreement dated December 20, 1999 between the Issuer and the Agent; (b) "Agent" means Yorkton Securities Inc.; (c) "Agreement" means this subscription agreement between the Issuer and the Subscriber; (d) "Applicable Securities Laws" includes, without limitation, collectively, all applicable securities, corporate and other laws, rules, regulations, notices and policies; (e) "Canadian Selling Jurisdictions" means the provinces of Ontario, Manitoba, Alberta and British Columbia; (f) "Closing" means the making of the deliveries contemplated in Section 7 of this Agreement in order to complete the purchase and sale of the Units contemplated hereby; (g) "Closing Date" means the date or dates of the Closing, as provided for in Section 6 of this Agreement; (h) "Common Shares" means the common shares in the capital of the Issuer; (i) "Documents" means, collectively: (i) the Annual Information Form on Form 20-F of the Issuer dated August 16, 1999 for the year ended March 31, 1999 and the management's discussion and analysis of financial condition and results of operations for the year ended March 31, 1999 incorporated by reference therein; (ii) the comparative audited financial statements of the Issuer as at and for the years ended March 31, 1999 and 1998, together with the notes thereto and the auditors' report thereon; (iii) the report to shareholders containing the unaudited interim comparative consolidated financial statements for the three month periods ended June 30, 1999 and 1998, and the three and six month periods ended September 30, 1999 and 1998; and -4- (iv) the Management Information Circular of the Issuer dated August 12, 1999 prepared in connection with the Issuer's annual meeting of shareholders held on September 22, 1999; (j) "Exchanges" means collectively, The Toronto Stock Exchange and the American Stock Exchange; (k) "Execution Page" means the page or pages at the end of this Agreement for execution by the parties hereto and marked "Execution Page"; (1) "Final Closing Date" means January 15, 2000 or such earlier date as may be agreed to in writing by the Agent and the Issuer; (m) "Financial Statements" means the audited financial statements of the Issuer for the year ended March 31, 1999 and the unaudited financial statements for the three months ended June 30, 1999 and the three and six months ended September 30, 1999; (n) "Issuer" means Lions Gate Entertainment Corp.; (o) "Misrepresentation", "material change" and "material fact" shall have the meanings ascribed thereto under the Applicable Securities Laws of the Selling Jurisdictions; "distribution" means "distribution" or "distribution to the public", as the case may be, as defined under the Applicable Securities Laws of the Selling Jurisdiction; and "distribute" has a corresponding meaning; (p) "Offering" means the offering by the Issuer and the Agent, on a best efforts basis, of up to 13,000 Units; (q) "Preferred Shares" means the 5.25% convertible redeemable preferred shares, Series A in the capital of the Issuer; (r) "Preliminary Prospectus" means the preliminary short form prospectus of the Issuer dated December 6, 1999 in respect of the distribution of the Preferred Shares and Warrants comprising the Units, including (except where otherwise provided) all documents incorporated by reference therein, and any amendments thereto; (s) "Prospectus" means the final short form prospectus of the Issuer dated December 20, 1999 in respect of the distribution of the Preferred Shares and Warrants comprising the Units, including (except where otherwise provided) all documents incorporated by reference therein, and any amendments thereto; (t) "Public Record" means all information filed by or on behalf of the Issuer after March 31, 1999 and on or before the cessation of distribution of the Units with the Securities Commissions, including without limitation, the Documents, the Preliminary Prospectus and the Prospectus and any other information filed with -5- any Securities Commission in compliance, or intended compliance, with any Applicable Securities Laws; (u) "Reference Date" means the reference date of this Agreement being the date first written above; (v) "Regulation D" means Regulation D under the U.S. Securities Act; (w) "Regulation S" means Regulation S under the U.S. Securities Act; (x) "Securities Commissions" means the securities commissions or similar regulatory authorities in the Canadian Selling Jurisdictions; (y) "Selling Jurisdictions" means the Canadian Selling Jurisdictions, the United States and such other jurisdictions as may be agreed to by the Issuer and the Agent; (z) "Subscription Price" means the price to be paid by the Subscriber to purchase the Units under the Offering, being US$2,550 per Unit; (aa) "Trust Company" means CIBC Mellon Trust Company in its capacity as registrar and transfer agent for the Preferred Shares and Common Shares and as trustee for the Warrants; (bb) "United States" means the United States as that term is defined in Regulation S under the U.S. Securities Act; (cc) "Units" means the units of the Issuer, where each Unit consists of one Preferred Share and 425 Warrants; (dd) "U.S. Person" means a "U.S. Person", as that term is defined in Regulation S under the U.S. Securities Act; (ee) "U.S. Securities Act" means the Securities Act of 1933, as amended, of the United States; (ff) "Warrant Indenture" means the warrant indenture to be dated as of the Closing Date between the Issuer and the Trust Company, as trustee, governing the terms and conditions of the Warrants; and (gg) "Warrants" means the common share purchase warrants of the Issuer, where each whole Warrant entitles the holder to purchase one Common Share at a price of US$5.00 prior to January 1, 2004. 2. Subscription for Units ---------------------- (a) On the terms and subject to the conditions set out in this Agreement, the Subscriber hereby subscribes for, and the Issuer agrees to issue and sell as herein provided, that number of Units set forth on the Execution Page, at and for the -6- Subscription Price of US$2,550 per Unit, for that total Subscription Price set forth on the Execution Page. (b) The Issuer will not accept subscriptions for more than 4,350 Units from: (i) any Subscriber acting alone; (ii) all Subscribers forming a "voting group" (as defined in the Investment Canada Act); or (iii) all Subscribers "acting jointly or in concert" (as defined in the Securities Act (British Columbia)). (c) No fractional Units may be purchased by a Subscriber. (d) At the Closing, Subscribers will be entitled to receive certificates representing the Preferred Shares and Warrants constituting the Units purchased, as provided for in Section 7 of this Agreement. 3. Certification and Covenants of the Subscriber --------------------------------------------- The Subscriber certifies and covenants with the Issuer and the Agent that as of the Reference Date and the Closing Date (and in respect of Sections 3(b), 3(c), 3(d) and 3(e), for the period referred to below): (a) Jurisdiction of Control: the Subscriber, or the beneficial purchaser ----------------------- for whom it is purchasing, is: (i) [_] "Canadian-controlled" as determined pursuant to subsection 26(1) or 26(2) of the Investment Canada Act and in respect of which no determination or declaration has been made under subsection 26(2.1) of that Act (see attached Appendix "A"), or (ii) [X] Other: Delaware, USA ---------------------------------------- (state jurisdiction of control) (b) Restrictions on Acquisitions: the Subscriber hereby covenants that the ---------------------------- Subscriber will not, acting alone, acting as part of a "voting group" (as defined in the Investment Canada Act) or "acting jointly or in concert" (as defined in the Securities Act (British Columbia)) with another person(s): (i) acquire an interest in Units which would cause the undersigned, such voting group or such group acting jointly or in concert, to acquire beneficial ownership of, or to exercise control or direction over, more than 4,350 Units; or (ii) acquire an interest in additional securities of the Issuer which would cause the undersigned, such voting group or such group acting jointly or in concert, to acquire beneficial ownership of, or to exercise control or direction over, more than 12.5% of the outstanding Common Shares (on a fully diluted basis); -7- in each case, without the prior written consent of a majority of the directors of the Issuer. (c) Restriction on Groups: the Subscriber hereby covenants that the --------------------- Subscriber will not act as part of a "voting group" (as defined in the Investment Canada Act) or act "jointly or in concert" (as defined in the Securities Act (British Columbia)) with another person(s), in any matter relating, directly or indirectly, to the Issuer; (d) Restrictions on Soliciting Proxies: the Subscriber hereby ---------------------------------- covenants that, during the period in which the Subscriber has beneficial ownership of, or exercises control or direction over, any Preferred Shares or more than 10% of the outstanding Common Shares (on a fully diluted basis), the Subscriber will not solicit proxies from any holders of securities of the Issuer, and will not participate in any solicitation of proxies (other than a solicitation by management), if such solicitation relates to the election of directors of the Issuer, provided that (i) the Issuer is not in default of its covenants contained in Sections 5(z) and/or 5(aa) and/or 5(dd) and (ii) that number of nominees of the holders of the Series A Preferred Shares equal to the number of directors which the holders of Series A Preferred Shares are or would have been entitled to elect, exclusively and separately as a class, pursuant to the provisions of the amendment to the articles and memorandum of the Issuer contemplated by Section 5(z), have been elected as directors of the Issuer; and (e) Restrictions on Transfer: the Subscriber hereby agrees that the ------------------------ Subscriber may not sell or otherwise transfer the Units, the Preferred Shares or the Warrants, without the prior written approval of the Issuer. The Subscriber acknowledges that such approval may not be granted if the transferee is not "Canadian- controlled" and such approval may only be granted subject to certain conditions, including, without limitation, that the transferee be bound by the covenants contained in Sections 3(b), 3(c), 3(d) and 3(e) in respect of such securities to be transferred. The Subscriber acknowledges and agrees that the foregoing certification and covenants set out herein are made by the Subscriber with the intent that they be relied upon in determining its suitability as a purchaser of Units and the Subscriber hereby agrees to indemnify the Issuer and the Agent against all losses, claims, costs, expenses arising from any inaccuracy in or breach by the Subscriber of the foregoing certification and covenants. The Subscriber further acknowledges that damages would be an insufficient remedy for a breach by it of the covenants contained in Sections 3(b), 3(c), 3(d) and 3(e) and agrees that the Issuer may apply for and obtain any relief available to it in a court of law or equity, including injunctive relief, to restrain breach or threat of breach of the foregoing covenants by the Subscriber or to enforce the foregoing covenants, in addition to rights the Issuer may have to damages arising from such breach or threat of breach. In addition, the Subscriber acknowledges that the Issuer will not register, and will direct the Transfer Agent of the Issuer's securities not to register, any proposed transfer of such securities which violates the covenants in Sections 3(b) and 3(e). -8- Notwithstanding any other provision herein, the covenants contained in Sections 3(b), 3(c), 3(d) and 3(e) shall not operate to prevent the Subscriber or any member of a "voting group" (as defined in the Investment Canada Act) of which the Subscriber forms a part or any person(s) with whom the Subscriber is "acting jointly or in concert" (as defined in the Securities Act (British Columbia)) from making a take-over bid for the Issuer in response to a competing take-over bid made for the Issuer by a person(s) who is not a member of a "voting group" (as defined in the Investment Canada Act) of which the Subscriber forms a part or a person(s) with whom the Subscriber is "acting jointly or in concert" (as defined in the Securities Act (British Columbia)). Notwithstanding any other provision herein, the covenants contained in Sections 3(b), 3(c), 3(d) and 3(e) shall survive the Closing Date for a period ending on the earlier of (i) 3 years from the Closing Date and (ii) the date on which the Issuer ceases to be "Canadian-controlled" as determined pursuant to subsection 26(l) or 26(2) of the Investment Canada Act and in respect of which no determination or declaration has been made under subsection 26(2.1) of that Act. 4. Further Acknowledgements, Warranties, Representations and Covenants of ---------------------------------------------------------------------- the Subscriber -------------- The Subscriber acknowledges, warrants and represents to, and covenants with, the Issuer and the Agent that as of the Reference Date and the Closing Date: (a) Legal Capacity: the Subscriber has the legal capacity to enter into, -------------- execute and deliver this Agreement and this Agreement has been duly authorized, executed and delivered by, and once accepted by the Issuer, constitutes a legal, valid and binding agreement of, the Subscriber enforceable against the Subscriber in accordance with its terms; (b) Age of Majority: if an individual, the Subscriber is of the full age --------------- of majority and is legally competent to execute this Agreement and to take all action pursuant to it; (c) Acceptance By the Issuer: the offer made by the Subscriber in this ------------------------ subscription is irrevocable and the offer requires acceptance by the Issuer and the Subscriber acknowledges that the Issuer may, in its sole discretion, accept or reject such offer in whole or in part, including pursuant to Section 2(b); (d) Legal Advice: the Subscriber acknowledges and agrees that it is ------------ responsible for obtaining such legal advice as it considers appropriate in connection with the execution, delivery and performance by it of this Agreement and the transactions contemplated hereunder; (e) Investment Suitability: the Subscriber, or any beneficial Subscriber ---------------------- on whose behalf the Subscriber is purchasing the Units, has such knowledge and experience in financial and business affairs as to be capable of evaluating the merits and risks -9- of the investment hereunder and is able to bear the economic risk of loss of such investment; (f) Compliance with Local Laws: the purchase by the Subscriber of the -------------------------- Units subscribed for hereunder will be made in compliance with all requirements of the applicable laws of the jurisdiction(s) in which it is resident or to which it is subject and no filings or approvals will be required by the Subscriber under the laws of such jurisdiction(s) in connection with the purchase by it of the Units hereunder; (g) No Representation: No person has made to the Subscriber any written or ----------------- oral representation: (i) as to the future price or value of the securities offered hereunder; or (ii) that the Units or the securities which constitute the Units (excluding, for greater certainty, the Common Shares issuable upon conversion of the Preferred Shares and upon exercise of the Warrants) will be listed and posted for trading on a stock exchange or that an application has been made to list and post such securities for trading on a stock exchange; (h) No Registration: the Subscriber understands that the Units, the --------------- Preferred Shares, the Warrants and the Common Shares issuable upon conversion of the Preferred Shares and upon exercise of the Warrants, have not been and will not be registered under the U.S. Securities Act, as amended or the securities laws of any state of the United States and that the sale contemplated hereby is being made in reliance on an exemption from such registration requirements and the Subscriber understands and agrees that the Units, the Preferred Shares, the Warrants and the Common Shares issuable upon conversion of the Preferred Shares and upon exercise of the Warrants, may not be traded in the United States or by or on behalf of a U.S. Person or a person in the United States unless registered under the U.S. Securities Act and any applicable state securities laws or unless an exemption from such registration requirements is available and that certificates representing the Preferred Shares, the Warrants and the Common Shares issuable upon conversion of the Preferred Shares and upon exercise of the Warrants, will bear a legend to such effect; and (i) The Subscriber is one of the following (please check appropriate lines): (i) _______ Not a "U.S. Person": the Subscriber, whether acting as principal, trustee or agent, is neither a U.S. Person, nor purchasing the Units as a U.S. Person or for resale in the United States and the Subscriber confirms that the Units have not been offered to the Subscriber in the United States and this Agreement has not been signed in the United States; or (ii) _______ U.S. Residents: the Subscriber satisfies one or more of the categories indicated below (please check appropriate lines): -10- _____ Category 1 Any bank as defined in Section 3(a)(2) of the U.S. Securities Act or any savings and loan association or other institution as defined in Section 3(a)(5)(A) of the U.S. Securities Act, whether acting in its individual or fiduciary capacity; any broker dealer registered pursuant to Section 15 of the Securities Exchange Act of 1934; any insurance company as defined in Section 2(13) of the U.S. Securities Act; any investment company registered under the Investment Company Act of 1940 or a business development company as defined in Section 2(a)(48) thereof; any Small Business Investment Company licensed by the U.S. Small Business Administration under Section 301(c) or (d) of the Small Business Investment Act of 1958; any plan established and maintained by a state, its political subdivisions, or any agency or instrumentality of a state or its political subdivisions, for the benefit of its employee, if such plan has total assets in excess of US$5,000,000; any employee benefit plan within the meaning of the Employee Retirement Income Security Act 1974, if the investment decision is made by plan fiduciary, as defined in Section 3(21) thereof, which is either a bank, savings and loan association, insurance company, or registered investment adviser, or if the employee benefit has total assets in excess of US$5,000,000, or, if a self-directed plan, with the investment decisions made solely by persons that are accredited investors; _____ Category 2. Any private business development company as defined in Section 202(a)(22) of the Investment Advisors Act of 1940; _[X]_ Category 3. Any organization described in Section 501(c)(3) of the Internal Revenue Code of 1986, corporation, Massachusetts or similar business trust, or partnership, not formed for the specific purpose of acquiring the Units, with total assets in excess of US$5,000,000; _____ Category 4. Any director or executive officer of the Issuer; _____ Category 5. Any natural person whose individual net worth, or joint net worth with that person's spouse, at the time of such person's purchase of the Units exceeds US$1,000,000; Category 6. Any natural person who had an individual income in excess of US$200,000 in each of the two most recent years or joint income with that person's spouse in excess of US$300,000 in each of -11- those years and has a reasonable expectation of reaching the same level in the current year; _____ Category 7. Any trust with total assets in excess of US$5,000,000, not formed for the specific purpose of acquiring the Units, whose purchase is directed by a sophisticated person as described in Rule 506(b)(2)(ii) of Regulation D under the U.S. Securities Act; or _[X]_ Category 8. Any entity in which all of the equity owners are accredited investors. and the Subscriber makes the additional representations and warranties contained in Schedule "A" attached to this Agreement. The Subscriber acknowledges and agrees that the foregoing representations, warranties and covenants set out herein are made by the Subscriber with the intent that they be relied upon in determining its suitability as a purchaser of Units and the Subscriber hereby agrees to indemnify the Issuer and the Agent against all losses, claims, costs, expenses arising from any inaccuracy in or breach by the Subscriber of the foregoing representations, warranties and covenants. The Subscriber further agrees that by accepting the Units, the Subscriber shall be representing and warranting that the foregoing representations and warranties are true as at the Closing Date with the same force and effect as if they had been made by the Subscriber at the Closing Date. The Subscriber undertakes to notify the Issuer and the Agent immediately at the address of the Issuer or the Agent first set forth above of any change in any representation, warranty or other information relating to the Subscriber set forth herein which takes place prior to the Closing Date. 5. Warranties, Representations and Covenants of the Issuer ------------------------------------------------------- The Issuer warrants and represents to, and covenants with the Subscriber and the Agent that as of the Reference Date and as at the Closing Date: (a) each of the Issuer and its subsidiaries has been duly incorporated and organized and is validly existing under the laws of the jurisdiction of its incorporation and has all requisite corporate authority and power to carry on its business, as now conducted and as presently proposed to be conducted by it, and to own, lease, or own and lease its property and assets (including licenses or other similar rights) and has all the requisite corporate power and authority to carry on its business as currently carried on or as currently proposed to be carried on; (b) each of the Issuer and its subsidiaries is qualified to carry on business under the laws of each jurisdiction in which it carries on a material portion of its business and is duly licensed, registered or qualified in all jurisdictions in which it owns, leases or operates any material portion of its property or carries on any material portion of its business to enable its business and assets to be owned, leased and -12- operated, except to the extent that the failure to so comply or to be so licensed, registered or qualified would not have a material adverse effect on the Issuer and its subsidiaries (taken as a whole) and all such licenses, registrations or qualifications which are material are valid and existing in good standing in all material respects; (c) except as otherwise disclosed in the Prospectus, each of the Issuer and its subsidiaries holds all requisite material licenses, registrations, qualifications, permits and consents necessary or appropriate for carrying on its business as currently carried on and all such licenses, registrations, qualifications, permits and consents are valid and subsisting and in good standing in all material respects and none of the same contains any burdensome term, provision, condition or limitation which has or may have a material adverse effect upon the operations of the business of the Company and its subsidiaries (taken as a whole) as currently carried on or as currently proposed to be carried on; (d) except as otherwise disclosed in the Prospectus, the Issuer owns all of the issued and outstanding shares of each of its subsidiaries, in each case free and clear of all mortgages, liens, charges, pledges, security interests, encumbrances, claims or demands whatsoever (other than mortgages, liens, charges, pledges and/or security interests granted to its principal banker in the ordinary course), and no person, firm or Issuer has any agreement, option, right or privilege (whether preemptive or contractual) capable of becoming an agreement, for the purchase from the Issuer or any of its subsidiaries of any interest in any of the issued or unissued shares in the capital stock of any subsidiary other than pursuant to a unanimous shareholders' agreement among the Issuer, Fox Family Worldwide Inc. and others dated June 23, 1998; (e) except as disclosed in the Prospectus, each of the Issuer and its subsidiaries has valid title to all of its material assets including all material licenses, free and clear of all charges, hypothecs, mortgages, encumbrances or other liens (other than mortgages, liens, charges, pledges and/or security interests granted to its principal lender and such other subordinated or project-specific lenders and other permitted liens as its principal lender permits); (f) the Issuer has full corporate power and authority to enter into this Agreement and the Warrant Indenture and to perform its obligations set out herein and therein and this Agreement and the Warrant Indenture have been, or will be, duly authorized, executed and delivered by the Issuer and are or will constitute a legal, valid and binding obligation of the Issuer enforceable against the Issuer in accordance with their terms, subject to laws relating to creditors' rights generally and except as rights to indemnity may be limited by applicable law; (g) at the Closing Date, the Preferred Shares and the Warrants will be duly and validly authorized, allotted and reserved for issuance and, in the case of the Preferred Shares, upon receipt of the purchase price therefor, will be issued as fully paid and non-assessable shares in the capital of the Issuer, as the case may -13- be, and the Common Shares issuable upon exercise of the Warrants or conversion of the Preferred Shares will have been allotted and reserved for issuance; (h) the Issuer is not in default or breach of, and the execution and delivery of, and the performance of and compliance with the terms of, this Agreement and the Warrant Indenture by the Issuer or any of the transactions contemplated hereby or thereby, does not and will not result in any breach of, or constitute a default under, and does not and will not create a state of facts which, after notice or lapse of time or both, would result in a breach of or constitute a default under, any term or provision of the charter documents of the Issuer, by-laws or resolutions of shareholders or directors of the Issuer, or any indenture, mortgage, note, contract, agreement (written or oral), instrument, lease or other document to which the Issuer or any of its subsidiaries is a party or by which any of them is bound, or any judgment, decree or order or, to the best of the knowledge of the Issuer, any law, statute, rule or regulation applicable to the Issuer or any of its subsidiaries, which default or breach might reasonably be expected to materially adversely affect the business, operations, capital or condition (financial or otherwise) of the Issuer and its subsidiaries (taken as a whole) or its assets (on a consolidated basis); (i) other than as has been publicly and generally disclosed, there has not been any material adverse change in the business, operations, capital or condition (financial or otherwise) or results of the operations of the Issuer and its subsidiaries (taken as a whole) since March 31, 1999; and since March 31, 1999, there have been no material facts, transactions, events or occurrences which, to the knowledge of the Issuer, could materially adversely affect the capital, assets, liabilities (absolute, accrued, contingent or otherwise), business, operations or condition (financial or otherwise) or results of the operations of the Issuer and its subsidiaries (taken as a whole) which have not been disclosed to the public or in writing to the Subscriber; (j) the Financial Statements fairly present, in all material respects and in accordance with generally accepted accounting principles in Canada consistently applied, the financial position of the Issuer and its subsidiaries (on a consolidated basis) as at the dates thereof and the results of the operations of the Issuer and its subsidiaries (on a consolidated basis) for the periods then ended and reflect all liabilities (absolute, accrued, contingent or otherwise) of the Issuer and its subsidiaries (on a consolidated basis) as at the dates thereof; (k) except as disclosed in the Financial Statements, there are no actions, suits, proceedings or inquiries pending or threatened against or affecting the Issuer or any of its subsidiaries at law or in equity or before or by any federal, provincial, state, municipal or other governmental department, commission, board, bureau, agency or instrumentality which in any way materially adversely affect, or may in any way materially adversely affect, the business, operations, capital or condition (financial or otherwise) of the Issuer and its subsidiaries (taken as a whole) or its assets (on a consolidated basis) or which questions the validity of any action taken -14- or to be taken by the Issuer pursuant to or in connection with this Agreement or as contemplated by the Prospectus, or which affects or may affect the distribution of the Preferred Shares and Warrants comprising the Units, and the Issuer is not aware of any existing ground on which such action, suit, proceeding or inquiry might be commenced with any reasonable likelihood of success; (l) the information and statements set forth in the Public Record were true, correct and complete and did not contain any misrepresentation, as of the date of such information or statement, and the Issuer has not filed any confidential material change reports still maintained on a confidential basis; (m) the Issuer has an authorized share capital of 500,000,000 Common Shares and 200,000,000 preference shares, of which 30,551,167 Common Shares and no preference shares were issued and outstanding as at December 20, 1999 before giving effect to the Offering, and all of such issued and outstanding shares in the capital of the Issuer are duly authorized, issued and outstanding as fully paid and non- assessable shares in the capital of the Issuer. No person, firm or Issuer (except employees, officers and directors of the Issuer and its subsidiaries who collectively hold, as at December 13, 1999, options to acquire approximately 3,511,123 Common Shares) has any agreement or option, or right or privilege (whether pre-emptive or contractual) capable of becoming an agreement or option, for the purchase from the Issuer of any unissued shares of the Issuer except as otherwise described in the Prospectus and except pursuant to a unanimous shareholders' agreement among the Issuer, Fox Family Worldwide Inc. and others dated June 23, 1998; (n) except as otherwise described in the Prospectus, to the knowledge of the Issuer no agreement is in force or effect which in any manner affects the voting or control of any of the securities of the Issuer or any of its subsidiaries; (o) no approval, authorization, consent or other order of, and no filing, registration or recording with, any governmental authority is required of the Issuer in connection with the execution and delivery or with the performance by the Issuer of this Agreement except compliance with the Applicable Securities Laws (including stock exchange approvals) with regard to the Offering; (p) the Issuer and its subsidiaries have timely filed all necessary material tax returns and notices and have paid or made provision for all applicable taxes of whatever nature for all tax years to the date hereof to the extent such taxes are material and have become due or have been alleged to be due; the Issuer is not aware of any material tax deficiencies or material interest or penalties accrued or accruing, or alleged to be accrued or accruing, thereon with respect to itself or its subsidiaries which have not otherwise been provided for by the Issuer; (q) except as otherwise disclosed in the Prospectus, the Issuer is not aware of any legislation which it anticipates will materially and adversely affect the business, affairs, operations, assets, liabilities (contingent or otherwise) or prospects of the Issuer and its subsidiaries considered as a whole; -15- (r) the Trust Company has been duly appointed transfer agent and registrar for the Common Shares of the Issuer and the Preferred Shares at its principal offices in the cities of Vancouver and Toronto and has been duly appointed as the Trustee for the Warrants and Chase Mellon Shareholder Services has been appointed co-transfer agent and co- registrar for the Common Shares; (s) no Securities Commission, other securities commission or similar regulatory authority, Exchange or other exchange in Canada, Europe, the United Kingdom or the United States has issued any order which is currently outstanding preventing or suspending trading in any securities of the Issuer, no such proceeding is, to the knowledge of the Issuer, pending, contemplated or threatened and the Issuer is not in default of any material requirement of Applicable Securities Laws of the Selling Jurisdictions; (t) the issued and outstanding Common Shares are listed and posted for trading on the Exchanges and the Common Shares issuable upon exercise of the Warrants and upon conversion of the Preferred Shares are conditionally approved for listing on the Exchanges subject to the fulfillment of all of the requirements of the Exchanges; (u) the Issuer is in compliance with its timely disclosure obligations under Applicable Securities Laws in the Selling Jurisdictions and under the rules of the Exchanges; (v) the Issuer is a "reporting issuer" or maintains an equivalent standard in each of the Canadian Selling Jurisdictions within the meaning of the Applicable Securities Laws in such provinces and is eligible to participate in the prompt offering qualification system in each of the Canadian Selling Jurisdictions with a "Current AIF" (within the meaning of National Policy Statement No. 47) and is not in default of any requirement in relation thereto in any material respect; (w) to the knowledge of the Issuer, no officer of the Issuer has a present intention to sell any material number of securities of the Issuer; (x) there are no actions, suits, proceedings, investigations or claims, pending or threatened against the Issuer or any of its subsidiaries in respect of any benefit acquired by the Issuer or any of its subsidiaries or any reassessment of any benefit acquired by the Issuer or any of its subsidiaries under any Canadian federal or provincial incentive program to promote the television and motion picture production and distribution industries ("Incentive Program") which would, if determined adversely to the Issuer or any of its subsidiaries, have a material adverse effect on the business, operations, capital or condition (financial or otherwise) of the Issuer and its subsidiaries (taken as a whole) or its assets (on a consolidated basis); any material representation or warranty made by the Issuer and/or its subsidiary in an application for a benefit issuable under an Incentive Program was true and accurate at the time said representation or warranty was made by the Issuer and/or subsidiary; -16- (y) on the Closing Date, the Issuer will appoint Jon Feltheimer, Herbert Kloiber and Howard A. Knight to the board of directors of the Issuer to serve as board members until the next annual meeting of the Issuer; (z) the Issuer will submit to the shareholders of the Issuer a resolution to approve an amendment to the articles and memorandum of the Issuer at the next special or annual meeting of shareholders of the Issuer to provide holders of the Preferred Shares with a right satisfactory to the Subscriber, acting reasonably, to appoint three members and nominate a fourth member (who must be a resident of Canada) to the board of directors of the Issuer for so long as a certain number of Preferred Shares remain outstanding; (aa) if the amendment to the articles and memorandum of the Issuer provided for in Section 5(z) is not approved by the holders of the Common Shares, the Issuer will include in any slate of nominees proposed for election by the holders of Common Shares as directors of the Issuer four nominees of the holders of the Preferred Shares (of whom one must be a resident of Canada) for so long as a certain number of Preferred Shares remain outstanding (or the lesser number of nominees contemplated by the amendment to the articles and memorandum of the Issuer provided for in Section 5(z), of whom one must be a resident of Canada, if a fewer number of Preferred Shares remain outstanding) and if (and to the extent that) the holders of the Common Shares fail to elect as directors of the Issuer three nominees of the holders of the Preferred Shares for so long as a certain number of Preferred Shares remain outstanding, those nominees of the holders of the Preferred Shares shall nevertheless be entitled to receive notice of, together with all materials delivered to directors in respect of, and to attend, each meeting of the directors of the Issuer; (bb) it will file amended articles and an amended memorandum of the Issuer to create the Preferred Shares, on terms satisfactory to the Subscriber, acting reasonably; (cc) it will grant to any resident of the United States holding more than US$5 million principal amount of Preferred Shares, where the Common Shares issuable upon their conversion would not be freely tradeable in the United States, rights to require the Issuer, up to two times, to file a registration statement to qualify such Common Shares in the United States, provided that such rights will be exercisable commencing 12 months after the Final Closing Date and will be at the expense of the Issuer and provided further that such holders will also be granted rights to register the Common Shares issuable upon conversion of their Preferred Shares in any registration statement filed by the Issuer in the United States in respect of Common Shares; and (dd) it will grant to the holders of not less than one half of the Preferred Shares then outstanding the right to designate, by instrument in writing, the nominees of the holders of the Preferred Shares to be included in the slate of nominees proposed for election as directors of the Issuer as contemplated by Sections 5(z)and 5(aa). -17- 6. Closing ------- (a) The Closing will take place at the offices of Goodman Phillips & Vineberg, Suite 1900, 355 Burrard Street, Vancouver, British Columbia at 8:00 a.m., Vancouver time on December 23, 1999, or on such date or dates and at such time or times as the Issuer and the Agent determine (the "Closing Date"), but in any event no later than January 15, 2000, unless extended in writing by the parties. (b) After the Closing, the Issuer is irrevocably entitled to the Subscription Price, subject to the rights of the Subscriber under this Agreement and any applicable laws. 7. Payment and Delivery -------------------- (a) At the Closing, the Agent, on behalf of the Subscriber, will deliver or will have delivered to the Issuer a bank draft or certified cheque payable to Lions Gate Entertainment Corp. representing the net aggregate Subscription Price for the Units subscribed for hereunder and the Issuer will thereupon deliver to the Agent, on behalf of the Subscriber, a photocopy of this Agreement confirming the execution hereof by the Issuer, and issue one or more definitive certificates representing the Preferred Shares and Warrants constituting the Units subscribed for hereunder, registered in the Subscriber's name (or in such other name as set forth under "Alternative Registration Instructions" on the first page of this Agreement) and will cause to be delivered to the Agent such definitive certificates. (b) In the event that the Closing has not occurred by January 15, 2000, unless extended, or this subscription is not accepted by the Issuer, this Agreement and the subscription proceeds, together with any other documents delivered in connection herewith, will be returned to the Subscriber at the address under "Name and Residential Address of the Subscriber" on the first page of this Subscription Agreement within ten business days of the date of such event. 8. Acceptance of Subscription -------------------------- (a) The Issuer intends to offer for issue and sale an aggregate of up to 13,000 Units at a per Unit price of US$2,550, for an aggregate amount of up to US$33,150,000 in accordance with the terms of this Agreement and the Agency Agreement. The Issuer in its sole discretion may accept or reject this subscription (in whole or in part), including pursuant to Section 2(b). (b) If this subscription is rejected, the Subscriber understands that any funds delivered by the Subscriber to the Agent will be promptly returned to the Subscriber without deduction or interest. The Subscriber hereby waives any requirement for the Issuer to communicate its acceptance of this subscription to the Subscriber. The Issuer will be deemed to have accepted this offer upon delivery at the Closing Date to the Subscriber of the certificate representing the Units referred to in Section 7 above. -18- 9. Authority of Agent ------------------ The Subscriber irrevocably authorizes the Agent in its sole discretion: (a) to act as the Subscriber's representative at the Closing, to execute in its name and on its behalf all required receipts and documents, to receive a certificate or certificates for the Preferred Shares and Warrants constituting the Units purchased by the Subscriber and to terminate this Agreement on its behalf in the event that any condition precedent to the offering has not been satisfied; and (b) to vary any time periods, including establishing and/or changing the Closing Date or the time of Closing. 10. No Assignment ------------- The Subscriber may not assign all or any part of its interest in or to this Agreement without the written consent of the Issuer and any purported assignment without such consent is void. 11. Notice ------ Any notice to be given by any party to another under this Agreement will be deemed to be properly given when in writing and delivered by hand or communicated by telecopier, on any business day to the following address for notice of the intended recipient: for the Subscriber: To the address of the Subscriber set out under "Name and Residential Address of the Subscriber" on the first page of this Agreement. for the Issuer: LIONS GATE ENTERTAINMENT CORP. Suite 3123, Three Bentall Centre 595 Burrard Street Vancouver, British Columbia V7X 1Jl Attention: Mr. Gordon Keep Fax: (604)609-6145 for the Agent: YORKTON SECURITIES INC. Suite 3100 BCE Place, 181 Bay Street Toronto, Ontario M5J 2T3 -19- Attention: Nelson Smith Fax: (416)864-9509 A party may by notice to the other party change its address for notice to some other address and will so change its address for notice to an address that is adequate whenever its existing address for notice is not adequate for delivery by hand. 12. Further Assurances ------------------ The parties hereto each covenant and agree to execute and deliver such further agreements, documents and writings and provide such further assurances as may be required by the parties to give effect to this Agreement and without limiting the generality of the foregoing to do all acts and things, execute and deliver all documents, agreements and writings and provide such assurances, undertakings, information and investment letters as may be required from time to time by all regulatory or governmental bodies or stock exchanges having jurisdiction over the Issuer's affairs or as may be required from time to time under the applicable securities legislation, and any other applicable law. 13. Miscellaneous ------------- (a) The representations, warranties and covenants contained in this Agreement, in any Schedule hereto, in any documents to be executed and delivered pursuant to this Agreement and in any documents executed and delivered in connection with the completion of the transaction contemplated herein shall survive the Closing and, notwithstanding the Closing and any investigations made by or on behalf of the Subscriber, shall continue in full force and effect for two years from the Closing Date and any claim in respect thereof, except a claim based on fraud (which may be made at any time), shall be made in writing within the time so limited for survival. (b) This Agreement is and will be deemed to have been made in British Columbia and for all purposes will be governed exclusively by and interpreted according to the laws of British Columbia, and the parties hereby agree to submit to the jurisdiction of the Courts of British Columbia in connection with any disputes arising hereunder. (c) Time is of the essence of this Agreement and will be calculated in accordance with the provisions of the Interpretation Act (British Columbia). (d) Except as expressly provided in this Agreement and in the agreements, instruments and other documents contemplated or provided for herein, this Agreement contains the entire agreement between the parties with respect to the sale of the Units and there are no other terms, conditions, representations or warranties, whether expressed, implied, oral or written, by statute, by common law, by the Issuer, by the Subscriber, by the Agent, or by anyone else. -20- (e) This Agreement may be amended only in writing signed by each of the Issuer, the Agent and the Subscriber. (f) In this Agreement a reference to: (i) currency means United States currency; (ii) a statute or code or a specific provision thereof includes every regulation made pursuant thereto, all amendments to the statute, code or any such regulation in force from time to time, and any statute, code or regulation that supplements or supersedes such statute, code or any such regulation; and (iii) an entity includes any entity that is a successor of such entity. (g) The terms, provisions, representations, warranties and covenants of the Issuer and the Subscriber, respectively, survive the Closing, the payment of the Subscription Price, the issue and delivery of the Preferred Shares and Warrants, the completion of filings contemplated herein, and all other transactions contemplated herein. (h) This Agreement may be executed in as many counterparts as may be necessary, each of which so executed shall be deemed to be an original and such counterparts together shall constitute one and the same instrument. (i) This Agreement enures to the benefit of and is binding upon the Issuer, the Agent and the Subscriber and their respective successors and permitted assigns. (j) The obligations of the parties hereunder are subject to any required regulatory approvals, if any, being obtained. The remainder of this page has been intentionally left blank. -21- Execution Page -------------- IN WITNESS WHEREOF the parties have executed this Agreement as of the day, month and year first above written. PLEASE COMPLETE THIS SECTION The undersigned Subscriber hereby subscribes for: ____ 648 _____ Units at a price of US$2,550 per Unit for a total Subscription Price of: US$ _____________________ Future Media Productions, Inc. - --------------------------------------------------------------- Name of Subscriber (Please print) - --------------------------------------------------------------- Signature of Subscriber Per: Alex Sandel ----------------------------------------------------------- Authorized Signatory (if Subscriber is not an individual) President /s/ ^^ILLEGIBLE SIGNATURE^^ - --------------------------------------------------------------- Title This subscription is hereby accepted as to ________________________ Units. LIONS GATE ENTERTAINMENT CORP. Per: /s/ ^^ILLEGIBLE SIGNATURE^^ ------------------------------------------ Authorized Signatory This subscription is hereby acknowledged and the authority provided in Section 9 is hereby accepted. YORKTON SECURITIES INC. Per: ------------------------------------------ Per: Authorized Signatory -21- Execution Page -------------- IN WITNESS WHEREOF the parties have executed this Agreement as of the day, month and year first above written. PLEASE COMPLETE THIS SECTION The undersigned Subscriber hereby subscribes for: _________ Units at a price of US$2,550 per Unit for a total Subscription Price of: US$_________________ - ------------------------------------------------------------------- Name of Subscriber (Please print) - ------------------------------------------------------------------- Signature of Subscriber Per: --------------------------------------------------------------- Authorized Signatory (if Subscriber is not an individual) - ------------------------------------------------------------------- Title This subscription is hereby accepted as to _____________________ Units. LIONS GATE ENTERTAINMENT CORP. Per: --------------------------------------------------------------- Authorized Signatory This subscription is hereby acknowledged and the authority provided in Section 9 is hereby accepted. YORKTON SECURITIES INC. Per: /s/ NELSON SMITH -------------------------------------------------------------- Per: Authorized Signatory -21- Execution Page -------------- IN WITNESS WHEREOF the parties have executed this Agreement as of the day, month and year first above written. PLEASE COMPLETE THIS SECTION The undersigned Subscriber hereby subscribes for: _____ 648 _____ Units at a price of US$2,550 per Unit for a total Subscription Price of: US$_________________ Future Media Productions, Inc. - ---------------------------------------------------------------- Name of Subscriber (Please print) - ---------------------------------------------------------------- Signature of Subscriber Per: Alex Sandel ----------------------------------------------------------- Authorized Signatory (if Subscriber is not an individual) President ^^ILLEGIBLE SIGNATURE^^ - ---------------------------------------------------------------- Title This subscription is hereby accepted as to __________________ Units. LIONS GATE ENTERTAINMENT CORP. Per: ------------------------------------------------------------ Authorized Signatory This subscription is hereby acknowledged and the authority provided in Section 9 is hereby accepted. YORKTON SECURITIES INC. Per: ------------------------------------------------------------ Per: Authorized Signatory A-l SCHEDULE "A" TO SUBSCRIPTION AGREEMENT U.S. Representations & Warranties --------------------------------- If the Subscriber falls under one of the categories listed in Section 4(i)(ii) of the Subscription Agreement, by executing the Subscription Agreement, the Subscriber, on its own behalf and, if applicable on behalf of others for whom it is contracting, represents, warrants and acknowledges to the Issuer the following: (a) the Subscriber is acquiring the Units for its own account, for investment purposes only and not with a view to any resale, distribution or other disposition of the Units in violation of the United States securities laws; (b) if the Subscriber decides to offer, sell or otherwise transfer any of the Units, the Preferred Shares, the Warrants or the Common Shares issuable upon conversion of the Preferred Shares or upon exercise of the Warrants, it will not offer, sell or otherwise transfer any of such securities directly or indirectly, unless: (i) the sale is to the Issuer; (ii) the sale is made outside the United States in a transaction meeting the requirements of Rule 904 of Regulation S under the U.S. Securities Act and in compliance with applicable local laws and regulations; (iii) the sale is made pursuant to the exemption from the registration requirements under the U.S. Securities Act provided by Rule 144 thereunder and in accordance with any applicable state securities or "Blue Sky" laws; or (iv) such securities are sold in a transaction exempt from registration under the U.S. Securities Act or any applicable state laws and regulations governing the offer and sale of securities, and it has prior to such sale furnished to the Issuer satisfactory evidence of the availability of such exemption which may, at the Issuer's discretion, include an opinion of counsel; (c) the Subscriber understands and agrees that there may be material tax consequences to the Subscriber of an acquisition or disposition of the Units, the Preferred Shares, the Warrants or the Common Shares issuable upon conversion of the Preferred Shares or upon exercise of the Warrants. The Issuer gives no opinion and makes no representation with respect to the tax consequences to the Subscriber under United States, state, local or foreign tax law of the undersigned's acquisition or disposition of such securities. In particular, no determination has been made whether the Issuer will be a "passive foreign investment company" ("PFIC") within the meaning of Section 1291 of the United States Internal Revenue Code; A-2 (d) the Subscriber understands and agrees that the financial statements of the Issuer have been prepared in accordance with Canadian generally accepted accounting principles, which differ in some respects from United States generally accepted accounting principles, and thus may not be comparable to financial statements of United States companies; and (e) the Subscriber understands that all certificates representing the Preferred Shares, the Warrants and the Common Shares issuable upon conversion of the Preferred Shares and upon exercise of the Warrants, sold in the United States as part of the Offering, and all certificates issued in exchange for or in substitution of the foregoing securities, will bear a legend to the following effect: THE SECURITIES REPRESENTED HEREBY HAVE NOT BEEN AND WILL NOT BE REGISTERED UNDER THE UNITED STATES SECURITIES ACT OF 1933, AS AMENDED (THE "U.S. SECURITIES ACT")NOR THE SECURITIES ACT OF ANY STATE OF THE UNITED STATES. THESE SECURITIES MAY NOT BE OFFERED FOR SALE, SOLD, OR OTHERWISE TRANSFERRED OR ASSIGNED UNLESS THEY ARE OFFERED FOR SALE, SOLD OR OTHERWISE TRANSFERRED OR ASSIGNED: (A) TO THE COMPANY, (B) OUTSIDE THE UNITED STATES IN ACCORDANCE WITH RULE 904 OF REGULATION S UNDER THE U.S. SECURITIES ACT, (C) PURSUANT TO THE EXEMPTION FROM THE REGISTRATION REQUIREMENTS UNDER THE U.S. SECURITIES ACT PROVIDED BY RULE 144 THEREUNDER, IF AVAILABLE AND IN ACCORDANCE WITH APPLICABLE STATE SECURITIES LAW, OR (D) PURSUANT TO ANOTHER EXEMPTION FROM REGISTRATION AFTER PROVIDING A SATISFACTORY LEGAL OPINION TO THE COMPANY; provided that, if any such Preferred Shares, Warrants and Common Shares issuable upon conversion of the Preferred Shares and upon exercise of the Warrants, are being sold outside the United States in accordance with Rule 904 of Regulation S, the legend relating to United States securities laws may be removed by providing a declaration to the Issuer in such form as the Issuer's counsel from time to time prescribes; and provided, further, that, if any such securities are being sold under paragraph (C) above, the legend relating to the United States securities laws may be removed by delivery to the Issuer, of an opinion of counsel, of recognized standing reasonably satisfactory to the Issuer's counsel, that such legend is no longer required under applicable requirements of the U.S. Securities Act or state securities laws. A-3 Appendix "A" to Subscription Agreement Relevant Provisions of the Investment Canada Act 1. Section 3 - Definitions: "Canadian" means (a) a Canadian citizen, (b) a permanent resident within the meaning of the Immigration Act who has been ordinarily resident in Canada for not more than one year after the time at which he first became eligible to apply for Canadian citizenship, (c) a Canadian government, whether federal, provincial or local, or an agency thereof, or (d) an entity that is Canadian-controlled, as determined pursuant to subsection 26(1) or (2) and in respect of which no determination or declaration has been made under subsection 26(2.1) or (2.2). "voting group" means two or more persons who are associated with respect to the exercise or rights attached to voting interests in an entity by contract, business arrangement, personal relationship, common control in fact through the ownership of voting interests, or otherwise, in such a manner that they would ordinarily be expected to act together on a continuing basis with respect to the exercise of those rights. "voting interest", with respect to (a) a corporation with share capital, means a voting share, (b) a corporation without share capital, means an ownership interest in the assets thereof that entitles the owner to rights similar to those enjoyed by the owner of a voting share, and (c) a partnership, trust or joint venture, means an ownership interest in the assets thereof that entitles the owner to receive a share of the profits and to share in the assets on dissolution. "voting share" means a share in the capital of a corporation to which is attached a voting right ordinarily exercisable at meetings of shareholders of the corporation and to which is ordinarily attached a right to receive a share of profits, or to share in the assets of the corporation on dissolution, or both. 2. Section 26(l) to (2.2) - Rules Respecting Control of Entities: (1) Subject to subsections (2.1) and (2.2), for the purposes of this Act, (a) where one Canadian or two or more members of a voting group who are Canadians own a majority of the voting interests of an entity, it is a Canadian-controlled entity; A-4 (b) where paragraph (a) does not apply and one non-Canadian or two or more members of a voting group who are non-Canadians own a majority of the voting interests of an entity, it is not a Canadian-controlled entity; (c) where paragraphs (a) and (b) do not apply and a majority of the voting interests of an entity are owned by Canadians and it can be established that the entity is not controlled in fact through the ownership of its voting interests by one non-Canadian or by a voting group in which a member or members who are non-Canadians own one-half or more of those voting interests of the entity owned by the voting group, it is a Canadian entity; and (d) where paragraphs (a) to (c) do not apply and less than a majority of the voting interests of an entity are owned by Canadians, it is presumed not to be a Canadian-controlled entity unless the contrary can be established by showing that: (i) the entity is controlled in fact through the ownership of its voting interests by one Canadian or by a voting group in which a member or members who are Canadians own a majority of those voting interests of the entity owned by the voting group, or (ii) in the case of an entity that is a corporation or limited partnership, the entity is not controlled in fact through the ownership of its voting interest and two-thirds of the members of its board of directors or, in the case of a limited partnership, two-thirds of its general partners, are Canadians. (2) Subject to subsection (2.1) and (2.2), where it can be established that a trust is not controlled in fact through the ownership of its voting interests, subsection (1) does not apply and the trust is a Canadian- controlled entity where two-thirds of its trustees are Canadians. (2.1) Where an entity that carries on or proposes to carry on a specific type of business activity that is prescribed for the purposes of paragraph 15(a) qualifies as a Canadian-controlled entity by virtue of subsection (1) or (2), the Minister may nevertheless determine that the entity is not a Canadian-controlled entity where, after considering any information and evidence submitted by or on behalf of the entity or otherwise made in fact by one or more non-Canadians. (2.2) Where an entity referred to in subsection (2.1) has refused or neglected to provide, within a reasonable time, information that the Minister or the Director has requested and that the Minister considers necessary in order to make a decision under that subsection, the Minister may declare that the entity is not a Canadian-controlled entity. EX-10.25 5 0005.txt LEASE AGREE FOR 24811 AVENUE ROCKEFELLER EXHIBIT 10.25 [LOGO] AMERICAN INDUSTRIAL REAL ESTATE ASSOCIATION STANDARD INDUSTRIAL/COMMERCIAL SINGLE-TENANT LEASE--NET (DO NOT USE THIS FORM FOR MULTI-TENANT BUILDINGS) 1. Basic Provisions ("Basic Provisions"). 1.1 Parties: This Lease ("Lease"), dated for reference purposes only, March 1, 2000, is made by and between 24811 Avenue Rockefeller, LLC, a Delaware limited liability company ("Lessor") and Future Media Productions, a California corporation (collectively, "Lessee"), (collectively the "Parties," or individually a "Party"). 1.2 Premises: That certain real property, including all improvements therein or to be provided by Lessor under the terms of this Lease, and commonly known as 24811 Avenue Rockefeller, Santa Clarita, located in the County of Los Angeles, State of California, and generally described as (describe briefly the nature of the property and, if applicable, the "Project", if the property is located within a Project) an approximate 82,835 square foot building situated on approximately 3.47 acres of land ("Premises"). (See also Paragraph 2) 1.3 Term: 13 years and 10 months ("Original Term") commencing March 1, 2000 ("Commencement Date") and ending December 31, 2013 (See Addendum Paragraph 52) ("Expiration Date"). (See also Paragraph 3) 1.5 Base Rent: $53,842.75 ($.65 x 82,835 sq. ft.) per month ("Base Rent"), payable on the 1st day of each month commencing March 1, 2000. (See also Paragraph 4) [X] If this box is checked, there are provisions in this Lease for the Base Rent to be adjusted. See Addendum Paragraph 50 and Paragraph 51. 1.6 Base Rent Paid Upon Execution: $53,842.75 as Base Rent for the period March 1, 2000 through March 31, 2000. 1.7 Security Deposit: $53,842.75 ("Security Deposit"). (See also Paragraph 5). 1.8 Agreed Use: Any legal use (See also Paragraph 6). 1.9 Insuring Party: Lessee is the "Insuring Party" unless otherwise stated herein. (See also Paragraph 8). 1.10 Real Estate Brokers: (See also Paragraph 15) None. See Addendum Paragraph 52. 1.12 Addenda and Exhibits. Attached hereto is an Addendum or Addenda consisting of Paragraphs 50 through 53 and Exhibits___, all of which constitute a part of this Lease. 2. Premises. 2.1 Letting. Lessor hereby leases to Lessee, and Lessee hereby leases from Lessor, the Premises, for the term, at the rental, and upon all of the terms, covenants and conditions set forth in this Lease. Unless otherwise provided herein, any statement of size set forth in this Lease, or that may have been used in calculating rental, is an approximation which the Parties agree is reasonable and the rental based thereon is not subject to revision whether or not the actual size is more or less. 2.2 Condition. Lessor shall deliver the Premises to Lessee broom clean and free of debris on the Commencement Date ("Start Date"). Lessor makes no warranty as to the condition of the existing electrical, plumbing, fire sprinkler, lighting, heating, ventilating and air conditioning systems, ("HVAC"), loading doors, if any, and all other such elements in the Premises. Page 1 of 15 Initials --------- --------- 2.3 Compliance. Lessor warrants that the improvements on the Premises comply with all applicable laws, covenants or restrictions of record, building codes, regulations and ordinances ("Applicable Requirements") in effect of the Start Date. Said warranty does not apply to the use to which Lessee will put the Premises or to any Alterations or Utility Installations (as defined in Paragraph 7.3(a)) made or to be made by Lessee. NOTE: Lessee is responsible for determining whether or not the zoning is appropriate for Lessee's intended use, and acknowledges that past uses of the Premises may no longer be allowed. If the Premises do not comply with said warranty, Lessor shall, except as otherwise provided, promptly after receipt of written notice from Lessee setting forth with specificity the nature and extent of such non-compliance, rectify the same at Lessor's expense. If Lessee does not give Lessor written notice of non- compliance with this warranty within six (6) months following the Start Date, correction of that non-compliance shall be the obligation of Lessee at Lessee's sole cost and expense. If the Applicable Requirements are hereafter changed (as opposed to being in existence at the Start Date, which is addressed in Paragraph 6.2(e) below) so as to require during the term of this Lease the construction of an addition to or an alteration of the Building, the remediation of any Hazardous Substance, or the reinforcement or other physical modification of the Building ("Capital Expenditure"), Lessor and Lessee shall allocate the cost of such work as follows: (a) Subject to Paragraph 2.3(c) below, if such Capital Expenditures are required as a result of the specific and unique use of the Premises by Lessee as compared with uses by tenants in general, Lessee shall be fully responsible for the cost thereof. (b) If such Capital Expenditure is not the result of the specific and unique use of the Premises by Lessee (such as, governmentally mandated seismic modifications), then Lessor and Lessee shall allocate the obligation to pay for such costs pursuant to the provisions of Paragraph 7.1(c); provided, however, that if such Capital Expenditure is required during the last two years of this Lease or if Lessor reasonably determines that it is not economically feasible to pay its share thereof, Lessor shall have the option to terminate this Lease upon ninety (90) days prior written notice to Lessee unless Lessee notifies Lessor, in writing, within ten (10) days after receipt of Lessor's termination notice that Lessee will pay for such Capital Expenditure. If Lessor does not elect to terminate, and fails to tender its share of any such Capital Expenditure, Lessee may advance such funds and deduct same, with Interest, from Rent until Lessor's share of such costs have been fully paid. If Lessee is unable to finance Lessor's share, or if the balance of the Rent due and payable for the remainder of this Lease is not sufficient to fully reimburse Lessee on an offset basis, Lessee shall have the right to terminate this Lease upon thirty (30) days written notice to Lessor. (c) Notwithstanding the above, the provisions concerning Capital Expenditures are intended to apply only to non-voluntary, unexpected, and new Applicable Requirements. If the Capital Expenditures are instead triggered by Lessee as a result of an actual or proposed change in use, change in intensity of use, or modification to the Premises then, and in that event, Lessee shall be fully responsible for the cost thereof, and Lessee shall not have any right to terminate this Lease. 2.4 Acknowledgements. Lessee acknowledges that: (a) it has been advised by Lessor to satisfy itself with respect to the condition of the Premises (including but not limited to the electrical, HVAC and fire sprinkler systems, security, environmental aspects, and compliance with Applicable Requirements), and their suitability for Lessee's intended use; (b) Lessee has made such investigation as it deems necessary with reference to such matters and assumes all responsibility therefor as the same relate to its occupancy of the Premises; and (c) neither Lessor, Lessor's agents, nor any Broker has made any oral or written representations or warranties with respect to said matters other than as set forth in this Lease. In addition, Lessor acknowledges that: (a) Broker has made no representations, promises or warranties concerning Lessee's ability to honor the Lease or suitability to occupy the Premises; and (b) it is Lessor's sole responsibility to investigate the financial capability and/or suitability of all proposed tenants. 3. Term. See, also, Paragraph 39 and Addendum Paragraph 53. 3.1 Term. The Commencement Date, Expiration Date and Original Term of this Lease are as specified in Paragraph 1.3 and Addendum Paragraph 50. 3.3 Delay in Possession. Lessor agrees to use its best commercially reasonable efforts to deliver possession of the Premises to Lessee by the Commencement Date. If, despite said efforts, Lessor is unable to deliver possession as agreed, Lessor shall not be subject to any liability thereof, nor shall such failure affect the validity of this Lease. Lessee shall not, however, be obligated to pay Rent or perform its other obligations until it receives possession of the Premises. If possession is not delivered within sixty (60) days after the Commencement Date, Lessee may, at its option, by notice in writing within ten (10) days after the end of such sixty (60) day period, cancel this Lease, in which event the Parties shall be discharged from all obligations hereunder. If such written notice is not received by Lessor within said ten (10) day period, Lessee's right to cancel shall terminate. Except as otherwise provided, if possession is not tendered to Lessee by the Start Date and Lessee does not terminate this Lease, as aforesaid, any period of rent abatement that Lessee would otherwise have enjoyed shall run from the date of delivery of possession and continue for a period equal to what Lessee would otherwise have enjoyed under the terms hereof, but minus any days of delay caused by the acts or omissions of Lessee. If possession of the Premises is not delivered within four (4) months after the Commencement Date, this Lease shall terminate unless other agreements are reached between Lessor and Lessee, in writing. 3.4 Lessee Compliance. Lessor shall not be required to tender possession of the Premises to Lessee until Lessee compiles with its obligation to provide evidence of insurance (Paragraph 8.5). Pending delivery of such evidence, Lessee shall be required to perform all of its obligations under this Lease from and after the Start Date, including the payment of Rent, notwithstanding Lessors election to withhold possession pending receipt of such evidence of insurance. Further, if Lessee is required to perform any other conditions prior to or concurrent with the Start Date, the Start Date shall occur but Lessor may elect to withhold possession until such conditions are satisfied. 4. Rent. See Addendum Paragraph 50 and Paragraph 51. 4.1 Rent Defined. All monetary obligations of Lessee to Lessor under the terms of this Lease are deemed to be rent Page 2 of 15 Initials ____ ____ ("Rent") 4.2 Payment. Lessee shall cause payment of Rent to be received by Lessor in lawful money of the United States, without offset or deduction (except as specifically permitted in this Lease), on or before the day on which it is due. Rent for any period during the term hereof which is for less than one (1) full calendar month shall be prorated based upon the actual number of days of said month. Payment of Rent shall be made to Lessor at its address stated herein or to such other persons or place as Lessor may from time to time designate in writing. Acceptance of a payment which is less than the amount then due shall not be a waiver of Lessor's rights to the balance of such Rent, regardless of Lessor's endorsement of any check so stating. 5. Security Deposit. Lessee shall deposit with Lessor upon execution hereof the Security Deposit as security for Lessee's faithful performance of its obligations under this Lease. If Lessee fails to pay Rent, or otherwise Defaults under this Lease, Lessor may use, apply or retain all or any portion of said Security Deposit for the payment of any amount due Lessor or to reimburse or compensate Lessor for any liability, expense, loss or damage which Lessor may suffer or incur by reason thereof. If Lessor uses or applies all or any portion of said Security Deposit, Lessee shall within ten (10) days after written request there for deposit monies with Lessor sufficient to restore said Security Deposit to the full amount required by this Lease. If the Base Rent increases during the term of this Lease, Lessee shall, upon written request from Lessor, deposit additional monies with Lessor so that the total amount of the Security Deposit shall at all times bear the same proportion to the increased Base Rent as the initial Security Deposit bore to the initial Base Rent. Should the Agreed Use be amended to accommodate a material change in the business of Lessee or to accommodate a sublessee or assignee, Lessor shall have the right to increase the Security Deposit to the extent necessary, in Lessor's reasonable judgment, to account for any increased wear and tear that the Premises may suffer as a result thereof. If a change in control of Lessee occurs during this Lease and following such change the financial condition of Lessee is, in Lessor's reasonable judgment, significantly reduced, Lessee shall deposit such addition monies with Lessor as shall be sufficient to cause the Security Deposit to be at a commercially reasonable level based on said change in financial condition. Lessor shall not be required to keep the Security Deposit separate from its general accounts. Within fourteen (14) days after the expiration or termination of this Lease, if Lessor elects to apply the Security Deposit only to unpaid Rent, and otherwise within thirty (30) days after the Premises have been vacated pursuant to Paragraph 7.4(c) below, Lessor shall return that portion of the Security Deposit not used or applied by Lessor. No part of the Security Deposit shall be considered to be held in trust, to bear interest or to be prepayment for any monies to be paid by Lessee under this Lease. 6. Use. 6.1 Use. Lessee shall use and occupy the Premises only for the Agreed Use, or any other legal use which is reasonably comparable thereto, and for no other purpose. Lessee shall not use or permit the use of the Premises in a manner that is unlawful, creates damage, waste or a nuisance, or that disturbs owners and/or occupants of, or causes damage to neighboring properties. Lessor shall not unreasonably withhold or delay its consent to any written request for a modification of the Agreed Use, so long as the same will not impair the structural integrity of the improvements of the Premises or the mechanical or electrical systems therein, is not significantly more burdensome to the Premises. If Lessor elects to withhold consent, Lessor shall within five (5) business days after such request give written notification of same, which notice shall include an explanation of Lessor's objections to the change in use. 6.2 Hazardous Substances. (a) Reportable Uses Require Consent. The term "Hazardous Substance" as used in this Lease shall mean any product, substance, or waste whose presence, use, manufacture, deposit, transportation, or release, either by itself or in combination with other materials expected to be on the Premises, is either: (i) potentially injurious to the public health, safety or welfare, the environment or the Premises, (ii) regulated or monitored by any governmental authority, or (iii) a basis for potential liability of Lessor to any governmental agency or third party under any applicable statute or common law theory. Hazardous Substances shall include, but not be limited to, hydrocarbons, petroleum, gasoline, and/or crude oil or any products, by-procuts or fractions thereof. Lessee shall not engage in any activity in or on the Premises which constitutes a Reportable Use of Hazardous Substances without the express prior written consent of Lessor and timely compliance (at Lessee's expense) with all Applicable Requirements. "Reportable Use" shall mean (i) the installation or use of any above or below ground storage tank, (ii) the generation, possession, storage, use, transportation, or disposal of a Hazardous Substance that requires a permit from, or with respect to which a report, notice, registration or business plan is required to be filed with, any governmental authority, and/or (iii) the presence at the Premises of a Hazardous Substance with respect to which any Applicable Requirements requires that a notice be given to persons entering or occupying the Premises or neighboring properties. Notwithstanding the foregoing, Lessee may use any ordinary and customary materials reasonably required to be used in the normal course of the Agreed Use, so long as such use is in compliance with all Applicable Requirements, is not a Reportable Use, and does not expose the Premises or neighboring property to any meaningful risk of contamination or damage or expose Lessor to any liability therefor. In addition, Lessor may condition its consent to any Reportable Use upon receiving such additional assurances as Lessor reasonably deems necessary to protect itself, the public, the Premises and/or the environment against damage, contamination, injury and/or liability, including, but not limited to, the installation (and removal on or before Lease expiration or termination) of protective modifications (such as concrete encasements) and/or increasing the Security Deposit. (b) Duty to Inform Lessor. If Lessee knows, or has reasonable cause to believe, that a Hazardous Substance has come to be located in, on, under or about the Premises, other than as previously consented to by Lessor, Lessee shall immediately give written notice of such fact to Lessor, and provide Lessor with a copy of any report, notice, claim or other documentation which it has concerning the presence of such Hazardous Substance. (c) Lessee Remediation. Lessee shall not cause or permit any Hazardous Substance to be spilled or released in, on, under, or about the Premises (including through the plumbing or sanitary sewer system) and shall promptly, at Lessee's expense, take all investigatory and/or remedial action reasonably recommended, whether or not formally ordered or required, for the cleanup of any contamination of, and for the maintenance, security and/or monitoring of the Premises or neighboring properties, that was caused or materially contributed to by Lessee, or pertaining to or involving any Hazardous Substance brought onto the Premises during the term of this Lease, by or for Lessee, or any third party. (d) Lessee Indemnification. Solely as between Lessee and Lessor, Lessee shall indemnify, defend and hold Lessor, its agents, employees, lenders and ground lessor, if any, harmless from and against any and all loss of rents and/or damages, liabilities, judgments, claims, expenses, penalties, and attorneys' and consultants' fees arising out of or involving any Hazardous Substance brought onto the Premises by or for Lessee, or any third party (provided, however, that Lessee shall have no liability under this Lease with respect to underground migration of any Hazardous Substance under the Premises from adjacent properties). Lessee's obligations shall include, but not be limited to, the effects of any contamination or injury to person, property or the environment created or suffered by Lessee, and the cost of investigation, removal, remediation, restoration and/or abatement, and shall survive the expiration or termination of this Lease. No termination, cancellation or release agreement entered into by Lessor and Lessee shall release Lessee from its obligations under this Lease with respect to Hazardous Substances, unless specifically so agreed by Lessor in writing at the time of such agreement. (e) Lessor Indemnification. Solely as between Lessor and Lessee, Lessor and its successors and assigns shall indemnify, defend, reimburse and hold Lessee, its employees and lenders, harmless from and against any and all environmental damages, including the cost of remediation, which existed as a result of Hazardous Substances on the Premises prior to the Start Date or which are caused by the gross negligence or willful misconduct of Lessor, its Page 3 of 15 Initials____ agents or emplyees. Lessor's obligations, as and when required by the Applicable Requirements, shall include, but not be limited to, the cost of investigation removal, remediation, restoration and/or abatement, and shall survive the expiration or termination of this Lease. (f) investigations and Remediations. Lessee shall be responsible for and shall pay for any investigations or remediation measures required by governmental entities having jurisdiction with respect to the existence of Hazardous Substances on the Premises Lessor shall cooperate fully in any such activities at the request of Lessee, including allowing Lessor and Lessor's agents to have reasonable access to the Premises at reasonable times in order to carry out Lessor's investigative and remedial responsibilities. 6.3 Lessee's Compliance with Applicable Requirements. Except as otherwise provided in this Lease, Lessee shall, at Lessee's sole expense, fully, diligently and in a timely manner, materially comply with all Applicable Requirements, the requirements of any applicable fire insurance underwriter or rating bureau, and the recommendations of Lessor's engineers and/or consultants which relate in any manner to the Premises, without regard to whether said requirements are now in effect or become effective after the Start Date. Lessee shall, within ten (10) days after receipt of Lessor's written request, provide Lessor with copies of all permits and other documents, and other information evidencing Lessee's compliance with any Applicable Requirements specified by Lessor, and shall immediately upon receipt, notify Lessor in writing (with copies of any documents involved) of any threatened or actual claim, notice, citation, warning, complaint or report pertaining to or involving the failure of Lessee or the Premises to comply with any Applicable Requirements. 6.4 Inspection; Compliance. Lessor and Lessor's "Lender" (as defined in Paragraph 30 below) and consultants shall have the right to enter into Premises at any time, in the case of an emergency, and otherwise at reasonable times, for the purpose of inspecting the condition of the Premises and for verifying compliance by Lessee with this Lease. The cost of any such inspections shall be paid by Lessor, unless a violation of Applicable Requirements, or a contamination is found to exist or be imminent, or the inspection is requested or ordered by a governmental authority. In such case, Lessee shall upon request reimburse Lessor for the cost of such inspections, so long as such inspection is reasonably related to the violation or contamination. 7. Maintenance; Repairs, Utility Installations; Trade Fixtures and Alterations. 7.1 Lessee's Obligations. (a) In General. Subject to the provisions of Paragraph 2.3 (Compliance), 6.3 (Lessee's Compliance with Applicable Requirements), 7.2 (Lessor's Obligations), 9 (Damage or Destruction), and 14 (Condemnation), Lessee shall, at Lessee's sole expense, keep the Premises, Utility Installations, and Alterations in good order, condition and repair (whether or not the portion of the Premises requiring repairs, or the means of repairing the same, are reasonably or readily accessible to Lessee, and whether or not the need for such repairs occurs as a result of Lessee's use, any prior use, the elements or the age of such portion of the Premises), including, but not limited to, all equipment or facilities, such as plumbing, heating, ventilating, air- conditioning, electrical, lighting facilities, boilers, pressure vessels, fire protection system, fixtures, walls (interior and exterior), foundations, ceilings, roofs, floors, windows, doors, plate glass, skylights, landscaping, driveways, parking lots, fences, retaining walls, signs, sidewalks and parkways located in, on, or adjacent to the Premises. Lessee, in keeping the Premises in good order, condition and repair, shall exercise and perform good maintenance practices, specifically including the procurement and maintenance of the service contracts required by Paragraph 7.1(b) below. Lessee's obligations shall include restorations, replacements or renewals when necessary to keep the Premises and all improvements thereon or a part thereof in good order, condition and state of repair. Lessee shall, during the term of this Lease, keep the exterior appearance of any buildings on the Premises (the "Building") in a first-class condition consistent with the exterior appearance of other similar facilities of comparable age and size in the vicinity, including, when necessary, the exterior repainting of the Building. (b) Service Contracts. Lessee shall, at Lessee's sole expense, procure and maintain contracts, with copies to Lessor, in customary form and substance for, and with contractors specializing and experienced in the maintenance of the following equipment and improvements, if any, if and when installed on the Premises: (iv) landscaping and irrigation systems, (v) roof covering and drains, (vi) driveways and parking lots, and (ix) any other equipment, if reasonably required by Lessor. (c) Replacement. Subject to Lessee's indemnification of Lessor as set forth in Paragraph 8.7 below, and without relieving Lessee of liability resulting from Lessee's failure to exercise and perform good maintenance practices, if the Basic Elements described in Paragraph 7.1(b) cannot be repaired other than at a cost which is in excess of 50% of the cost of replacing such Basic Elements, then such Basic Elements shall be replaced by Lessor, and the cost thereof shall be prorated between the Parties and Lessee shall only be obligated to pay, each month during the remainder of the term of this Lease, on the date on which Base Rent is due, an amount equal to the product of multiplying the cost of such replacement by a fraction, the numerator of which is one, and the denominator of which is the number of months of the useful life of such replacement as such useful life is specified pursuant to Federal income tax regulations or guidelines for depreciation thereof (including interest on the unamortized balance as is then commercially reasonable in the judgement of Lessor's accountants), with Lessee reserving the right to prepay its obligation at any time. 7.2 Lessor's Obligations. Subject to the provisions of Paragraphs 2.3 (Compliance), 9 (Damage or Destruction) and 14 (Condemnation), it is intended by the Parties hereto that Lessor have no obligation, in any manner whatsoever, to repair and maintain the Premises, or the equipment therein, all of which obligations are intended to be that of the Lessee. It is the intention of the Parties that the terms of this Lease govern the respective obligations of the Parties as to maintenance and repair of the Premises, and they expressly waive the benefit of any statute now or hereafter in effect to the extent it is inconsistent with the terms of this Lease. Page 4 of 15 Initials ________ ________ 7.3 Utility Installations; Trade Fixtures; Alterations. (a) Definitions; Consent Required. The term "Utility Installations" refers to all floor and window coverings, air lines, power panels, electrical distribution, security and fire protection systems, communication systems, lighting fixtures, heating, ventilating and air conditioning systems ("HVAC" equipment, plumbing and fencing in or on the Premises. The term "Trade Fixtures" shall mean Lessee's machinery and equipment that can be removed without doing material damage to the Premises. The term "Alterations" shall mean any modification of the improvements, other than Utility installations or Trade Fixtures whether by addition or deletion. "Lessee Owned Alterations and/or Utility Installations" are defined as Alterations and/or Utility installations made by Lessee that are not yet owned by Lessor pursuant to Paragraph 7.4(a). Lessee shall not make any Alterations or Utility Installations to the Premises without Lessor's prior written consent. Lessee may, however, make non-structural Utility installations to the interior of the Premises (excluding the roof) without such consent but upon notice to Lessor, as long as they are not visible from the outside, do not involve puncturing, relocating or removing the roof or any existing walls, and the cumulative cost thereof during this Lease as extended does not exceed $50,000 in the aggregate or $10,000 in any one year. (b) Consent. Any Alterations or Utility Installations that Lessee shall desire to make and which require the consent of the Lessor shall be presented to Lessor in written form with detailed plans. Consent shall be deemed conditioned upon Lessee's: (i) acquiring all applicable governmental permits, (ii) furnishing Lessor with copies of both the permits and the plans and specifications prior to commencement of the work and, (iii) compliance with all conditions of said permits and other Applicable Requirements in a prompt and expeditious manner. Any Alterations or Utility Installations shall be performed in a workmanlike manner with good and sufficient materials. Lessee shall promptly upon completion furnish Lessor with as-built plans and specifications. For work which costs an amount greater than $10,000, Lessor may condition its consent upon Lessee providing a lien and completion bond in an amount equal to one and one-half times the estimated cost of such Alteration or Utility Installation and/or upon Lessee's posting an additional Security Deposit with Lessor. (c) Indemnification. Lessee shall pay, when due, all claims for labor or materials furnished or alleged to have been furnished to or for Lessee at or for use on the Premises, which claims are or may be secured by any mechanic's or materialmen's lien against the Premises or any interest therein. Lessee shall give Lessor not less than ten (10) days' notice prior to the commencement of any work in, on or about the Premises, and Lessor shall have the right to post notices of non-responsibility. If Lessee shall contest the validity of any such lien, claim or demand, then Lessee shall, at its sole expense defend and protect itself, Lessor and the Premises against the same and shall pay and satisfy any such adverse judgment that may be rendered thereon before the enforcement thereof. If Lessor shall require, Lessee shall furnish a surety bond in an amount equal to one and one-half times the amount of such contested lien, claim or demand, indemnifying Lessor against liability for the same. If Lessor elects to participate in any such action, Lessee shall pay Lessor's attorneys' fees and costs. 7.4 Ownership; Removal; Surrender; and Restoration. (a) Ownership. Subject to Lessor's right to require removal or elect ownership as hereinafter provided, all Alterations and Utility Installations made by Lessee shall be the property of Lessee, but considered a part of the Premises. Lessor may, at any time, elect in writing to be the owner of all or any specified part of the Lessee Owned Alterations and Utility Installations. Unless otherwise instructed per Paragraph 7.4(b) hereof, all Lessee Owned Alterations and Utility Installations shall, at the expiration or termination of this Lease, become the property of Lessor and be surrendered by Lessee with the Premises. (b) Removal. By delivery to Lessee of written notice from Lessor not earlier than ninety (90) and not later than thirty (30) days prior to the end of the term of this Lease, Lessor may require that any or all Lessee Owned Alterations or Utility Installations be removed by the expiration or termination of this Lease. Lessor may require the removal at any time of all or any part of any Lessee Owned Alterations or Utility Installations made without the required consent. (c) Surrender/Restoration. Lessee shall surrender the Premises by the Expiration Date or any earlier termination date, with all of the improvements, part and surfaces thereof broom clean and free of debris, and in good operating order, condition and state of repair, ordinary wear and tear excepted. "Ordinary wear and tear" shall not include any damage or deterioration that would have been prevented by good maintenance practice. Lessee shall repair any damage occasioned by the installation, maintenance or removal of Trade Fixtures, Lessee Owned Alterations and/or Utility Installations, furnishings, and equipment as well as the removal of any storage tank installed by or for Lessee, and the removal, replacement, or remediation of any soil, material or groundwater contaminated by Lessee. Trade Fixtures shall remain the property of Lessee, shall be removed by Lessee. The failure by Lessee to timely vacate the Premises pursuant to this Paragraph 7.4(c) without the express written consent of Lessor shall constitute a holdover under the provisions of Paragraph 26 below. 8. Insurance; Indemnity. 8.1 Payment for Insurance. Lessee shall pay for all insurance required under Paragraph 8. Premiums for policy periods commencing prior to or extending beyond the Lease term shall be prorated to correspond to the Lease term. Payment shall be made by Lessee to Lessor within ten (10) days following receipt of an invoice. 8.2 Liability Insurance. (a) Carried by Lessee. Lessee shall obtain and keep in force a Commercial General Liability Policy of Insurance protecting Lessee and Lessor against claims for bodily injury, personal injury and property damage based upon or arising out of the ownership, use, occupancy or maintenance of the Premises and all areas appurtenant thereto. Such insurance shall be on an occurence basis providing single limit coverage in an amount not less than $2,000,000 per occurence with an "Additional Insured-Managers or Lessors of Premises Endorsement" and contain the "Amendment of the Pollution Exclusion Endorsement" for damage caused by heat, smoke or fumes from a hostile fire. The Policy shall not contain any intra-insured exclusions as between insured persons or organizations, but shall include coverage for liability assumed under this Lease as an "insured contract" for the performance of Lessee's indemnity obligations under this Lease. The limits of said insurance shall not, however, limit the liability of Lessee nor relieve Lessee of any obligation hereunder. All insurance carried by Lessee shall be primary to and not contributory with any similar insurance carried by Lessor, whose insurance shall be considered excess insurance only. 8.3 Property Insurance - Building, Improvements and Rental Value. (a) Building and Improvements. The Insuring Party shall obtain and keep in force a policy or policies in the name of Lessor, with loss payable to Lessor, any groundlessor, and to any Lender(s) insuring loss or damage to the Premises. The amount of such insurance shall be equal to the full replacement cost of the Premises, as the same shall exist from time to time, or the amount required by any Lenders, but in no event more than the commercially reasonable and available insurance value thereof. Lessee Owned Alterations and Utility Installations, Trade Fixtures, and Lessee's personal property shall be insured by Lessee under Paragraph 8.4. If the coverage is available and commercially appropriate, such policy or policies shall insure against all risks of direct physical loss or damage (except the perils of flood and/or earthquake unless required by a Lender), including coverage for debris removal and the enforcement of any Applicable Requirements requiring the upgrading, demolition, reconstruction or replacement of any portion of the Premises as the result of a covered loss. Said policy or policies shall also contain an agreed valuation provision in lieu of any coinsurance clause, waiver of subrogation, and inflation guard protection causing an increase in the annual property insurance coverage amount by a factor of not less than the adjusted U.S. Page 5 of 15 Initials__________ Department of Labor Consumer Price Index for All Urban Consumers for the city nearest to where the Premises are located. If such insurance coverage has a deductible clause, the deductible amount shall not exceed $1,000 per occurrence, and Lessee shall be liable for such deductible amount in the event of an Insured Loss. (b) Rental Value. The Insuring Party shall obtain and keep in force a policy or policies in the name of Lessor with loss payable to Lessor and any Lender, insuring the loss of the full Rent for one (1) year. Said insurance shall provide that in the event the Lease is terminated by reason of an insured loss, the period of indemnity for such coverage shall be extended beyond the date of the completion of repairs or replacement of the Premises, to provide for one full year's loss of Rent from the date of any such loss. Said insurance shall contain an agreed valuation provision in lieu of any coinsurance clause, and the amount of coverage shall be adjusted annually to reflect the projected Rent otherwise payable by Lessee, for the next twelve (12) month period. Lessee shall be liable for any deductible amount in the event of such loss. (c) Adjacent Premises. If the Premises are part of a larger building, or of a group of buildings owned by Lessor which are adjacent to the Premises, the Lessee shall pay for any increase in the premiums for the property insurance of such building or buildings if said increase is caused by Lessee's acts, omissions, use or occupancy of the Premises. 8.4 Lessee's Property/Business Interruption Insurance. (a) Property Damage. Lessee shall obtain and maintain insurance coverage on all of Lessee's personal property. Trade Fixtures, and Lessee Owned Alterations and Utility Installations. Such insurance shall be full replacement cost coverage with a deductible of not to exceed $1,000 per occurrence. The proceeds from any such insurance shall be used by Lessee for the replacement of personal property, Trade Fixtures and Lessee Owned Alterations and Utility Installations. Lessee shall provide Lessor with written evidence that such insurance is in force. (b) Business Interruption. Lessee shall obtain and maintain loss of income and extra expense insurance in amounts as will reimburse Lessee for direct or indirect loss of earnings attributable to all perils commonly insured against by prudent lessees in the business of Lessee or attributable to prevention of access to the Premises as a result of such perils. (c) No Representation of Adequate Coverage. Lessor makes no representation that the limits or forms of coverage of insurance specified herein are adequate to cover Lessee's property, business operations or obligations under this Lease. 8.5 Insurance Policies. Insurance required herein shall be by companies duly licensed or admitted to transact business in the state where the Premises are located, and maintaining during the policy term a "General Policyholders Rating" of at least 8+, V, as set forth in the most current issue of "Best's Insurance Guide", or such other rating as may be required by a Lender. Lessee shall not do or permit to be done anything which invalidates the required insurance policies. Lessee shall, prior to the Start Date, deliver to Lessor certified copies of policies of such insurance or certificates evidencing the existence and amounts of the required insurance. No such policy shall be cancelable or subject to modification except after thirty (30) days prior written notice to Lessor. Lessee shall, at least thirty (30) days prior to the expiration of such policies, furnish Lessor with evidence of renewals or "insurance binders" evidencing renewal thereof, or Lessor may order such insurance and charge the cost thereof to Lessee, which amount shall be payable to Lessee to Lessor upon demand. Such policies shall be for a term of at least one year, or length of the remaining term of this Lease, whichever is less. If either Party shall fail to procure and maintain the insurance required to be carried by it, the other Party may, but shall not be required to, procure and maintain the same. 8.6 Waiver of Subrogation. Without affecting any other rights or remedies, Lessee and Lessor each hereby release and relieve the other, and waive their entire right to recover damages against the other, for loss of or damage to its property arising out of or incident to the perils required to be insured against herein. The affect of such releases and waivers is not limited by the amount of insurance carried or required, or by any deductibles applicable hereto. The Parties agree to have their respective property damage insurance carriers waive any right to subrogation that such companies may have against Lessor or Lessee, as the case may be, so long as the insurance is not invalidated thereby. 8.7 Indemnity. Except for Lessor's gross negligence or willful misconduct, Lessee shall indemnify, protect, defend and hold harmless the Premises, Lessor and its agent, Lessor's master or ground lessor, partners and Lenders, from and against any and all claims, loss of rents and/or damages, liens, judgments, penalties, attorneys' and consultants' fees, expenses and/or liabilities arising out of, involving, or in connection with, the sue and/or occupancy of the Premises by Lessee. If any action or proceeding is brought against Lessor by reason of any of the foregoing matters, Lessee shall upon notice defend the same at Lessee's expense by counsel reasonably satisfactory to Lessor and Lessor shall cooperate with Lessee in such defense. Lessor need not have first paid any such claim in order to be defended or indemnified. 8.8 Exemption of Lessor from Liability. Lessor shall not be liable for injury or damage to the person or goods, wares, merchandise or other property of Lessee, Lessee's employees, contractors, invitees, customers, or any other person in or about the Premises, whether such damage or injury is caused by or results from fire, steam, electricity, gas, water or rain, or from the breakage, leakage, obstruction or other defects of pipes, fire sprinklers, wires, appliances plumbing, HVAC or lighting fixtures, or from any other cause, whether the said injury or damage results from conditions arising upon the Premises or upon other portions of the Building of which the Premises are a part, or from other sources or places. Lessor shall not be liable for any damages arising from any act or neglect of any other tenant of Lessor. Notwithstanding Lessor's negligence or breach of this Lease, Lessor shall under no circumstances be liable for injury to Lessee's business or for any loss of income or profit therefrom. 9. Damage or Destruction. 9.1 Definitions. (a) "Premises Partial Damage" shall mean damage or destruction to the improvements on the Premises, other than Lessee Owned Alterations and Utility Installations, which can reasonably be repaired in six (6) months or less from the date of the damage or destruction at a cost of no more than $100,000. Lessor shall notify Lessee in writing within thirty (30) days from the date of the damage or destruction as to whether or not the damage is Partial or Total. (b) "Premises Total Destruction" shall mean damage or destruction to the Premises, other than Lessee Owned Alterations and Utility Installations and Trade Fixture, which cannot reasonably be repaired in six (6) months or less from the date of the damage or destruction or which costs more than $100,000 to repair. Lessor shall notify Lessee in writing within thirty (30) days from the date of the damage or destruction as to whether or not the damage is Partial or Total. (c) "Insured Loss" shall mean damage or destruction to improvements on the Premises, other than Lessee Owned Alterations and Utility Installations and Trade Fixtures, which was caused by an event required to be covered by the insurance described in Paragraph 8.3(a), irrespective of any deductible amounts or coverage limits involved. (d) "Replacement Cost" shall mean the cost to repair or rebuild the improvements owned by Lessor at the time of the occurrence to their condition existing immediately prior thereto, including demolition, debris removal and upgrading required by the operation of Applicable Requirements, and without Page 6 of 15 Initials ______ ______ deduction for depreciation. (e) "Hazardous Substance Condition" shall mean the occurrence or discovery of a condition involving the presence of, or a contamination by, a Hazardous Substance as defined in Paragraph 6.2(a), in, on, or under the Premises. 9.2 Partial Damage - Insured Loss. If a Premises Partial Damage that is an Insured Loss occurs, then Lessor shall, but only to the extent of any insurance proceeds, repair such damage (but not Lessee's Trade Fixtures or Lessee Owned Alterations and Utility Installations) as soon as reasonably possible and this Lease shall continue in full force and effect; provided, however, that Lessee shall, at Lessor's election, make the repair of any damage or destruction the total cost to repair of which is $10,000 or less, and, in such event, Lessor shall make any applicable insurance proceeds available to Lessee on a reasonable basis for that purpose. Notwithstanding the foregoing, if the required insurance was not in force or the insurance proceeds are not sufficient to effect such repair, the Insuring Party shall promptly contribute the shortage in proceeds (except as to the deductible which is Lessee's responsibility) as and when required to complete said repairs. In the event, however, such shortage was due to the fact that, by reason of the unique nature of the improvements, full replacement cost insurance coverage was not commercially reasonable and available, Lessor shall have no obligation to pay for the shortage in insurance proceeds or to fully restore the unique aspects of the Premises unless Lessee provides Lessor with the funds to cover same, or adequate assurance thereof, within ten (10) days following receipt of written notice of such shortage and request therefor. If Lessor receives said funds or adequate assurance thereof within said ten (10) day period, the party responsible for making the repairs shall complete them as soon as reasonably possible and this Lease shall remain in full force and effect. If such funds or assurance are not received, Lessor may nevertheless elect by written notice to Lessee within ten (10) days thereafter to: (i) make such restoration and repair as is commercially reasonable with Lessee payee any shortage in proceeds, in which case this Lease shall remain in full force and effect, or have this Lease terminate thirty (30) days thereafter. Lessee shall not be entitled to reimbursement of any funds contributed by Lessee to repair any such damage or destruction. Premises Partial Damage due to flood or earthquake shall be subject to Paragraph 9.3, notwithstanding that there may be some insurance coverage, but the net proceeds of any such insurance shall be made available for the repairs if made by either Party. 9.3 Partial Damage - Uninsured Loss. If a Premises Partial Damage that is not an Insured Loss occurs, unless caused by a negligent or willful act of Lessor (in which event Lessor shall make the repairs at Lessor's expense). Lessee shall repair such damage as soon as reasonably possible at Lessee's expense and this Lease shall continue in full force and effect, but subject to Lessor's rights under Paragraph 13. 9.4 Total Destruction. Notwithstanding any other provision hereof, if a Premises Total Destruction occurs, at the option of Lessor, this Lease shall terminate sixty (60) days following such Destruction. If the damage or destruction was caused by the gross negligence or willful misconduct of Lessee, Lessor shall have the right to recover Lessor's damages from Lessee, except as provided in Paragraph 8.6. 9.5 Damage Near End of Term. If at any time during the last six (6) months of this Lease there is damage for which the cost to repair exceeds one (1) month's Base Rent, whether or not an insured Loss, Lessor may terminate this Lease effective sixty (60) days following the date of occurrence of such damage by giving a written termination notice to Lessee within the thirty (30) days after the date of occurrence of such damage. Notwithstanding the foregoing, if Lessee at that time has an exercisable option to extend this Lease or to purchase the Premises, then Lessee may preserve this Lease by, (a) exercising such option and (b) providing Lessor with any shortage in insurance proceeds (or adequate assurance thereof) needed to make the repairs on or before the earlier of (i) the date which is ten days after Lessee's receipt of Lessor's written notice purporting to terminate this Lease, or (ii) the day prior to the date upon which such option expires. If Lessee duly exercises such option during such period and provides Lessor with funds (or adequate assurance thereof) to cover any shortage in insurance proceeds, Lessor shall, at Lessor's commercially reasonable expense, repair such damage as soon as reasonably possible and this Lease shall continue in full force and effect. If Lessee fails to exercise such option and provide such funds or assurance during such period, then this Lease shall terminate on the date specified in the termination notice and Lessee's option shall be extinguished. 9.6 Abatement of Rent; Lessee's Remedies. (a) Abatement. In the event of Premises Partial Damage or Premises Total Destruction or a Hazardous Substance Condition for which Lessee is not responsible under this Lease, the Rent payable by Lessee for the period required for the repair, remediation or restoration of such damage shall be abated in proportion to the degree to which Lessee's use of the Premises is impaired, but not to exceed the proceeds received from the Rental Value insurance. All other obligations of Lessee hereunder shall be performed by Lessee, and Lessor shall have no liability for any such damage, destruction, remediation, repair or restoration except as provided herein. (b) Remedies. If Lessor shall be obligated to repair or restore the Premises and does not commence, in a substantial and meaningful way, such repair or restoration within ninety (90) days after such obligation shall accrue, Lessee may, at any time prior to the commencement of such repair or restoration, give written notice to Lessor and to any Lenders of which Lessee has actual notice, of Lessee's election to terminate this Lease on a date not less than sixty (60) days following the giving of such notice. If Lessee gives such notice and such repair or restoration is not commenced within thirty (30) days thereafter, this Lease shall terminate as of the date specified in said notice. If the repair or restoration is commenced within said thirty (30) days, this Lease shall continue in full force and effect. "Commence" shall mean either the unconditional authorization of the preparation of the required plans, or the beginning of the actual work on the Premises, whichever first occurs. 9.7 Termination - Advance Payments. Upon termination of this Lease pursuant to Paragraph 6.2(g) or Paragraph 9, an equitable adjustment shall be made concerning advance Base Rent and any other advance payments made by Lessee to Lessor. Lessor shall, in addition, return to Lessee so much of Lessee's Security Deposit as has not been, or is not then required to be, used by Lessor. 9.8 Waive Statutes. Lessor and Lessee agree that the terms of this Lease shall govern the effect of any damage to or destruction of the Premises with respect to the termination of this Lease and hereby waive the provisions of any present or future statute to the extent inconsistent herewith. 10. Real Property Taxes. 10.1 Definition of "Real Property Taxes." As used herein, the term "Real Property Taxes" shall include any form of assessment; real estate, general, special, ordinary or extraordinary, or rental levy or tax (other than inheritance, personal income or estate taxes); improvement bond; and/or license fee Page 7 of 15 REVISED Initials _______ _______ imposed upon or levied against any legal or equitable interest of Lessor in the Premises, Lesssor's right to other income therefrom, and/or Lessor's business of leasing, by any authority having the direct or indirect power to tax and where the funds are generated with reference to the Building address and where the proceeds so generated are to be applied by the city, county or other local taxing authority of a jurisdiction within which the Premises are located. The term "Real Property Taxes" shall also include any tax, fee, levy, assessment or charge, or any increase therein, imposed by reason of events occurring during the term of this Lease, including but not limited to, a change in the ownership of the Premises. 10.2 (a) Payment of Taxes. Lessee shall pay the Real Property Taxes applicable to the Premises during the term of this Lease. Subject to Paragraph 10.2(b), all such payments shall be made at least ten (10) days prior to any delinquency date. Lessee shall promptly furnish Lessor with satisfactory evidence that such taxes have been paid. If any such taxes shall cover any period of time prior to or after the expiration or termination of this Lease, Lessee's share of such taxes shall be prorated to cover only that portion of the tax bill applicable to the period that this Lease is in effect, and Lessor shall reimburse Lessee for any overpayment. If Lessee shall fail to pay any required Real Property Taxes, Lessor shall have the right to pay the same, and Lessee shall reimburse Lessor therefor upon demand. (b) Advance Payment. In the event Lessee incurs a late charge on any Rent payment, Lessor may, at Lessor's option, estimate the current Real Property Taxes, and require that such taxes be paid in advance to Lessor by Lessee, either: (i) in a lump sum amount equal to the installment due, at least twenty (20) days prior to the applicable delinquency date, or (ii) monthly in advance with the payment of the Base Rent. If Lessor elects to require payment monthly in advance, the monthly payment shall be an amount equal to the amount of the estimated installment of taxes divided by the number of months remaining before the month in which said installment becomes delinquent. When the actual amount of the applicable tax bill is known, the amount of such equal monthly advance payments shall be adjusted as required to provide the funds needed to pay the applicable taxes. If the amount collected by Lessor is insufficient to pay such Real Property Taxes when due, Lessee shall pay Lessor, upon demand, such additional sums as are necessary to pay such obligations. All monies paid to Lessor under this Paragraph may be intermingled with other monies of Lessor and shall not bear interest. In the event of a Breach by Lessee in the performance of its obligations under this Lease, then any balance of funds paid to Lessor under the provisions of this Paragraph may, at the option of Lessor, be treated as an additional Security Deposit. 10.3 Joint Assessment. If the Premises are not separately assessed, Lessee's liability shall be an equitable proportion of the Real Property Taxes for all of the land and improvements included within the tax parcel assessed, such proportion to be conclusively determined by Lessor from the respective valuations assigned in the assessor's work sheets or such other information as may be reasonably available. 10.4 Personal Property Taxes. Lessee shall pay, prior to delinquency, all taxes assessed against and levied upon Lessee Owned Alterations, Utility installations, Trade Fixtures, furnishings, equipment and all personal property of Lessee. When possible, Lessee shall cause such property to be assessed and billed separately from the real property of Lessor. If any of Lessee's said personal property shall be assessed with Lessor's real property, Lessee shall pay Lessor the taxes attributable to Lessee's property within ten (10) days after receipt of a written statement. 11. Utilities. Lessee shall pay for all water, gas, heat, light, power, telephone, trash disposal and other utilities and services supplied to the Premises, together with any taxes thereon. If any such services are not separately metered to Lessee, Lessee shall pay a reasonable proportion, to be determined by Lessor, of all charges jointly metered. 12. Assignment and Subletting. 12.1 Lessor's Consent Required. (a) Lessee shall not voluntarily or by operation of law assign, transfer, mortgage or encumber (collectively, "assign or assignment") or sublet all or any part of Lessee's interest in this Lease or in the Premises without Lessor's prior written consent, which consent shall not be unreasonably withheld. (b) A change in the control of Lessee shall constitute an assignment requiring consent. The transfer, on a cumulative basis, of (50)% or more of the voting control of Lessee shall constitute a change in control for this purpose. This Paragraph 12.1(b) shall not apply if the shares of Lessee are owned by 50 or more persons. (c) The involvement of Lessee or this assets in any transaction, or series of transactions (by way of merger, sale, acquisition, financing, transfer, leverage buy-out or otherwise), whether or not a formal assignment or hypothecation of this Lease or Lessee's assets occurs, which results or will result in a reduction of the Net Worth of Lessee (or the restructured entity) by an amount greater than twenty-five percent (25%) of such Net Worth as it was represented at the time of the execution of this Lease or at the time of the most recent assignment to which Lessor has consented, or as it exists immediately prior to said transaction or transactions constituting such reduction, whichever was or is greater, shall be considered an assignment of this Lease to which Lessor may withhold its consent. "Net Worth of Lessee" shall mean the net worth of Lessee (excluding any guarantors) established under generally accepted accounting principles. This Paragraph 12.1(c) shall not apply if the shares of Lessee are owned by 50 or more persons. (d) An assignment or subletting without consent shall, at Lessor's option, be a default curable after notice per Paragraph 13.1(c), or a noncurable Breach without the necessity of any notice and grace period. If Lessor elects to treat such unapproved assignment or subletting as a noncurable Breach, Lessor may either; (i) terminate this Lease, or (ii) upon thirty (30) days written notice, increase the monthly Base Rent to one hundred ten percent (110%) of the Base Rent then in effect. Further, in the event of such Breach and rental adjustment, (i) the purchase price of any option to purchase the Premises held by Lessee shall be subject to similar adjustment to one hundred ten percent (110%) of the price previously in effect, and (ii) all fixed and non-fixed rental adjustments scheduled during the remainder of the Lease term shall be increased to One Hundred Ten Percent (110%) of the scheduled adjusted rent. (e) Lessee's remedy for any breach of Paragraph 12.1 by Lessor shall be limited to compensatory damages and/or injunctive relief. 12.2 Terms and Conditions Applicable to Assignment and Subletting. (a) Regardless of Lessor's consent, any assignment or subletting shall not: (i) be effective without the express written assumption by such assignee or sublessee of the obligations of Lessee under this Lease; (ii) release Lessee of any obligations hereunder, or (iii) after the primary liability of Lessee for the payment of Rent or for the performance of any other obligations to be performed by Lessee. (b) Lessor may accept Rent or performance of Lessee's obligations from any person other than Lessee pending approval or disapproval of an assignment. Neither a delay in the approval or disapproval of such assignment nor the acceptance of Rent or performance shall constitute a waiver or estoppel of Lessor's right to exercise its remedies for Lessee's Default or Breach. (c) Lessor's consent to any assignment or subletting shall not constitute a consent to any subsequent assignment or subletting. (d) In the event of any Default or Breach by Lessee, Lessor may proceed directly against Lessee, any Guarantors or anyone else responsible for the performance of Lessee's obligations under this Lease, including any assignee or sublessee, without first exhausting Lessor's remedies against any other person Page 8 of 15 Initials ---- ---- or entity responsible therefore to Lessor, or any security held by Lessor. (e) Each request for consent to an assignment or subletting shall be in writing, accompanied by information relevant to Lessor's determination as to the financial and operational responsibility and appropriateness of the proposed assignee or sublessee, including but not limited to the intended use and/or required modification of the Premises, if any, together with a fee of $1,000 or ten percent (10%) of the current monthly Base Rent applicable to the portion of the Premises which is the subject of the proposed assignment or sublease, whichever is greater, as consideration for Lessor's considering and processing said request. Lessee agrees to provide Lessor with such other or additional information and/or documentation as may be reasonably requested. (f) Any assignee of, or sublessee under, this Lease shall, by reason of accepting such assignment or entering into such sublease, be deemed to have assumed and agreed to conform and comply with each and every term, covenant, condition and obligation herein to be observed or performed by Lessee during the term of said assignment or sublease, other than such obligations as are contrary to or inconsistent with provisions of an assignment or sublease to which Lessor has specifically consented to in writing. 12.3 Additional Terms and Conditions Applicable to Subletting. The following terms and conditions shall apply to any subletting by Lessee of all or any part of the Premises and shall be deemed included in all subleases under this Lease whether or not expressly incorporated therein; (a) Lessee hereby assigns and transfers to Lessor all of Lessee's interest in all Rent payable on any sublease, and Lessor may collect such Rent and apply same toward Lessee's obligations under this Lease; provided, however, that until a Breach shall occur in the performance of Lessee's obligations, Lessee may collect said Rent. Lessor shall not, by reason of the foregoing or any assignment of such sublease, nor by reason of the collection of Rent, be deemed liable to the sublessee for any failure of Lessee to perform and comply with any of Lessee's obligations to such sublessee. Lessee herby irrevocably authorizes and directs any such sublessee, upon receipt of a written notice from Lessor stating that a Breach exists in the performance of Lessee's obligations under this Lease, to pay to Lessor all Rent due and to become due under the sublease. Sublessee shall rely upon any such notice from Lessor and shall pay all Rents to Lessor without any obligation or right to inquire as to whether such Breach exists, notwithstanding any claim from Lessee to the contrary. (b) In the event of a Breach by Lessee, Lessor may, at its option, require sublessee to attorn to Lessor, in which event Lessor shall undertake the obligations of the sublessor under such sublease from the time of the exercise of said option to the expiration of such sublease; provided, however, Lessor shall not be liable for any prepaid rents or security deposit paid by such sublessee to such sublessor or for any prior Defaults or Breaches of such sublessor. (c) Any matter requiring the consent of the sublessor under a sublease shall also require the consent of Lessor. (d) No sublessee shall further assign or sublet all or any part of the Premises without Lessor's prior written consent. (e) Lessor shall deliver a copy of any notice of Default or Breach by Lessee to the sublessee, who shall have the right to cure the Default of Lessee within the grace period, if any, specified in such notice. The sublessee shall have a right of reimbursement and offset from and against Lessee for any such Defaults cured by the sublessee. 13. Default; Breach; Remedies. 13.1 Default; Breach. A "Default" is defined as a failure by the Lessee to comply with or perform any of the terms, covenants, conditions or rules under this Lease. A "Breach" is defined as the occurrence of one or more of the following Defaults, and the failure of Lessee to cure such Default within any applicable grace period: (a) The abandonment of the Premises; or the vacating of the Premises without providing a commercially reasonable level of security, or where the coverage of the property insurance described in Paragraph 8.3 is jeopardized as a result thereof, or without providing reasonable assurances to minimize potential vandalism. (b) The failure of Lessee to make any payment of Rent or any Security Deposit required to be made by Lessee hereunder, whether to Lessor or to a third party, when due, to provide reasonable evidence of insurance or surety bond, or to fulfill any obligation under this Lease which endangers or threatens life or property, where such failure continues for a period of three (3) business days following written notice to Lessee. (c) The failure by Lessee to provide (i) reasonable written evidence of compliance with Applicable Requirements, (ii) the service contracts, (iii) the rescission of an unauthorized assignment or subletting, (iv) a Tenancy Statement, (v) a requested subordination, (vi) any document requested under Paragraph 42 (easements), or (vii) any other documentation or information which Lessor may reasonably require of Lessee under the terms of this Lease, where any such failure continues for a period of ten (10) days following written notice to Lessee. (d) A Default by Lessee as to the terms, covenants, conditions or provisions of this Lease, or of the rules adopted under Paragraph 40 hereof, other than those described in subparagraphs 13.1(a),(b) or (c), above, where such Default continues for a period of thirty (30) days after written notice; provided, however, that if the nature of Lessee's Default is such that more than thirty (30) days are reasonably required for its cure, then it shall not be deemed to be a Breach if Lessee commences such cure within said thirty (30) day period and thereafter diligently prosecutes such cure to completion. (e) The occurrence of any of the following events; (i) the making of any general arrangement or assignment for the benefit of creditors; (ii) becoming a "debtor" as defined in 11 U.S.C (S) 101 or any successor statute thereto (unless, in the case of a petition filed against Lessee, the same is dismissed within sixty (60) days); (iii) the appointment of a trustee or receiver to take possession of substantially all of Lessee's assets located at the Premises or of Lessee's interest in this Lease, where possession is not restored to Lessee within thirty (30) days; or (iv) the attachment, execution or other judicial seizure of substantially all of Lessee's assets located at the Premises or of Lessee's interest in this Lease, where such seizure is not discharged within thirty (30) days; provided, however, in the event that any provision of this subparagraph 13.1 (e) is contrary to any applicable law, such provision shall be of no force or effect, and not affect the validity of the remaining provisions. (f) The discovery that any financial statement of Lessee given to Lessor was materially false. 13.2 Remedies. If Lessee fails to perform any of its affirmative duties or obligations, within ten (10) days after written notice (or in case of an emergency, without notice), Lessor may, at its option, perform such duty or obligation on Lessee's behalf, including but not limited to the obtaining of reasonably required bonds, insurance policies, or governmental licenses, permits or approvals. The costs and expenses of any such performance by Lessor shall be due and payable by Lessee upon receipt of invoice therefor. If any check given to Lessor by Lessee shall not be honored by the bank upon which it is drawn, Lessor, at its option, may require all future payments to be made by Lessee to be by cashier's check. In the event of a Breach, Lessor may, with or without further notice or demand, and without limiting Lessor in the exercise of any right or remedy which Lessor may have by reason of such Breach: Page 9 of 15 Initials ________ ________ (a) Terminate Lessee's right to possession of the Premises by any lawful means, in which case this Lease shall terminate and Lessee shall immediately surrender possession to Lessor. In such event, Lessor shall be entitled to recover from Lessee: (i) the unpaid Rent which had been named at the time of termination; (ii) the worth at the time of award of the amount by which the unpaid rent which would have been earned after termination until the time of award exceeds the amount of such rental loss that the Lessee proves could have been reasonably avoided; (iii) the worth at the time of award of the amount by which the unpaid rent for the balance of the term after the time of award exceeds the amount of such rental loss that the Lessee proves could be reasonably avoided; and (iv) any other amount necessary to compensate Lessor for all the detriment proximately caused by the Lessee's failure to perform its obligations under this Lease or which in the ordinary course of things would be likely to result therefrom, including but not limited to the cost of recovering possession of the Premises, expenses of reletting including necessary renovation and alteration of the Premises, reasonable attorneys' fees, and that portion of any leasing commission paid by Lessor in connection with this Lease applicable to the unexpired term of this Lease. The worth at the time of award of the amount referred to in provision (iii) of the immediately preceding sentence shall be computed by discounting such amount at the discount rate of the Federal Reserve Bank of the District within which the Premises are located at the time of award plus one percent (1%). Efforts by Lessor to mitigate damages caused by Lessee's Breach of this Lease shall not waive Lessor's right to recover damages under Paragraph 12. If termination of this Lease is obtained through the provisional remedy of unlawful detainer, Lessor shall have the right to recover in such proceeding any unpaid Rent and damages as are recoverable therein, or Lessor may reserve the right to recover all or any part thereof in a separate suit. If a notice and grace period required under Paragraph 13.1 was not previously given, a notice to pay rent or quit, or to perform or quit given to Lessee under the unlawful detainer statute shall also constitute the notice required by Paragraph 13.1. In such case, the applicable grace period required by Paragraph 13.1 and the unlawful detainer statute shall run concurrently, and the failure of Lessee to cure the Default within the greater of the two such grace periods shall constitute both an unlawful detainer and a Breach of this Lease entitling Lessor to remedies provided for in this Lease and/or by said statute. (b) Continue the Lease and Lessee's right to possession and recover the Rent as it becomes due, in which event Lessee may sublet or assign, subject only to reasonable limitations. Acts of maintenance, efforts to relet, and/or the appointment of a receiver to protect the Lessor's interests, shall not constitute a termination of the Lessee's right to possession. (c) Pursue any other remedy now or hereafter available under the laws or judicial decisions of the state wherein the Premises are located. The expiration or termination of the Lease and/or the termination of Lessee's right to possession shall not relieve Lessee from liability under any indemnity provisions of this Lease as to matters occurring or accruing during the term hereof or by reason of Lessee's occupancy of the Premises. 13.4 Late Charges. Lessee hereby acknowledges that late payment by Lessee of Rent will cause the Lessor to incur costs not contemplated by this Lease, the exact amount of which will be extremely difficult to ascertain. Such costs include, but are not limited to, processing and accounting charges, and late charges which may be imposed upon Lessor by any Lender. Accordingly, if any Rent shall not be received by Lessor within five (5) days after such amount shall be due, then, without any requirement for notice to Lessee, Lessee shall pay to Lessor a one-time late charge equal to ten percent (10%) of each such overdue amount. The Parties hereby agree that such late charge represents a fair and reasonable estimate of the costs Lessor will incur by reason of such late payment. Acceptance of such late charge by Lessor shall in no event constitute a waiver of Lessee's Default or Breach with respect to such overdue amount, nor prevent the exercise of any of the other rights and remedies granted hereunder. In the event that a late charge is payable hereunder, whether or not collected, for three (3) consecutive installments of Base Rent, then notwithstanding any provision of this Lease to the contrary, Base Rent shall, at Lessor's option, become due and payable quarterly in advance. 13.5 Interest. Any monetary payment due Lessor hereunder, other than late charges, not received by Lessor, when due as to scheduled payments (such as Base Rent) or within thirty (30) days following the date on which it was due for non- scheduled payment, shall bear interest from the date when due, as to scheduled payments, or the thirty-first (31st) day after it was due as to non-scheduled payments. The interest ("Interest") charged shall be equal to the prime rate reported in the Wall Street Journal as published closest prior to the date when due plus four percent (4%), but shall not exceed the maximum rate allowed by law. Interest is payable in addition to the potential late charge provided for in Paragraph 13.4. 13.6 Breach by Lessor. (a) Notice of Breach. Lessor shall not be deemed in breach of this Lease unless Lessor fails within a reasonable time to perform an obligation required to be performed by Lessor. For purposes of this Paragraph, a reasonable time shall in no event be less than thirty (30) days after receipt by Lessor, and any Lender whose name and address shall have been furnished Lessee in writing for such purpose, of written notice specifying wherein such obligation of Lessor has not been performed; provided, however, that if the nature of Lessor's obligation is such that more than thirty (30) days are reasonably required for its performance, then Lessor shall not be in breach if performance is commenced within such thirty (30) day period and thereafter diligently pursued to completion. (b) Performance of Lessee on Behalf of Lessor. In the event that neither Lessor nor Lender cures said breach within thirty (30) days after receipt of said notice, or if having commenced said cure they do not diligently pursue it to completion, the Lessee may elect to cure said breach at Lessee's expense and offset from Rent an amount equal to the greater of one month's Base Rent or the Security Deposit, and to pay an excess of such expense under protest, reserving Lessee's right to reimbursement from Lessor, Lessee shall document the cost of said cure and supply said documentation to Lessor. 14. Condemnation. If the Premises or any portion thereof are taken under the power of eminent domain or sold under the threat of the exercise of said power (collectively "Condemnation"), the Lease shall terminate as to the part taken as of the date the condemning authority takes title or possession, whichever first occurs. If more than ten percent (10%) of any building portion of the Premises, or more than twenty-five percent (25%) of the land area portion of the Premises not occupied by any building, is taken by Condemnation, Lessee may, at Lessee's option, to be exercised in writing within ten (10) days after Lessor shall have given Lessee written notice of such taking (or in the absence of such notice, within ten (10) days after condemning authority shall have taken possession) terminate this Lease as of the date the condemning authority takes such possession. If Lessee does not terminate this Lease in accordance with the foregoing, this Lease shall remain in full force and effect as to the portion of the Premises remaining, except that the Base Rent shall be reduced in proportion to the reduction in utility of the Premises caused by such Condemnation. Condemnation awards and/or payments shall be the property of Lessor, whether such award shall be made as compensation for diminution in value of the leasehold, the value of the part taken, or for severance damages; provided, however, that Lessee shall be entitled to any Page 10 of 15 Initials________ (c)1997 - American Industrial Real Estate Association REVISED FORM STN-6-2/97E
compensation for Lessee's relocation expenses, loss of business goodwill and/or Trade Fixtures, without regard to whether or not this Lease is terminated pursuant to the provisions of this Paragraph. All Alterations and Utility Installations made to the Premises by Lessee, for purposes of Condemnation only, shall be considered the property of the Lessee and Lessee shall be entitled to any and all compensation which is payable therefor. In the event that this Lease is not terminated by reason of the Condemnation, Lessor shall repair any damage to the Premises caused by such Condemnation. 15. Brokers' Fee. None. See Addendum (P)52. 16. Estoppel Certificates. (a) Each Party (as "Responding Party") shall within ten (10) days after written notice from the other Party (the "Requesting Party") execute, acknowledge and deliver to the Requesting Party a statement in writing in form similar to the then most current "Estoppel Certificate" form published by the American Industrial Real Estate Association, plus such additional information, confirmation and/or statements as may be reasonably requested by the Requesting Party. (b) If the Responding Party shall fail to execute or deliver the Estoppel Certificate within such ten day period, the Requesting Party may execute an Estoppel Certificate stating that: (i) the Lease is in full force and effect without modification except as may be represented by the Requesting Party, (ii) there are no uncured defaults in the Requesting Party's performance, and (iii) if Lessor is the Requesting Party, not more than one month's Rent has been paid in advance. Prospective purchasers and encumbrancers may rely upon the Requesting Party's Estoppel Certificate, and the Responding Party shall be estopped from denying the truth of the facts contained in said Certificate. (c) If Lessor desires to finance, refinance, or sell the Premises, or any part thereof, Lessee and all Guarantors shall deliver to any potential lender or purchaser designated by Lessor such financial statements as may be reasonably required by such lender of purchaser, including, but not limited to, Lessee's financial statements for the past three (3) years. All such financial statements shall be received by Lessor and such lender or purchaser in confidence and shall be used only for the purposes herein set forth. 17. Definition of Lessor. The term "Lessor" as used herein shall mean the owner or owners at the time in question of the fee title to the Premises, or, if this is a sublease, of the Lessee's interest in the prior lease. In the event of a transfer of Lessor's title or interest in the Premises or this Lease, Lessor shall deliver to the transferee or assignee (in cash or by credit) any unused Security Deposit held by Lessor. Except as provided in Paragraph 15, upon such transfer or assignment and delivery of the Security Deposit, as aforesaid, the prior Lessor shall be relieved of all liability with respect to the obligations and/or covenants under this Lease thereafter to be performed by the Lessor. Subject to the foregoing, the obligations and/or covenants in this Lease to be performed by the Lessor shall be binding only upon the Lessor as hereinabove defined. Notwithstanding the above, and subject to the provisions of Paragraph 20 below, the original Lessor under this Lease, and all subsequent holders of the Lessor's interest in this Lease shall remain liable and responsible with regard to the potential duties and liabilities of Lessor pertaining to Hazardous Substances as outlined in Paragraph 6 above. 18. Severability. The invalidity of any provision of this Lease, as determined by a court of competent jurisdiction, shall in no way affect the validity of any other provision hereof. 19. Days. Unless otherwise specifically indicated to the contrary, the word "days" as used in this Lease shall mean and refer to calendar days. 20. Limitation on Liability. Subject to the provisions of Paragraph 17 above, the obligations of Lessor under this Lease shall not constitute personal obligations of Lessor, the individual partners of Lessor or its or their individual partners, directors, officers or shareholders, and Lessee shall look to the Premises, and to no other assets of Lessor, for the satisfaction of any liability of Lessor with respect to this Lease, and shall not seek recourse against the individual partners of Lessor, or its or their individual partners, directors, officers or shareholders, or any of their personal assets for such satisfaction. 21. Time of Essence. Time is of the essence with respect to the performance of all obligations to be performed or observed by the Parties under this Lease. 22. No Prior or Other Agreements. This Lease contains all agreements between the Parties with respect to an matter mentioned herein, and no other prior or contemporaneous agreement or understanding shall be effective. Lessor and Lessee each represents and warrants to the Brokers that it has made, and is relying solely upon, its own investigation as to the nature, quality, character and financial responsibility of the other Party to this Lease and as to the nature, quality and character of the Premises. 23. Notices. 23.1 Notice Requirements. All notices required or permitted by this Lease shall be in writing and may be delivered in person (by hand or by courier) or may be sent by regular, certified or registered mail or U.S. Postal Service Express Mail, with postage prepaid, or by facsimile transmission, and shall be deemed sufficiently given if served in a manner specified in this Paragraph 23. The addresses noted adjacent to a Party's signature on this Lease shall be that Party's address for delivery or mailing of notices. Either Party may by written notice to the other specify a different address for notice, except that upon Lessee's taking Page 11 of 16 Initials________ (c)1997 . American Industrial Real Estate Association REVISED FORM STN-6-2/97E
possession of the Premises, the Premises shall constitute Lessee's address for notice. A copy of all notices to Lessor shall be concurrently transmitted to such party or parties at such addresses as Lessor may from time to time hereafter designate in writing. 23.2 Date of Notice. Any notice sent by registered or certified mail, return receipt requested, shall be deemed given on the date of delivery shown on the receipt card, or if no delivery date is shown, the postmark thereon. If sent by regular mail the notice shall be deemed given forty-eight (48) hours after the same is addressed as required herein and mailed with postage prepaid. Notices delivered by United States Express Mail or overnight courier that guarantee next day delivery shall be deemed given twenty-four (24) hours after delivery of the same to the Postal Service or courier. Notices transmitted by facsimile transmission or similar means shall be deemed delivered upon telephone confirmation of receipt. provided a copy is also delivered via delivery or mail. If notice is received on a Saturday, Sunday or legal holiday, it shall be deemed received on the next business day. 24. Waivers. No waiver by Lessor of the Default or Breach of any term, covenant or condition hereof by Lessee, shall be deemed a waiver of any other term covenant or condition hereof, or of any subsequent Default or Breach by Lessee of the same or of any other term, covenant or condition hereof. Lessor's consent to or approval of, any act shall not be deemed to render unnecessary the obtaining of Lessor's consent to, or approval of, any subsequent or similar act by Lessee, or be construed as the basis of an estoppel to enforce the provision of provisions of this Lease requiring such consent. The acceptance of Rent by Lessor shall not be a waiver of any Default or Breach of Lessee. Any payment by Lessee may be accepted by Lessor on account of monies of damages due Lessor, notwithstanding any qualifying statements or conditions made by Lessee in connection therewith, which such statements and/or conditions shall be of no force or effect whatsoever unless specifically agreed to in writing by Lessor at or before the time of deposit of such payment. 25. Recording. Either Lessor Lessee shall, upon request of the other, execute, acknowledge and deliver to the other a short form memorandum of this Lease for recording purposes. The Party requesting recordation shall be responsible for payment of any fees applicable thereto. 26. No Right to Holdover. Lessee has no right to retain possession of the Premises or any part thereof beyond the expiration or termination of this Lease. In the event that Lessee holds over, then the Base Rent shall be increased to one hundred fifty percent (150%) of the Base Rent applicable during the month immediately preceding the expiration or termination. Nothing contained herein shall be construed as consent by Lessor to any holding over by Lessee. 27. Cumulative Remedies. No remedy or election hereunder shall be deemed exclusive but shall, wherever possible, be cumulative with all other remedies at law or in equity. 28. Covenants and Conditions; Construction of Agreement. All provisions of this Lease to be observed or performed by Lessee are both covenants and conditions. In constructing this Lease, all headings and titles are for the convenience of the Parties only and shall not be considered a part of this Lease. Whenever required by the context, the singular shall include the plural and vice versa. This lease shall not be construed as if prepared by one of the Parties, but rather according to its fair meaning as a whole, as if both Parties had prepared it. 29. Binding Effect; Choice of Law. This Lease shall be binding upon the Parties, their personal representatives, successors and assigns and be governed by the laws of the State in which the Premises are located. Any litigation between the Parties hereto concerning this Lease shall be initiated in the county in which the Premises are located. 30. Subordination; Attornment; Non-Disturbance. 30.1 Subordination. This Lease and any Options granted hereby shall be subject and subordinate to any ground lease, mortgage, deed of trust, or other hypothecation or security device (collectively, "Security Device"), now or hereafter placed upon the Premises, to any and all advances made on the security thereof, and to all renewals, modifications, and extensions thereof. Lessees agrees that the holders of any such Security Devices (in this Lease together referred to as "Lessor's Lender") shall have no liability or obligation to perform any of the obligations of Lessor under this Lease. Any Lender may elect to have this Lease and/or any Option granted hereby superior to the lien of its Security Device by giving written notice thereof to Lessee, whereupon this Lease and such Options shall be deemed prior to such Security Device, notwithstanding the relative date of the documentation or recordation thereof. 30.2 Attornment. Subject to the non-disturbance provisions of Paragraph 30.3, Lessee agrees to attorn to a Lender or any other party who acquires ownership of the Premises by reason of a foreclosure of a Security Device, and for any act or omission or any prior lessor or with respect to the events occurring prior to the acquisition of ownership; (ii) be subject to any offsets of defenses which Lessee might have against any prior lessor; of (iii) be bound by prepayment of more than one (1) month's rent. 30.3 Non-Disturbance. With respect to Security Devices entered into by Lessor and after the execution of this Lease, Lessee's subordination of this Lease shall be subject to receiving a commercially reasonable non-disturbance agreement (a "Non-Disturbance Agreement") from the Lender which Non-Disturbance Agreement provides that Lessee's possession of the Premises, and this Lease, including any options to extend the term hereof, will not be disturbed so long as Lessee is not in Breach hereof and attorns to the record owner of the Premises. Further, within sixty days (60) after the execution of this Lease, Lessor shall use its commercially reasonable efforts to obtain a Non-Disturbance Agreement from the holder of any pre-existing Security Device which is secured by the Premises. In the event that the Lessor is unable to provide the Non- Disturbance Agreement within sixty (60) days, then Lessee may, at Lessee's option directly contact Lessor's lender and attempt to negotiate for the execution and delivery of a Non-Disturbance Agreement. 30.4 Self-Executing. The agreements contained in this Paragraph 30 shall be effective without the execution of any further documents; provided, however, that, upon written request from Lessor or a Lender in connection with a sale, financing or refinancing of the Premises, Lessee and Lessor shall execute such further writings as may be reasonably required to separately document any subordination, attornment and/or Non-Disturbance Agreement provided for herein. 31. Attorneys Fees. If any Party brings an action or proceeding involving the Premises to enforce the terms hereof or to declare rights hereunder, the Prevailing Party (as hereafter defined) in any such proceeding, action or appeal thereon, shall be entitled to reasonable attorneys' fees. Such fees may be awarded in the same suit or recovered in a separate suit, whether or not such action or proceeding is pursued to decision or judgment. The term, "Prevailing Party" shall include, without limitation, a Party who substantially obtains or defeats the relief sought, as the case may be, whether by compromise, settlement, judgement, or the abandonment by the other Party of its claim of defenses. The attorneys' fees shall not be computed in accordance with any court fee schedule, but shall be such as to fully reimburse all attorneys' fees reasonably incurred. In addition, Lessor shall be entitled to attorneys' fees, costs and expenses incurred in the preparation and service of notices of Default and consultations in connection therewith, whether or not a legal action is subsequently commenced in connection with such Default or resulting Breach. 32. Lessor's Access; Showing Premises; Repairs. Lessor and Lessee's agents shall have the right to enter the Premises at any time, in the case of an emergency, and otherwise at reasonable times for the purpose of showing the same to prospective purchasers, lenders, or lessees, and making such alterations, repairs, improvements or additions to the Premises as Lessor may deem necessary. All such activities shall be without abatement of rent or liability to Lessee. Lessor may at any time place on the Premises any ordinary "For Sale" signs and Lessor may during the last six (6) months of the term hereof place on the Premises any ordinary "For Lease" signs. Lessee may at any time place on or about the Premises any ordinary "For Sublease" sign. 33. Auctions. Lessee shall not conduct, nor permit to be conducted, any auction upon the Premises without the Lessor's prior written consent. Lessor shall not Page 12 of 15 Initials________ (c)1997 - American Industrial Real Estate Association REVISED FORM STN-6-2/97E
be obligated to exercise any standard of reasonableness in determining whether to permit an auction. 34. Signs. Except for ordinary "For Sublease" signs, Lessee shall not place any sign upon the Premises with Lessor's prior written consent. All signs must comply with all Applicable Requirements. 35. Termination; Merger. Unless specifically stated otherwise in writing by Lessor, the voluntary or other surrender of this Lease by Lessee, the mutual termination or cancellation hereof, or a termination hereof by Lessor for Breach by Lessee, shall automatically terminate any sublease or lesser estate in the Premises; provided, however, that Lessor may elect to continue any one or all existing subtenancies. Lessor's failure within ten (10) days following any such event to elect to the contrary by written notice to the holder of any such lesser interest, shall constitute Lessor's election to have such event constitute the termination of such interest. 36. Consents. Except as otherwise provided herein, wherever in this Lease the consent of a party is required to an act by or for the other Party, such consent shall not be unreasonably withheld or delayed. Lessor's actual reasonable costs and expenses (including, but not limited to, architects', attorneys', engineers' and other consultants' fees) incurred in the consideration of, or response to, a request by Lessee for any Lessor consent, including, but not limited to, consents to an assignment, a subletting or the presence or use of a Hazardous Substance, shall be paid by Lessee upon receipt of an invoice and supporting documentation therefor. Lessor's consent to any act, assignment or subletting shall not constitute an acknowledgement that no Default or Breach by Lessee of this Lease exists, nor shall such consent be deemed a waiver of any then existing Default or Breach, except as may be otherwise specifically stated in writing by Lessor at the time of such consent. The failure to specify herein any particular condition to Lessor's consent shall not preclude the imposition by Lessor at the time of consent of such further or other conditions as are then reasonable with reference to the particular matter for which consent is being given. In the event that either Party disagrees with any determination made by the other hereunder and reasonably requests the reasons for such determination, the determining party shall furnish its reasons in writing and in reasonable detail within ten (10) business days following such request. 38. Quiet Possession. Subject to payment by Lessee of the Rent and performance of all of the covenants, conditions and provisions on Lessee's part to by observed and performed under this Lease, Lessee shall have quiet possession and quiet enjoyment of the Premises during the term hereof. 39. Options. See Addendum (P)53. 39.1 Definition. "Option" shall mean: (a) the right to extend the term of this Lease. 39.3 Multiple Options. In the event that Lessee has any multiple Options to extend or renew this Lease, a later Option cannot be exercised unless the prior Options have been validly exercised. 39.4 Effect of Default on Options. (a) Lessee shall have no right to exercise an Option: (i) during the period commencing with the giving of any notice of Default and continuing until said Default is cured, (ii) during the period of time any Rent is unpaid (without regard to whether notice thereof is given Lessee), (iii) during the time Lessee is in Breach of this Lease, or (iv) in the event that Lessee has been given three (3) or more notices of separate Default, whether or not the Defaults are cured, during the twelve (12) month period immediately preceding the exercise of the Option. (b) The period of time within which an Option may be exercised shall not be extended or enlarged by reason of Lessee's inability to exercise an Option because of the provisions of Paragraph 39.4(a). (c) An Option shall terminate and be of no further force or effect, notwithstanding Lessee's due and timely exercise of the Option, if, after such exercise and prior to the commencement of the extended term, (i) Lessee fails to pay Rent for a period of thirty (30) days after such Rent becomes due (without any necessity of Lessor to give notice thereof), (ii) Lessor gives to Lessee three (3) or more notices of separate Default during any twelve (12) month period, whether or not the Defaults are cured, or (iii) if Lessee commits a Breach of this Lease. 40. Multiple Buildings. If the Premises are a part of a group of buildings controlled by Lessor, Lessee agrees that it will observe all reasonable rules and regulations which Lessor may make from time to time for the management, safety, and care of said properties, including the care and cleanliness of the grounds and including the parking, loading and unloading of vehicles, and that Lessee will pay its fair share of common expenses incurred in connection therewith. 41. Security Measures. Lessee hereby acknowledges that the rental payable to Lessor hereunder does not include the cost of guard service or other security measures, and that Lessor shall have no obligation whatsoever to provide same. Lessee assumes all responsibility for the protection of the Premises, Lessee, its agents and invitees and their property from the acts of third parties. 42. Reservations. Lessor reserves to itself the right, from time to time, to grant, without the consent or joinder of Lessee, such easements, rights and indications that Lessor deems necessary, and to cause the recordation of parcel maps and restrictions, so long as such easements, rights, dedications, maps and restrictions do not unreasonable interfere with the use of the Premises by Lessee. Lessee agrees to sign any documents reasonable requested by Lessor to effectuate any such easement rights, dedication, map or restrictions. 43. Performance Under Protest. If at any time a dispute shall arise as to any amount or sum of money to be paid by one Party to the other under the provisions hereof, the Party against whom the obligation to pay the money is asserted shall have the right to may payment "under protest" and such payment shall not be regarded as a voluntary payment and there shall survive the right on the part of said Party to institute suit for recovery of such sum. If it shall be adjudged that there was no legal obligation on the part of said Party to pay such sum or any part thereof, said Party shall be entitled to recover such sum or so much thereof as it was not legally required to pay. 44. Authority. If either Party hereto is a corporation, trust, limited liability company, partnership, or similar entity, each individual executing this Lease on behalf of such entity represents and warrants that he or she is duly authorized to execute and deliver this Lease on its behalf. Each Party shall, within thirty (30) days Page 13 of 16 Initials____________ (c) . American Industrial Real Estate Association REVISED FORM STN-6-2/97E
after request, deliver to the other Party satisfactory evidence of such authority. 45. Conflict. Any conflict between the printed provisions of this Lease and the typewritten or handwritten provisions shall be controlled by the typewritten or handwritten provisions. 46. Offer. Preparation of this Lease by either Party or their agent and submission of same to the other Party shall not be deemed an offer to lease to the other Party. This Lease is not intended to be binding until executed and delivered by all Parties hereto. 47. Amendments. This Lease may be modified only in writing, signed by the Parties in interest at the time of the modification. As long as they do not materially change Lessee's obligations hereunder, Lessee agrees to make such reasonable non-monetary modifications to this Lease as may be reasonably required by a Lender in connection with the obtaining of normal financing or refinancing of the Premises. 48. Multiple Parties. If more than one person or entity is named herein as either Lessor or Lessee, such multiple Parties shall have joint and several responsibility to comply with the terms of this Lease. 49. Mediation and Arbitration of Disputes. An Addendum requiring the Mediation and/or the Arbitration of all disputes between the Parties arising out of this Lease [ ] is [X] is not attached to this Lease. LESSOR AND LESSEE HAVE CAREFULLY READ AND REVIEWED THIS LEASE AND EACH TERM AND PROVISION CONTAINED HEREIN, AND BY THE EXECUTION OF THIS LEASE SHOW THEIR INFORMED AND VOLUNTARY CONSENT THERETO. THE PARTIES HEREBY AGREE THAT, AT THE TIME THIS LEASE IS EXECUTED, THE TERMS OF THIS LEASE ARE COMMERCIALLY REASONABLE AND EFFECTUATE THE INTENT AND PURPOSE OF LESSOR AND LESSEE WITH RESPECT TO THE PREMISES. - -------------------------------------------------------------------------------- ATTENTION: NO REPRESENTATION OR RECOMMENDATION IS MADE BY THE AMERICAN INDUSTRIAL REAL ESTATE ASSOCIATION OR BY ANY BROKER AS TO THE LEGAL SUFFICIENCY, LEGAL EFFECT, OR TAX CONSEQUENCES OF THIS LEASE OR THE TRANSACTION TO WHICH IT RELATES. THE PARTIES ARE URGED TO: 1. SEEK ADVICE OF COUNSEL AS TO THE LEGAL AND TAX CONSEQUENCES OF THIS LEASE. 2. RETAIN APPROPRIATE CONSULTANTS TO REVIEW AND INVESTIGATE THE CONDITION OF THE PREMISES. SAID INVESTIGATION SHOULD INCLUDE BUT NOT BE LIMITED TO: THE POSSIBLE PRESENCE OF HAZARDOUS SUBSTANCES, THE ZONING OF THE PREMISES, THE STRUCTURAL INTEGRITY, THE CONDITION OF THE ROOF AND OPERATING SYSTEMS, AND THE SUITABILITY OF THE PREMISES FOR LESSEE'S INTENDED USE. WARNING: IF THE PREMISES IS LOCATED IN A STATE OTHER THAN CALIFORNIA, CERTAIN PROVISIONS OF THE LEASE MAY NEED TO BE REVISED TO COMPLY WITH THE LAWS OF THE STATE IN WHICH THE PREMISES IS LOCATED. - -------------------------------------------------------------------------------- The parties hereto have executed this Lease at the place and on the dates specified above their respective signatures. Executed at: 24811 Avenue Rockefeller, Executed at: 24811 Avenue Rockefeller, Valencia, CA Valencia, CA on: on: ----------------------------------- ----------------------------------- By LESSOR: By LESSEE: 24811 AVENUE ROCKEFELLER, LLC, FUTURE MEDIA PRODUCTIONS, a California - -------------------------------------- -------------------------------------- a Delaware limited liability company corporation - -------------------------------------- -------------------------------------- By: /s/ Alex Sandel By: [signature illegible] ----------------------------------- ----------------------------------- Name Printed: Alex Sandel Name Printed: ------------------------- ------------------------- Title: Manager Title: -------------------------------- -------------------------------- By: By: ----------------------------------- ----------------------------------- Name Printed: Name Printed: ------------------------- ------------------------- Title: Title: -------------------------------- -------------------------------- Page 14 of 15 Initials (c)1997 - American Industrial REVISED ------ ------- Real Estate Association FORM STN-6-2/97E Address: Address: ------------------------------- ------------------------------- ------------------------------- ------------------------------- Telephone: ( ) Telephone: ( ) ----------------------------- ----------------------------- Facsimile: ( ) Facsimile: ( ) ----------------------------- ----------------------------- Federal ID No. Federal ID No. ------------------------- ------------------------- NOTE: These forms are often modified to meet the changing requirements of law and industry needs. Always write or call to make sure you are utilizing the most current form: AMERICAN INDUSTRIAL REAL ESTATE ASSOCIATION, 700 So. Flower Street, Suite 600, Los Angeles, California 90017. (213) 687- 8777. Fax No. (213) 687-8616. Page 15 of 15 (c) 1997 - American Industrial REVISED FORM STN-6-2/97E Real Estate Association ADDENDUM TO STANDARD INDUSTRIAL/COMMERCIAL SINGLE-TENANT LEASE - NET BY AND BETWEEN 24811 AVENUE ROCKEFELLER, LLC, A DELAWARE LIMITED LIABILITY COMPANY ("LESSOR"), AND FUTURE MEDIA PRODUCTION, A CALIFORNIA CORPORATION ("LESSEE") Dated For Reference Purposes Only, March 1, 2000 50. Base Rent: "Fair Market Rental". Subject to the provisions of Paragraph 51 hereof, the Base Rent payable hereunder shall be $53,842.75 ($.65 X 82,835 square feet) per month, payable on the 1st day of each month, commencing on March 1, 2000 and continuing through and including February 28, 2005. Commencing on March 1, 2005 (the "First Adjustment Date") and again on March 1, 2010 (the "Second Adjustment Date"), the monthly rental shall be adjusted to the then "Fair Market Rental" (as such term is defined in Paragraph 53(a) hereof) for the Premises, as determined pursuant to Paragraph 53(c) hereof. Subject to the provisions of Paragraph 51 hereof, the Fair Market Rental, as so determined, shall become the new Base Rent for the Premises for the 60-month period following the First Adjustment Date, beginning on March 1, 2005 and continuing through and including February 28, 2010, and for the remainder of the Original Term following the Second Adjustment Date, beginning on March 1, 2010 and continuing through and including February 28, 2013. Following the expiration of the Original Term, if Lessee exercises one or both Options pursuant to Paragraph 53 hereof, subject to the provisions of Paragraph 51 hereof, the Base Rent payable during each "Option Term" (as such term is hereinafter defined) will be the Fair Market Rental for the Premises determined as of the first day of the applicable Option Term. 51. Rental Increases tied to Changes in the Consumer Price Index. Beginning on March 1, 2001 and on March 1 of each succeeding year during the Original Term (except March 1, 2005 and March 1, 2010) and beginning on March 1 of the second year of each Option Term, the Base Rent, as determined pursuant to Paragraph 50 hereof, shall be increased (but shall not decrease) by the percentage increase in the "CPI" (as such term is hereinafter defined) for the 12 month period ending one month before each such March 1 date. The increased monthly rent shall become the new Base Rent for purposes of determining the increased monthly rental amount for the following 12 month period. The term "CPI" means the Consumer Price Index of the Bureau of Labor Statistics of the U.S. Department of Labor for All Urban Consumers for Los Angeles-Riverside- Orange County, All Items (1982-1984 = 100). The provisions of this Paragraph 51 shall not apply during the first 12 months following the adjustment of the monthly rental to the then Fair Market Rental for the Premises on the First Adjustment Date and the Second Adjustment Date. 52. Brokers. Lessee warrants and represents that it has not had any contact or dealings with any real estate broker, finder or other person which would give rise to the obligation to pay any brokerage commission or other fee in connection with the Lease, and Lessee hereby indemnifies, holds harmless and agrees to defend Lessor from and against any liability with respect to any brokerage commission or fee arising out of any act or omission of Lessee, including attorney's fees and costs. 53. Option to Extend Lease. (a) Option to Extend Lease. Lessor hereby grants to Lessee the right and option (the "Option") to renew the Lease upon its termination for 2 additional periods of 5 years each, with the term for the first Option beginning on the day following the expiration of the Original Term (each Option period being an "Option Term"), and with the term for the second Option beginning on the day following the expiration of the first Option Term, at the fair market rental for properties similar in quality and character to the Premises (the "Fair Market Rental") (as determined pursuant to Paragraph 53(c) hereof). The Option shall be effective as of the date hereof (the "Effective Date"). (b) Exercise of Option. Provided (i) the Option has not otherwise expired or terminated as provided herein and (ii) Lessee is not then in default under the Lease, the Option shall be exercised by Lessee providing Lessor written notice of its unconditional and irrevocable exercise of the Option (the "Notice"), at any time within 9 months, but no later than 6 months prior to the expiration of the initial term (or, if applicable, within said time period prior to the expiration of the first Option Term). If the Option is not exercised after the last date to do so as provided in the foregoing sentence, the Option shall expire and terminate and be of no further force or effect. If the Option shall terminate with respect to the first Option Term, it shall also terminate and be of no further force or effect with respect to the second Option Term. Time is of the essence of the Option and this entire Paragraph 53. (c) Determination of Fair Market Rental. The Fair Market Rental for the Premises shall be as mutually agreed between the parties. In the event Lessor and Lessee shall disagree as to the determination of the Fair Market Rental for the Premises for either Option Term, such dispute shall be settled by an arbitrator mutually selected by Lessor and Lessee and shall be conducted in accordance with the rules existing at the date thereof of the American Arbitration Association. The dispute shall be submitted to a single arbitrator, who shall have had at lease 10 years' experience in connection with matters such as fair market rental determinations of commercial property located in Los Angeles, California. Lessor and Lessee shall share equally the cost of such arbitrator's fees and expenses. Judgment may be entered on any award rendered by the arbitrator -2- in any federal or state court having jurisdiction. If the arbitrator determines that there is a "prevailing party" in any arbitration under the Lease, that party shall be awarded reasonable attorneys' fees and costs in connection with that arbitration, as determined by the arbitrator. Lessor and Lessee shall accept as final the Fair Market Rental as determined by the arbitrator. (d) Termination of Option. Lessee agrees to execute, acknowledge and deliver to Lessor a quitclaim deed to the Premises, if requested by Lessor, upon expiration or termination of the Option as provided in the Lease. -3- EX-23.2 6 0006.txt CONSENT OF ERNST & YOUNG LLP EXHIBIT 23.2 CONSENT OF INDEPENDENT AUDITORS We consent to the reference to our firm under the caption "Experts" and to the use of our reports dated February 25, 2000 except for Note 11, as to which the date is April 13, 2000 in Amendment No. 2 to the Registration Statement (Form S-1 333-32444) and related Prospectus of Future Media Productions, Inc. for the registration of 5,962,962 shares of its common stock. /s/ Ernst & Young LLP Los Angeles, California June 7, 2000 EX-23.3 7 0007.txt CONSENT OF INFOTECH EXHIBIT 23.3 [LETTERHEAD OF INFOTECH, INCORPORATED] MEMO TO: Ted Fundoukos, Prudential Securities Via Fax: 1.310.728.2200 FROM: Julie B. Schwerin, InfoTech This letter serves as permission for Prudential Securities Incorporated to make reference to InfoTech and to use data provided by InfoTech in a Registration Statement No. 333-32444 filed with the SEC on behalf of Future Media Productions, Inc. We understand and hereby provide our permission for the use of our name and data to be included in the Registration Statement No. 333-32444 provided that the following stipulations are met: 1. Please note that the client and Prudential Securities Incorporated are responsible for the accurate application of any InfoTech time-series data and the attachment of InfoTech data to its source and copyright in any subsequent publication. No other party is authorized to reprint in part or total. 2. InfoTech time-series data delivered to clients may not be incorporated into a document sold or underwritten for its content value except under fair use as provided in copyright law. 3. To ensure the accuracy of information in fast-changing times, InfoTech time-series data may not be introduced into a publication more than 18 months after release by InfoTech. Please rely on us for any additional clarification with regard to the application or interpretation of InfoTech time-series data in valuing business properties. We appreciate the opportunity to be of service and wish you every success. /s/ Julir B. Schwerin EX-27.1 8 0008.txt FINANCIAL DATA SCHEDULE
5 1,000 3-MOS 3-MOS DEC-31-1999 DEC-31-2000 JAN-01-1999 JAN-01-2000 MAR-31-1999 MAR-31-2000 0 0 0 0 7,468 4,147 266 296 767 877 8,253 5,020 41,231 47,418 11,394 12,543 41,089 45,503 16,165 20,161 0 0 0 0 0 0 3,790 3,790 15,679 14,027 41,089 45,503 8,675 14,780 8,675 14,780 5,865 9,342 5,865 9,342 1,072 1,594 0 155 351 399 1,387 3,299 1 1 1,386 3,298 0 0 0 0 0 0 1,386 3,298 .09 .22 .09 .20
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