-----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, LyXu7amVzt5gSzxV4MLpZCYbIkAbNxTyV25qH78ooxsYXB0XgABY/nNynh2L2DOk MCSQ8/a+WDGAcb3rLJEQ5Q== 0001185185-02-000042.txt : 20021114 0001185185-02-000042.hdr.sgml : 20021114 20021114144649 ACCESSION NUMBER: 0001185185-02-000042 CONFORMED SUBMISSION TYPE: 10QSB PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20020930 FILED AS OF DATE: 20021114 FILER: COMPANY DATA: COMPANY CONFORMED NAME: 2KSOUNDS CORP CENTRAL INDEX KEY: 0001094767 STANDARD INDUSTRIAL CLASSIFICATION: BLANK CHECKS [6770] IRS NUMBER: 760616474 STATE OF INCORPORATION: NV FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10QSB SEC ACT: 1934 Act SEC FILE NUMBER: 000-32229 FILM NUMBER: 02824479 BUSINESS ADDRESS: STREET 1: 21700 OXNARD STREET STREET 2: SUITE 1030 CITY: WOODLAND HILLS STATE: CA ZIP: 91367 MAIL ADDRESS: STREET 1: 21700 OXNARD STREET STREET 2: SUITE 1030 CITY: WOODLAND HILLS STATE: CA ZIP: 91367 FORMER COMPANY: FORMER CONFORMED NAME: TEXAS E SOLUTIONS INC DATE OF NAME CHANGE: 20010103 FORMER COMPANY: FORMER CONFORMED NAME: WIRELESS SYNERGIES INC DATE OF NAME CHANGE: 20020403 10QSB 1 twok10q093002.txt 2K 10QSB 09-30-02 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 FORM 10-QSB _____________________________ (Mark One) (X) Quarterly Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended September 30, 2002 ( ) Transition Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from ___________ to _____________ Commission File Number: 000-32229 2KSounds Corporation -------------------- (Exact name of small business issuer as specified in its charter) Nevada 76-0616474 - ------------------------------------------------ ------------------------------ (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 21700 Oxnard Street, Suite 1030 Woodland Hills, California 91367 - ------------------------------------------------ ------------------------------ (Address of principal executive offices) Zip Code Issuer's telephone number (818) 593-2225 - ------------------------------------------------ ------------------------------ -------------------------------------- (Former name, former address and former fiscal year, if changed since last report) APPLICABLE ONLY TO CORPORATE ISSUERS The number of shares outstanding of the issuer's common stock as of November 13, 2002 was 376,188,138. 2KSOUNDS CORPORATION AND SUBSIDIARIES QUARTERLY REPORT ON FORM 10-QSB TABLE OF CONTENTS Page Number PART I. FINANCIAL INFORMATION Item 1. Financial Statements (unaudited): Consolidated Balance Sheet as of September 30, 2002 .............1 Consolidated Statements of Operations for the three and nine months ended September 30, 2002 and September 30, 2001 ..........2 Consolidated Statements of Cash Flows for the nine months ended September 30, 2002 and September 30, 2001 .................3 Notes to Consolidated Financial Statements.......................4 Item 2. Management's Discussion and Analysis or Plan of Operation.......13 Item 3. Controls and Procedures.........................................16 PART II. OTHER INFORMATION Item 1. Legal Proceedings...............................................25 Item 2. Changes in Securities...........................................25 Item 3. Defaults Upon Senior Securities.................................25 Item 4. Submission of Matters to a Vote of Securities Holders...........25 Item 5. Other Information...............................................25 Item 6. Exhibits and Reports on Form 8-K................................26 Signatures......................................................27 Certifications..................................................28 i PART I FINANCIAL INFORMATION ITEM 1 Financial Statements 2KSOUNDS CORPORATION AND SUBSIDIARIES Consolidated Balance Sheet September 30, 2002 (Unaudited) ------------------ ASSETS Current assets: Cash and cash equivalents $1,098,831 Accounts and other receivables 41,524 Inventories 26,910 ------------------ Total current assets 1,167,265 ------------------ Property and equipment, net of accumulated depreciation of $326,742 510,280 ------------------ Other assets: Capitalized master recordings 300,000 Deposits 28,665 ------------------ Total other assets 328,665 ------------------ Total assets $2,006,210 ================== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable and accrued liabilities $40,696 ------------------ Total current liabilities 40,696 ------------------ Commitments and contingencies Stockholders' equity: Preferred stock, $.001 par value; 100,000,000 shares authorized, 0 shares issued and outstanding -- Common stock, $.001 par value; 500,000,000 shares authorized, 376,188,138 shares issued and outstanding 376,189 Additional paid-in capital 6,132,510 Subscriptions receivable (19,713) Accumulated deficit (4,523,472) Total stockholders' equity 1,965,514 ------------------ Total liabilities and stockholders' equity $2,006,210 ================== The accompanying notes are an integral part of these consolidated financial statements. 1 2KSOUNDS CORPORATION AND SUBSIDIARIES Consolidated Statements of Operation For the Three Months For the Nine Months Ended September 30, Ended September 30, ----------------------------------- ----------------------------------- 2002 2001 2002 2001 (Unaudited) (Unaudited) (Unaudited) (Unaudited) ---------------- ---------------- ---------------- ---------------- Revenues: Product, net of allowance for returns $ 110,792 $ (11,568) $ 163,786 $ 64,545 Service - - - 3,500,000 ---------------- ---------------- ---------------- ---------------- Total revenues 110,792 (11,568) 163,786 3,564,545 Cost of sales 24,567 10,059 32,701 188,446 ---------------- ---------------- ---------------- ---------------- Gross profit 86,225 (21,627) 131,085 3,376,099 ---------------- ---------------- ---------------- ---------------- Operating expenses: Salaries and wages 396,874 362,710 1,257,106 1,298,377 Professional services 187,031 27,461 589,424 861,078 Selling, general and administrative 354,608 359,515 1,283,699 1,146,941 ---------------- ---------------- ---------------- ---------------- Total operating expenses 938,513 749,686 3,130,229 3,306,396 ---------------- ---------------- ---------------- ---------------- Operating income (loss) (852,288) (771,313) (2,999,144) 69,703 ---------------- ---------------- ---------------- ---------------- Other income (expense): Settlement income - - - 500,000 Loss on sale of assets - - (7,354) - Interest income (expense) 4,832 440 17,697 (17,581) ---------------- ---------------- ---------------- ---------------- Total other income (expense) 4,832 (770,873) 10,343 482,419 ---------------- ---------------- ---------------- ---------------- Income (loss) before provision for income taxes (847,456) (770,873) (2,988,801) 552,122 Provision for income taxes - - - 493,000 ---------------- ---------------- ---------------- ---------------- Net income (loss) $ (847,456) $ (770,873) $ (2,988,801) $ 59,122 ================ ================ ================ ================ Income (loss) per common share: Basic and diluted $ (0.00) $ (0.00) $ (0.01) $ 0.00 ================ ================ ================ ================ Weighted average common shares outstanding: Basic 375,857,172 215,314,450 325,373,053 213,367,826 ================ ================ ================ ================ Diluted 375,857,172 215,314,450 325,373,053 252,303,661 ================ ================ ================ ================
The accompanying notes are an integral part of these consolidated financial statements. 2 2KSOUNDS CORPORATION AND SUBSIDIARIES Consolidated Statements of Cash Flows Nine Months Ended September 30, --------------------------------- 2002 2001 --------------- --------------- (Unaudited) (Unaudited) Cash flows from operating activities: Net loss $ (2,988,801) $ 59,122 Adjustments to reconcile net income (loss) to net cash used in operating activities: Depreciation and amortization 101,378 115,733 Loss on disposition of fixed assets 7,354 - Estimated fair market value of common stock issued for services 120,268 - Estimated fair market value of options and warrants issued for services - 71,000 Deferred taxes - 493,000 Changes in operating assets and liabilities: Accounts receivable 588,516 26,776 Inventory (26,910) - Accounts payable (219,238) 194,370 --------------- --------------- Net cash provided by (used in) operating activities (2,417,433) 960,001 --------------- --------------- Cash flows from investing activities: Purchases of fixed assets (27,956) (74,366) Proceeds from disposal of fixed assets 13,560 - --------------- --------------- Net cash used in investing activities (14,396) (74,366) --------------- --------------- Cash flows from financing activities: Proceeds from the sale of common stock, net of offering costs 2,015,000 - Proceeds from the sale of preferred stock, net of offering costs 468,750 275,650 Proceeds from the exercise of options and warrants 8,959 - Principal payments on related party notes payable - (1,200,000) Principal borrowing from related parties - 550,000 Redemption of preferred stock - (400,000) --------------- --------------- Net cash provided by (used in) financing activities 2,492,709 (774,350) --------------- --------------- Net increase in cash 60,880 111,285 Cash at beginning of period 1,037,951 583,849 --------------- --------------- Cash at end of period $ 1,098,831 $ 695,134 =============== =============== Supplemental disclosure of cash flow information: Interest paid during the period $ 1,000 $ 20,100 =============== =============== Income taxes paid during the period $ - $ - =============== ===============
The accompanying notes are an integral part of these consolidated financial statements. 3 NOTE 1 - BASIS OF PRESENTATION - ------------------------------ The accompanying unaudited interim consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 2002 are not necessarily indicative of the results that may be expected for the year ending December 31, 2002. These interim financial statements should be read in conjunction with the Company's historical audited consolidated financial statements and notes thereto for the year ended December 31, 2001, which were included in Amendment No. 1 to Current Report on Form 8-K/A of 2KSounds Corporation, formerly Wireless Synergies, Inc. (the "Company" or "2KSounds") filed with the Securities and Exchange Commission on June 12, 2002. NOTE 2 - ORGANIZATION AND ACCOUNTING POLICIES - --------------------------------------------- The Company was incorporated on August 19, 1999 under the laws of the State of Nevada. Until March 29, 2002, the Company was a development stage enterprise, as defined by Statement of Financial Accounting Standards No. 7 (SFAS No. 7). From inception until March 29, 2002, the Company was a public shell corporation which conducted no meaningful business operations and had no revenues. On March 13, 2002, the Company, its wholly owned subsidiary 2K Sounds Merger Co., Inc. ("Merger Sub"), and 2KSounds, Inc. ("Oldco") entered into an Amended and Restated Agreement and Plan of Merger (the "Agreement"), as amended by that certain letter agreement dated March 21, 2002 (the "Letter," the Agreement and the Letter are collectively referred to as the "Merger Agreement"), whereby on March 29, 2002, 283,945,580 shares of the common stock of the Company were exchanged for 100% of the common stock and preferred stock of Oldco. Prior to this transaction, 2KSounds had 90,000,000 shares issued and outstanding; accordingly, after the consummation of this transaction, 2KSounds had 373,945,580 shares outstanding. The transaction is accounted for as a reverse merger (the "Merger"), whereby Oldco was considered the accounting acquiror, as the management of Oldco now controls 2KSounds after the Merger. As a result, a reclassification has been recorded in the accounts of Oldco for the change in the number of shares outstanding as a result of the Merger. Oldco, which was incorporated on December 2, 1999 under the laws of the State of California, locates new musical talent, produces their recordings, and promotes and distributes their music through a variety of methods, including joint ventures with major record labels, sub-labeling and partnerships on albums by existing artists. As a result of the Merger, Merger Sub was merged with and into Oldco, with Oldco as the surviving corporation. Oldco continues as a subsidiary of the Company and as its sole operating entity, and its historical financial statements have replaced those of 2KSounds. In furtherance of the historical financial statements of Oldco replacing those of 2KSounds, the Company's Board of Directors approved a change in the fiscal year of the Company from June 30 to December 31. 4 NOTE 2 - ORGANIZATION AND ACCOUNTING POLICIES, continued - -------------------------------------------------------- Principles of Consolidation - --------------------------- The consolidated financial statements include the accounts of the Company, 2KSounds, Inc., 2KSounds Publishing, Inc. and Bosko Inc. All significant inter-company balances and transactions have been eliminated in the consolidation. Bosko Inc. was incorporated on September 19, 2002 as a California Corporation. Bosko Inc., a wholly owned subsidiary of the Company, intends to advertise and sell music on television, among other things. Risks and Uncertainties - ----------------------- The Company is subject to risks and uncertainties common to growing companies engaged in the promotion and distribution of music, including but not limited to the level of commercial acceptance by the public of the music offerings of the Company's artists, the long-term "staying power" of the Company's artists and their songs, the Company's ability to retain existing artists and recruit new artists, the timing and success of the Company's promotions of its artists, the Company's ability to enter into joint venture distribution and promotion agreements, which reduce its risk in investing in new unproven artists, and fluctuations in the demand for recorded music sales and products associated with music and other entertainment events. The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern, which contemplates, among other things, the realization of assets and satisfaction of liabilities in the normal course of business. The Company has a limited operational history and has experienced significant losses from operations for the period ended September 30, 2002, and had an accumulated deficit of $4,523,472 at September 30, 2002. The Company expects to continue to increase its revenues from the exploitation of music recorded by artists signed by the Company to recording contracts. The Company also intends to fund the development of additional artists through additional equity financing arrangements and revenue from albums the Company expects to release over the next twelve months, which management believes will be sufficient to fund its capital expenditures, working capital, and other cash requirements for the fiscal year ending December 31, 2002. There are no assurances, however, that the Company will generate sufficient revenue from album sales or complete any equity financing transactions or, even if such transactions are completed, have sufficient funds to execute its intended business plan or generate positive operating results. The accompanying financial statements do not include any adjustments that might be necessary should the Company be unable to continue as a going concern. Inventories - ----------- Inventories are stated at the lower of cost or market. Cost is determined on a weighted average basis, which approximates the first-in, first-out basis. Market is determined by estimates of the projected sales value of the inventory to customers. Such value is based on management's forecast for sales of the Company's products. The industry in which the Company operates is characterized by constant change in consumer preferences, making accurate forecasting extremely difficult. 5 NOTE 2 - ORGANIZATION AND ACCOUNTING POLICIES, continued - -------------------------------------------------------- Advance Royalties - ----------------- The Company records advance royalties for monies paid to and expenses paid on behalf of their recording artists that will be repaid through royalties to be earned on future sales. These advances are recorded as an asset, with a reserve for amounts that are considered uncollectible. For all periods presented herein the entire amount of such advances has been fully reserved. Capitalized Master Recordings - ----------------------------- In 2000, the Company acquired recordings and the rights to manufacture, distribute and commercially exploit an album featuring Patsy Cline for $300,000 of consideration. Pursuant to Statement of Financial Accounting Standards No. 50, "Financial Reporting in the Record and Music Industry," costs borne by the Company for the production of master recordings should be capitalized and amortized over the period revenue is realized. As the Company has not yet begun distribution of this album, no amount of amortization has been recognized, but will begin once distribution of the album begins. Revenue Recognition - ------------------- The Company recognizes revenue on album sales when such albums are shipped to record stores, retail stores, and distributors. The Company records a reserve for returns at the time of sale based on an estimated amount of returns. Current period revenues are decreased or increased when projected returns from sales in prior periods are estimated to be in excess of, or less than, reserves previously recognized on a release by release basis. Earnings Per Share - ------------------ The Company has adopted Statement of Financial Accounting Standards No. 128 ("SFAS 128"), "Earnings Per Share." Under SFAS 128, basic earnings per share is computed by dividing income available to common shareholders by the weighted-average number of common shares assumed to be outstanding during the period of computation. Diluted earnings per share is computed similar to basic earnings per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potential common shares had been issued and if the additional common shares were dilutive. Because the Company has incurred net losses, basic and diluted loss per share are the same for these periods as additional potential common shares would be anti-dilutive. Stock-Based Compensation - ------------------------ The Company accounts for non-employee stock-based compensation under Statement of Financial Accounting Standards No. 123 ("SFAS 123"), "Accounting for Stock Based Compensation." SFAS 123 defines a fair value based method of accounting for stock-based compensation. However, SFAS 123 allows an entity to continue to measure compensation cost related to stock and stock options issued to employees using the intrinsic method accounting prescribed by Accounting Principles Board Opinion No. 25 ("APB 25"), "Accounting for Stock Issued to Employees." Under APB 25, compensation cost, if any, is recognized over the 6 respective vesting period based on the difference, on the date of grant, between the fair value of the Company's common stock and the grant price. Entities electing to remain with the NOTE 2 - ORGANIZATION AND ACCOUNTING POLICIES, continued - -------------------------------------------------------- accounting method of APB 25 must make pro forma disclosures of net income and earnings per share, as if the fair value method of accounting defined in SFAS 123 had been applied. The Company has elected to account for its stock-based compensation to employees under APB 25. Comprehensive Income - -------------------- The Company has adopted Statement of Financial Accounting Standards No. 130 ("SFAS 130"), "Reporting Comprehensive Income." SFAS 130 establishes standards for reporting and display of comprehensive income and its components in a full set of general-purpose financial statements. The adoption of SFAS 130 did not have a material effect on the Company's results of operations or financial position as the Company has no items of comprehensive income. Segments of Business - -------------------- The Company has adopted Statement of Financial Accounting Standards No. 131 ("SFAS 131"), "Disclosures about Segments of an Enterprise and Related Information." SFAS 131 changes the way public companies report information about segments of their business in their annual financial statements and requires them to report selected segment information in their quarterly reports issued to shareholders. It also requires entity-wide disclosures about the products and services an entity provides, the material countries in which it holds assets and reports revenues and its major customers. The Company currently operates in one segment as disclosed in the accompanying consolidated statements of operations. The Company has no foreign sales. Recent Pronouncements - --------------------- On April 30, 2002 the Financial Accounting Standards Board ("FASB") issued Statement 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." FASB 145 rescinds Statement 4, which required all gains and losses from extinguishments of debt to be aggregated and, if material, classified as an extraordinary item, net of related income tax effect. Early application of the provisions of FASB 145 may be as of the beginning of the fiscal year or as of the beginning of the interim period in which FASB 145 is issued. The Company has elected to adopt FASB 145 as of the beginning of the current fiscal year. NOTE 3 - STOCKHOLDERS' EQUITY - ----------------------------- Forward Stock Split and Stock Conversion as a Result of the Merger - ------------------------------------------------------------------ On May 21, 2002, the Company effected a 20 for 1 forward stock split which granted stockholders of record an additional nineteen shares of the Company's common stock for each one share of common stock owned as of the close of business on May 20, 2002. As a result, all references to the Company's and Oldco's common stock, preferred stock, merger ratio, stock options granted and warrants granted have been retroactively adjusted for this stock split. As a result of the Merger, all Oldco's shareholders received 8.56828 shares of the Company's common stock for each share of Oldco's common and preferred stock they owned 7 NOTE 3 - STOCKHOLDERS' EQUITY, continued - ---------------------------------------- prior to the Merger. As a result all references to historic stock, stock option and warrant amounts have been adjusted for this ratio. Preferred Stock - --------------- The articles of incorporation of Oldco authorize it to issue up to 10,000,000 shares of Series A Preferred Stock, par value $0.001 per share (the "Series A Preferred Stock"). The outstanding shares of Series A Preferred Stock, which were exchanged for shares of the Company's common stock in the Merger, had, subject to certain conditions, a liquidation preference of $1.00 per share plus any declared and unpaid dividends, and were convertible at any time into such number of fully paid and non-assessable shares of common stock at a conversion price determined by dividing $1.00 by the applicable conversion rate then in effect. During the three months ended March 31, 2002, Oldco sold 4,284,140 of its Series A Preferred stock to investors for net consideration of $468,750 (net of issuance costs of $131,250). On March 29, 2002, pursuant to the Merger, all of the outstanding shares of Oldco's Series A Preferred stock were converted to shares of common stock of 2KSounds. (see Note 2). The articles of incorporation of 2KSounds authorize the Company to issue up to 100,000,000 shares of $.001 par value preferred stock. Shares of preferred stock may be issued in one or more classes or series with such powers, designations, preferences and other rights as the Board of Directors of the Company may from time to time determine. All shares of any series shall be equal in rank and identical in all respects. As of September 30, 2002, there were no shares of 2KSounds preferred stock outstanding. Common Stock - ------------ In January 2002, Oldco issued 694,660 shares of its common stock valued at $20,268 (based on the estimated fair market value on the date of grant) to an outside party for advertising and promotion services. In March 2002, Oldco sold 34,273,120 shares of its common stock to an investor for net proceeds of $2,015,000 (net of issuance costs of $985,000). During the quarter ended June 30, 2002, 2KSounds issued 35,681 shares of its common stock in connection with the exercise of a stock option for a subscription receivable of $208. In June 2002, 2KSounds issued 1,428,571 shares of its common stock valued at $100,000 (based on the estimated fair market value on the date of grant) for legal services. During the quarter ended September 30, 2002, the Company received $709 in cash for outstanding subscriptions receivable. During the quarter ended September 30, 2002, the Company issued a total of 813,987 shares of common stock for proceeds of $8,250 for options and warrants exercised. 8 NOTE 3 - STOCKHOLDERS' EQUITY, continued - ---------------------------------------- Stock Options - ------------- Prior to the Merger, Oldco had adopted the 2000 Stock Option Plan (the "2000 Plan"). Under the Plan, incentive stock options and nonqualified options may be granted to employees, directors, and consultants of Oldco for the purchase of up to 12,000,000 shares of Oldco's common stock. The exercise price per share under the 2000 Plan shall not be less than 100% of the fair market value of the shares on the date of grant, or 110% for persons owning 10% or more of the voting power of Oldco, as defined. The exercise price per share under non-qualified stock options shall not be less than 85% of the fair market value per share on the date of grant. Expiration dates for the grants may not exceed 10 years from the date of grant. The 2000 Plan terminates automatically on March 8, 2010. During the quarter ended March 31, 2002, Oldco issued 3,341,629 options to employees with an exercise price equal to the fair market value on the date of grant. Such options vest over four years and expire in ten years. Since the exercise price of these options was equal to the fair market value on the date of grant, no compensation expense was recognized for the granting of these options. During the quarter ended March 31, 2002, Oldco issued 6,854,626 options as a commission related to the sale of its common stock. These options have an exercise price equal to the fair market value on the date. Of the 6,854,626 options granted, 3,427,312 vested immediately, with the remaining vesting at a rate of 142,807 per month. All such options will expire in ten years. Since these options were issued in connection with equity fundraising, no compensation expense was recognized for the granting of these options. In April, 2002, the Company's shareholders approved the 2002 Stock Option Plan (the "2002 Plan"). Under the 2002 Plan, the Company may grant options to purchase up to 60,000,000 shares of its common stock to employees, directors and consultants of the Company. Options under the 2002 may be either incentive or non-qualified stock options. Pursuant to the terms of the Merger Agreement, all options to purchase shares of Oldco's common stock outstanding prior to the Merger were converted into options to purchase 19,621,360 shares of 2KSounds common stock with similar terms under its 2002 plan. During the quarter ended September 30, 2002, the Company issued a total of 2,741,850 options to certain employees and members of the board of directors. These options are exercisable at $0.025, and will expire in ten (10) years. As the exercise price of these options was equal to the fair market value on the date of grant, the Company did not recognize any compensation expense related to these grants. Warrants - -------- From time to time, Oldco issued warrants to certain of its investors. Prior to the Merger, Oldco had outstanding 6,433,060 warrants. Pursuant to the Merger Agreement, all warrants to purchase Oldco's common stock outstanding at the time of merger were converted into warrants to purchase 2KSounds common stock with similar terms. 9 NOTE 4 - RELATED PARTY TRANSACTIONS - ----------------------------------- Stockholders' Agreement - ----------------------- The majority stockholders (collectively, the "Stockholders") entered into a stockholders' agreement with Oldco on March 13, 2002 which was adopted by 2KSounds upon consummation of the Merger (the "Stockholders' Agreement"). The Stockholders' Agreement provides, among other things, that, for so long as each Stockholder shall own beneficially at least two percent of the fully diluted capital stock of the Company, each Stockholder shall take all actions as may be necessary or appropriate within their power, including voting all shares of common stock owned, to cause the Board of Directors of the Company to consist (i) solely and entirely of the Stockholders or their respective designees, and (ii) of such other person as an independent director who shall be acceptable to a majority of the Stockholders. The Stockholders' Agreement also restricts the transfer of the common stock owned by the Stockholders and provides for "Tag-Along" and "Drag-Along" rights. Pursuant to such "Tag Along" right, any Stockholder proposing to transfer his shares of common stock shall refrain from making such transfer unless, prior to the consummation thereof, the other Stockholders have been afforded the opportunity to join in such sale on a pro rata basis, pursuant to the provisions of the Stockholders' Agreement. Pursuant to the "Drag-Along" right, if one or more Stockholders proposes to transfer to a non-affiliated third person all of their shares of common stock at any time when: (i) such selling Stockholder(s) own at least 35% of the fully diluted common stock; and (ii) the total number of shares proposed to be sold constitutes at least 50% of the fully diluted common stock, then such selling Stockholder(s) shall have the right to require the other Stockholders to sell all their shares of common stock to such non-affiliated third person on the same terms and for the same consideration per share as is being paid to the selling Stockholder(s). The Stockholders' Agreement terminates upon the earlier to occur of December 31, 2004 or the occurrence of a fundamental event, which is described as (i) the sale or issuance by the Company of shares of common stock in any one or more transactions to any person such that the common stock owned by such person subsequent to such sale of issuance equals more than 50% of the issued and outstanding common stock; (ii) the sale of all or substantially all the assets of the Company or its operating subsidiary (2KSounds, Inc.) to any unaffiliated third person; and (iii) the merger, consolidation or combination of the Company with or into any unaffiliated third person, in each instance, where the composition of a majority of the members of the Board of the surviving corporation or other entity shall no longer be the Stockholders or otherwise under the direct influence and control of the Stockholders. Agreement with JAM'N-D Records - ------------------------------ On April 11, 2002, the Company entered into a Memorandum of Understanding with JAM'N-D Records ("JAM'N-D") and J. Michael Nixon, a director and 13.7% stockholder of the Company, pursuant to which, among other things, the Company has agreed to distribute recorded music produced by JAM'N-D. Mr. Nixon owns a majority of the outstanding capital stock of JAM'N-D. During the two year period ending April 11, 2004, JAM'N-D has the right to sign up to five recording artists, subject to the approval of the Company. For each recording artist signed by JAM'N-D and approved by the Company (the "JAM'N-D" Artists"), JAM'N-D shall reimburse 10 NOTE 4 - RELATED PARTY TRANSACTIONS, continued - ---------------------------------------------- the Company up to $1.0 million for expenses the Company incurs in connection with the recording, manufacturing, marketing and promotion of each JAM'N-D Artist, as well as exploiting records derived from the master recordings of each such artist (an "Allowance"). JAM'N-D may recoup all or any portion of the Allowance allocated for each JAM'N-D Artist from the exploitation of recorded music. The Company is responsible for any expenses which exceed $1.0 million, provided that such excess is recoupable from the exploitation of recorded music on an equal dollar for dollar basis as those expenses recoupable by JAM'N-D. Subject to the right of recoupment, the net proceeds derived from the exploitation of music recorded by JAM'N-D Artists will be divided between JAM'N-D and the Company, with JAM'N-D receiving 75% and the Company receiving 25% of such net proceeds. If the combined sales of records from all JAM'N-D Artists is 500,000 units, then the division of the net proceeds shall be adjusted, as defined, with JAM'N-D receiving 60% and the Company receiving 40% of such net proceeds. If the combined sales of records from all the JAM'N-D Artists is 1.0 million units, then the division of the net proceeds shall be further adjusted, as defined, with each of JAM'N-D and the Company receiving 50% of such net proceeds. The Company will receive a distribution fee from the gross proceeds realized from the exploitation of recorded music under this agreement in the amount of 21% of such gross proceeds realized. The Company may purchase all of the outstanding shares of capital stock of JAM'N-D if the combined record sales of all JAM'N-D Artists exceeds 2.0 million units. If the Company exercises such option, the purchase price would be equal to two and one-half times of the aggregate amount of Allowances actually spent by the Company. Such purchase price may be paid in whole or in part in the form of shares of the Company's common stock. During the nine months ended September 30, 2002, JAM'N-D entered into an exclusive artist recording agreement with a new artist, the first artist anticipated to be released pursuant to the joint venture. NOTE 5 - LEGAL PROCEEDINGS - -------------------------- On July 15, 2002, four individuals filed a lawsuit in the Superior Court of the County of Los Angeles, State of California against Oldco and certain of the Company's officers and directors. The complaint alleges breach of fiduciary duty against the named officers and directors and improper determination of the value of dissenting shares against Oldco. The complaint seeks damages in excess of $3.5 million together with punitive damages. The plaintiffs amended their lawsuit in response to a Demurrer filed by the Company, and have filed a First Amended Complaint seeking substantially the same relief which was sought in the Complaint. The Company has responded to the First Amended Complaint through another Demurrer, which attacks the legal sufficiency of the allegations. A favorable ruling in connection with the Demurrer could result in the dismissal of some or all of the causes of action against the Company. While management intends to vigorously defend the Company's position, there can be no assurance that a favorable outcome will be obtained. If the matter were resolved in favor of the plaintiffs, there would be a material adverse effect on the Company. 11 NOTE 5 - LEGAL PROCEEDINGS, continued - ------------------------------------- In July, 2002, the Company commenced a lawsuit in the Los Angeles Superior Court against a former joint venture partner seeking damages for the breach of a release agreement, negligence, breach of fiduciary duty, and fraud. NOTE 6 - SUBSEQUENT EVENTS - -------------------------- On November 1, 2002, the Company entered into an agreement with two of its executive officers to provide the Company with a $1 million unsecured line of credit. The line of credit may be utilized by the Company upon demand by giving three days' written notice to the Lenders. The maturity date of the line of credit is October 31, 2004, and borrowed sums bear simple interest at the rate of seven percent (7%) per annum. As of November 7, 2002, two of the Company's executive officers agreed to defer the payment of their salaries and one of the Company's executive officers agreed to defer partial payment of his salary until the Company determines it has the ability to resume those salary payments. The Company will continue to accrue the salaries due the officers at their current rates. 12 Item 2. Management's Discussion and Analysis or Plan of Operation Introduction - ------------ The following discussion of the Company's results of operations and analysis of financial condition for the three and nine months ended September 30, 2002 and September 30, 2001, respectively, should be read in conjunction with the unaudited interim consolidated financial statements included in this Quarterly Report on Form 10-QSB, including the accompanying notes thereto. For purposes of the following discussion and analysis of the results of operations and liquidity and capital resources, all references to the term "Company" refer only to the operations of 2KSounds, Inc. since it is deemed to be the surviving entity of the Merger for accounting purposes. Except for historical information contained herein, the matters discussed in this Quarterly Report on Form 10-QSB are forward-looking statements that are subject to certain risks and uncertainties that could cause actual results to differ materially from those set forth in such forward looking statements. Such forward-looking statements may be identified by the use of certain forward-looking terminology, such as "may," "will," "expect," "anticipate," "intend," "estimate," "believe" or comparable terminology that involves risks or uncertainties. Actual future results and trends may differ materially from historical and anticipated results, which may occur as a result of a variety of factors. Such risks and uncertainties include, without limitation, the Company's limited operating history, the unpredictability of its future revenues, the unpredictable and evolving nature of its key markets, competition, internet-related risks, dependence on key personnel, dependence on content acquisition, creation and licensing, and the Company's need for additional capital. The Company undertakes no obligation to update any forward-looking statement, whether as a result of new information, future events or otherwise. Investors should carefully review the risk factors and other disclosures set forth in other reports or documents that the Company files from time-to-time with the Securities and Exchange Commission and matters generally affecting the music industry. Results of Operations - --------------------- Revenues - -------- Revenues increased $122,360 to $110,792 for the three months ended September 30, 2002 from $(11,568) for the three months ended September 30, 2001. Sales for the three months ended September 30, 2002 were higher than sales for the three months ended September 30, 2001 due to the Company's focus on marketing and promotion of its products. Revenues for the three months ended September 30, 2001 include higher than expected returns of product sold in prior periods. Revenues decreased $3,400,759 to $163,786 for the nine months ended September 30, 2002 from $3,564,545 for the nine months ended September 30, 2001. The nine months ended September 30, 2001 includes recognition of income generated from a joint venture agreement between the Company and a major record company. Product sales for the nine months ended September 30, 2002 were higher than product sales for the nine months ended September 30, 2001 due to the Company's focus on marketing and promotion of its products. Cost of Sales - ------------- Cost of sales increased by $14,508 to $24,567 for the three months ended September 30, 2002 from $10,059 for the three months ended September 30, 13 2001. This increase was due primarily to an increase in sales during the three months ended September 30, 2002. Cost of sales decreased $155,745, or 83%, to $32,701 for the nine months ended September 30, 2002 from $188,446 for the nine months ended September 30, 2001. This decrease was due primarily to less inventory impairment recognized, which was partially offset by an increase in sales, during the nine months ended September 30, 2002. During the nine months ended September 30, 2002, the Company recognized approximately $136,000 of impairment losses for returned inventory. Salary and Wages - ---------------- Salary and wages increased by $34,164, or 9%, to $396,874 for the three months ended September 30, 2002, from $362,710 for the three months ended September 30, 2001. This increase was due primarily to an increase in headcount for the three months ended September 30, 2002. Salary and wages decreased $41,271, or 3%, to $1,257,106 for the nine months ended September 30, 2002, from $1,298,377 for the nine months ended September 30, 2001. This decrease was due primarily to bonuses paid during the nine months ended September 30, 2001, partially offset by an increase in management salaries. No bonuses were paid during the nine months ended September 30, 2002. Professional Services - --------------------- Professional services increased by $159,570 to $187,031 for the three months ended September 30, 2002, from $27,461 for the three months ended September 30, 2001. This increase was mainly due to an increase in final production and promotional campaign expenses for various artists. Professional services decreased $271,654, or 32%, to $589,424 for the nine months ended September 30, 2002, from $861,078 for the nine months ended September 30, 2001. The primary components of this decrease were reductions made in production and promotional campaign expenses for various artists. The majority of the production and promotional expenses for the nine months ended September 30, 2001 were incurred in the first two quarters of 2001. Selling, General and Administrative Expenses - -------------------------------------------- Selling, general, and administrative expenses decreased by $4,907 to $354,608 for the three months ended September 30, 2002, from $359,515 for the three months ended September 30, 2001. This decrease was primarily due to cost savings on web site rental fees provided by the Company's existing web site provider. Selling, general, and administrative expenses increased by $136,758, or 12%, to $1,283,699 for the nine months ended September 30, 2002, from $1,146,941 for the nine months ended September 30, 2001. This increase was primarily due to legal and accounting expenses incurred in relation to public filings during the nine months ended September 30, 2002, partially offset by a decrease in travel and advertising expenses related to a particular artist incurred during the nine months ended September 30, 2001. The Company did not incur similar expenses on this artist during the nine months ended September 30, 2002. Settlement Income - ----------------- Settlement income decreased by $500,000 to $0 for the nine months ended September 30, 2002, from $500,000 for the nine months ended September 30, 2001. This decrease was due to the recognition of income generated in 2001 from the 14 one-time settlement of a joint venture agreement between the Company and a major record company. Interest Income - --------------- Interest income, net increased by $4,392 to $4,832 for the three months ended September 30, 2002 from interest income of $440 for the three months ended September 30, 2001. This increase was primarily due to higher cash balances maintained in interest bearing accounts during the three months ended September 30, 2002. Interest income, net increased by $35,278 to $17,697 for the nine months ended September 30, 2002 from interest expense of $17,581 for the nine months ended September 30, 2001. This increase was primarily due to interest expense for related party loans incurred during the nine months ended September 30, 2001. The Company had no significant interest expense for the nine months ended September 30, 2002. In addition, the Company maintained higher cash balances in interest bearing accounts during the nine months ended September 30, 2002. Provision for Income Taxes - -------------------------- Provision for income taxes decreased by $493,000 to $0 for the nine months ended September 30, 2002 from $493,000 for the nine months ended September 30, 2001. The Company incurred a net loss before provision for taxes during the nine months ended September 30, 2002, as compared to net income for the corresponding period in the prior year. Because of net operating loss carryforwards from the prior years' operations, the Company did not pay federal or state income taxes in 2001. Net Loss - -------- The Company's net loss increased by $76,583 to a net loss of $847,456 for the three months ended September 30, 2002, from a net loss of $770,873 for the three months ended September 30, 2001. The Company's net loss in the three months ended September 30, 2002 was largely due to the reasons described above. The Company incurred a net loss of $2,988,801 for the nine months ended September 30, 2002, compared to net income of $59,122 for the nine months ended September 30, 2001. The Company's net loss in the nine months ended September 30, 2002 was largely due to the reasons described above. Liquidity and Capital Resources - ------------------------------- The Company's cash and cash equivalents balance was $1,098,831 at September 30, 2002. The Company's primary use of cash and cash equivalents was primarily associated with funding normal operations. For the nine months ended September 30, 2002, net cash used in operating activities was $2,417,433. Net cash provided by operating activities was $960,001 for the same period in 2001. This decrease in cash provided by operating activities was primarily due to the cash generated by a joint venture agreement between the Company and a major record company during the nine months ended September 30, 2001. For the nine months ended September 30, 2002, net cash used in investing activities was $14,396. Net cash used in investing activities was $74,366 for the same period in 2001. This decrease was primarily due to decreased spending on purchases of fixed assets. 15 For the nine months ended September 30, 2002, net cash provided by financing activities was $2,492,709. Net cash used in financing activities was $774,350 for the same period in 2001. This increase was primarily due to the issuance of equity securities. For the nine months ended September 30, 2002, the Company realized (i) $2,023,959, net of offering costs, from the sale of shares of its common stock and exercises of options and warrants; and (ii) $468,750, net of offering costs, from the sale of its preferred stock. Historically, the Company has relied on sales of its equity securities to fund its operations. The Company generated an insignificant amount of revenue during the three months ended September 30, 2002, and there is no guarantee that the Company will be able to generate sufficient revenues in the future to fund its operations. If cash flows from operating activities continue to be insufficient to fund the Company's operating and investing activities, the Company will be required to seek additional debt or equity financings during the coming quarters. There can be no assurance that the Company will be able to consummate debt or equity financings in a timely manner or on terms favorable to the Company, or at all. In the absence of significant revenue, the Company intends to fund operations through (i) additional debt or equity financings, or both, and (ii) loans from affiliates. The Company has taken steps to locate capital to fund operations. Subsequent to September 30, 2002, the Company secured a $1 million unsecured line of credit from a related party; signed an agreement with certain of its executive officers to defer the entire amount, or in some cases a portion of, their salaries; instituted a reduction in staff headcount and salaries; and re-evaluated their artist roster in order to focus resources more efficiently. As a result of these measures, the Company has reduced its burn rate and increased its available capital for operations. While there can be no assurances about future results, the Company believes it has adequate cash, including a $1 million unsecured line of credit, to fund its operations and operational expenses of approximately $175,000 per month through July 2003. The Company determined that it would have sufficient funds for operations until July 2003 based on the following assumptions: (i) the availability of the $1 million line of credit, and (ii) operational expenses not varying significantly from $175,000 per month. The Company has, however, experienced significant fluctuations in its operational expenses in the past due to the cash requirements of a given artist project. In the event additional revenues are not generated by the end of July 2003, the Company will have to seek additional funds to finance its long-term operations. The successful outcome of future activities cannot be determined at this time and there are no assurances that if achieved, the Company will have sufficient funds to execute its intended business plan or generate positive operating results. Item 3. Controls and Procedures The Company's management, including the principal executive officer and principal chief financial officer, conducted an evaluation of the Company's disclosure controls and procedures, as such term is defined under Rule 13a-14(c) promulgated under the Securities Exchange Act of 1934, as amended, within 90 days of the filing date of this report. Based on their evaluation, the Company's principal executive officer and principal accounting officer concluded that the Company's disclosure controls and procedures are effective. There have been no significant changes (including corrective actions with regard to significant deficiencies or material weaknesses) in the Company's 16 internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation referenced in the paragraph above. FACTORS THAT MAY AFFECT FUTURE RESULTS In future periods, our business, financial condition and results of operations may be affected by many factors, including but not limited to the following: Risks related to our business: - ----------------------------- We anticipate that we will need to raise additional capital or obtain funding in the amount of at least $500,000, excluding our $1 million unsecured line of credit, to finance our operating activities over the next twelve months. Our failure to raise at least $500,000 may significantly limit our ability to finance operating activities over the next twelve months. We may not be able to obtain additional financing at commercially reasonable rates, or at all. Our failure to obtain additional funds would significantly limit or eliminate our ability to conduct the foregoing activities or we may have to curtail or eliminate other activities. We anticipate that we will seek additional funding through the public or private sales of our securities and/or through commercial or private financing arrangements, including borrowing from affiliates. Adequate funds may not be available when needed or on terms acceptable to us, or at all. In the event that we are not able to obtain additional funding on a timely basis, we may be required to limit any proposed operations, development and promotion activities. We have incurred substantial losses and deficits and expect to incur losses for the foreseeable future. We have incurred net losses of $2,988,801 for the nine months ended September 30, 2002 and have an accumulated deficit of $4,523,472 at September 30, 2002. In the last 12 months, we have financed our operations primarily through the sale of its equity securities, not from cash generated by operating activities. As a result, we expect to incur losses and negative cash flows from operations for the foreseeable future until we are able to generate significant revenues. Even if we are able to generate positive cash flows from operations, there can be no assurance that we will achieve profitability on a quarterly or annual basis. It is difficult to evaluate our business and prospects because we have a limited operating history. Texas E-Solutions, Inc., our predecessor, was formed in September 1999. Until we completed our reverse merger transaction with 2KSounds, Inc. (at which point our name was Wireless Synergies, Inc.) in March 2002, we were a public shell corporation which conducted no meaningful business operations and had no revenue. 2KSounds, Inc. was organized in October 1999 and did not commence business until April 2000. Accordingly, our limited operating history, particularly as a combined company with 2KSounds, makes it difficult to evaluate our current business and prospects or to accurately predict our future revenue or results of operations. 17 We depend on EMI Music Distribution ("EMD"), with whom we have a contractual relationship, to manufacture and distribute CDs, DVDs and other forms of reproduction, transmission or distribution of singles and albums derived from master recordings of our artists. We have formed a direct distribution relationship with EMD. We depend on EMD to manufacture, fulfill orders from retailers, warehouse finished goods, and provide product delivery and credit and collection services to our company. This direct distribution relationship significantly reduces our distribution costs and generates revenue. Our relationship with EMD is exclusive with respect to us, and therefore precludes us from entering into similar agreements with any other party in the U.S. If EMD fails to perform its obligations under the agreement with EMD, our business, financial condition and operating results could be materially and adversely affected. Although we believe that other distributors could provide us with the same services as EMD, we would have to expend significant time, money and human resources to secure a suitable substitute able to provide us with the same or similar services as EMD. In addition, no assurance can be made that we will be able to find a substitute able to provide us with services comparable to those provided by EMD or on terms as favorable as those contained in the EMD Agreement. If we were unable to secure a suitable substitute for EMD, our business, financial condition and operating results could be materially and adversely affected. If we fail to perform our obligations under the agreement with EMD, it may foreclose on its first priority security interest in and to a significant portion of our assets. We have granted a first priority security interest in a significant portion of our assets to EMD as collateral for our payment obligations under our agreement with EMD. If we fail to perform our obligations to EMD, EMD may seize our assets. In such event, we would lose our rights to master recordings of all artists under contract to us at the time. If this were to occur, our business, financial condition and operating results would be materially and adversely affected. Many of our artist agreements are short-term and we face the risk of losing them to competitors with greater resources. We believe that our future success depends in large part upon our ability to maintain our existing artist agreements. If we become unable to provide valuable services to our existing artists, or if we otherwise fail to maintain good relations with such artists, they may elect to terminate their agreements with us when their contractual terms expire, or they may elect not to renew their agreements with us. Although under our artist agreements, we typically retain our rights in all master recordings and other intellectual property produced prior to the date of termination, if an artist elects to terminate his or her agreement with us, would not necessarily earn any revenues from recordings, or other commercial properties, which we were not produced prior to the termination of our relationship. In addition, if we cannot provide adequate incentives for these artists to remain with us, our efforts to sign new artists may be impaired. Furthermore, historically, when recording artists have achieved substantial commercial success they have sought to renegotiate the terms of their recording agreements. This may adversely affect our future profitability with respect to such artists. Our music offerings may not be commercially successful. 18 We expect a significant amount of our revenue to come from the sale of records, as well as the use of our artist's music in feature films and television programs. The success of our music offerings depends primarily upon their acceptance by the public, which is difficult to predict. The commercial success of a record, feature film or television program depends on the quality and acceptance of competing offerings released into the marketplace at or near the same time, the availability of alternative forms of entertainment and leisure time activities, general economic conditions and other tangible and intangible factors, all of which can change quickly. Because we expect the popularity of our music offerings to be a significant factor driving the growth of our company, our failure to produce records with broad consumer appeal could materially harm our business and prospects for growth. We depend upon our existing artists to attract new artists. In order for us to sign new artists, our principal existing artists must remain with us and sustain their popularity. Our business would be adversely affected by: o Our inability to recruit new artists with commercial promise and to enter into production and promotional agreements with them; o The loss of popularity of our existing artists; o Increased competition to maintain relationships with existing artists; o Non-renewals of current agreements with existing artists; and o Poor performance or negative publicity of existing artists. Unless our artists develop a strong brand identity, our business may not continue to grow and our financial results may suffer. We believe that continuing to strengthen each artist's brand will be critical to attracting artists and achieving widespread acceptance of their music. However, brand promotion activities may not yield increased revenues, and even if they do, any increased revenues may not offset the expenses we incur in building our artists' brands. The members of our management team may have no or only limited significant experience in leadership roles in a public company. We cannot assure you that our management team will be able to successfully lead a public company. The failure of the management team to adequately handle this challenge could have a material adverse effect on our business. If we do not manage our growth efficiently, we may not be able to operate our business effectively. We expect to expand our operations by seeking additional financing to expand our artist and consumer bases and the breadth of our music product and service offerings. If we expand our operations, we may strain our management, operations, systems and financial resources. To manage our future growth, we must improve and effectively utilize our existing operational, management, marketing and financial systems and successfully recruit, hire, train and manage personnel and maintain close coordination among our artists, technical, finance, 19 marketing, sales and production staffs. We expect that we will need to hire additional personnel in all areas of our business during 2003. In addition, we may also need to improve our accounting systems and procedures and computer software and hardware systems in order to operate our business more effectively and manage our expansion. We also will need to manage an increasing number of complex relationships with artists, strategic partners, advertisers and other third parties. Our failure to effectively manage our growth could disrupt our operations and ultimately prevent us from generating the revenue we expect. Future acquisitions of companies or assets may disrupt our business or distract our management. In the future, we may seek to acquire or make investments in complementary companies or businesses. We may not be able to acquire or manage additional businesses profitably or to successfully integrate any acquired businesses or assets with our business. Businesses that we acquire may have liabilities that we underestimate or do not discover during our pre-acquisition investigations. Certain liabilities, even if we do not expressly assume them, may be imposed on us as the successor to the business. Further, each acquisition may involve other special risks that could cause the acquired businesses to fail to meet our expectations. For example: o The acquired businesses may not achieve expected results; o We may not be able to retain key personnel of the acquired businesses; o We may incur substantial, unanticipated costs, delays or other operational or financial problems when we try to integrate businesses we acquire with our own; o Our financial and managerial resources may be diverted from our core business; or o Our management may not be able to manage the combined entity effectively or to make acquisitions and grow our business internally at the same time. In addition, we may incur debt or issue equity securities to pay for any future acquisitions or investments, which could dilute the ownership interest of our existing stockholders in our company. The loss of certain key management and creative personnel could materially and adversely affect our business. Our future success depends to a significant extent on the continued services of our senior management and other key creative personnel, particularly John Guidon and Michael Blakey. We do not have employment agreements with any of our employees, including any member of our senior management. The loss of any of Messrs. Guidon, or Blakey, or certain other key creative employees, would likely have a material and adverse effect on our business. Competition for talented personnel throughout our industry is intense and we may be unable to retain our current key employees or attract, integrate or retain other highly qualified employees in the future. We have in the past experienced, and we expect to continue to experience, difficulty in hiring and retaining highly skilled employees with appropriate qualifications. If we do not succeed in attracting 20 new personnel or retaining and motivating our current personnel, our business could be adversely affected. Risks related to our industry: ----------------------------- Because a substantial portion of our revenues will be derived from the sale of CDs, cassettes and other merchandise relating to our artists, an economic downturn that resulted in a reduction in discretionary spending by consumers on entertainment could adversely affect our business. A substantial portion of our revenues will be derived from, and our future success will be dependent upon, sales of CDs, cassettes and other artist-related merchandise to consumers. If the economy suffers a downturn or other long-term disruption, and consumers reduce their discretionary spending on entertainment-related products and services, it is likely that we would experience a decline in revenues, which would materially harm our business, financial condition and operating results. Changes in consumer preferences could negatively impact our results. With some exceptions our artists' music fits into one of four categories: popular, urban, alternative rock and Rhythm and Blues. Our continued success depends, in part, upon the popularity of these music genres. Shifts in consumer preferences away from these categories of music could materially affect our business, financial condition and operating results. The music industry is extremely competitive and we may not be able to compete successfully against other record labels, both large and small, for both artists and the public's attention. The market for the promotion and distribution of music is extremely competitive and rapidly changing. We currently and in the future face competitive pressures from numerous actual and potential competitors. Many of our current and potential competitors in the recorded music business may have substantial competitive advantages than we have, including: o Longer operating histories; o Significantly greater financial, technical and marketing resources; o Greater brand name recognition; o Better distribution channels; o Larger existing customer bases; and o More popular content or artists. Our competitors may be able to respond more quickly to new or emerging technologies and changes in the public's musical tastes and devote greater resources to identify, develop and promote artists, and distribute and sell their music offerings than we can. 21 We may be liable to third parties for music and other content that is on the records we produce and distribute. We may be liable to third parties for the content on the records we distribute: o If the music, text, graphics, or other content on our records violates their copyright, trademark, or other intellectual property rights; o If our artists violate their contractual obligations to others by providing content on our records they do not have the right to provide; o If anything on our records is deemed obscene, indecent or defamatory we may be subject to legal actions or find ourselves unable to sell those records. We attempt to minimize these types of liability by requiring representations and warranties relating to our artists' ownership of and rights to distribute and submit their music and by taking related measures to review content on our records. However, alleged liability could harm our business by damaging our reputation, requiring us to incur legal costs in defense, exposing us to awards of damages and costs and diverting management's attention away from our business. We may have difficulty enforcing our intellectual property rights. The decreasing cost of electronic equipment and related technology has made it easier to create unauthorized versions of audio and audiovisual products such as compact discs, videotapes and DVDs. A substantial portion of our revenue comes from the sale of audio and audiovisual products that are subject to unauthorized copying. Similarly, advances in Internet technology have increasingly made it possible for computer users to share audio and audiovisual information without the permission of the copyright owners and without paying royalties to holders of applicable intellectual property or other rights. Intellectual property rights to information that is potentially subject to widespread, uncompensated dissemination on the Internet represents a substantial portion of our market value. If we fail to obtain appropriate relief through the judicial process or the complete enforcement of judicial decisions issued in our favor, or if we fail to develop effective means of protecting our intellectual property or entertainment-related products and services, our results of operations and financial position may suffer. We expect our business to be seasonal for the foreseeable future which may make it more difficult to evaluate our business. We expect that we will experience seasonality in our business, reflecting traditional retail seasonality patterns affecting sales of recorded music. Sales in the traditional retail music industry are significantly higher in the fourth calendar quarter of each year than in the preceding three quarters. However, to date, our limited operating history and rapid growth make it difficult to ascertain the effects of seasonality on our business. Therefore, we believe that period-to-period comparisons of our historical results are not necessarily meaningful and should not be relied upon as an indication of future results. 22 Risks relating to owning our common stock: ----------------------------------------- Our operating results may prove unpredictable, and our common stock price may decrease or fluctuate significantly. Our operating results are likely to fluctuate significantly in the future due to a variety of factors, many of which are outside of our control. Because our operating results are difficult to predict, in some future quarters our operating results may fall below the expectations of securities analysts and investors. If this happens, the trading price of our common stock may fall significantly. Factors that may cause our operating results to fluctuate significantly include the following: o The level of commercial acceptance by the public of the music offerings of our artists; o The long-term "staying power" of our artists and their songs; o Our ability to retain existing artists and recruit new artists; o The timing and success of our promotions of our artists; o Fluctuations in the levels of consumer purchasing activity relating to the purchase of recorded music; o The level of commercial success achieved by new music and new music products introduced by us or by our competitors; o Our ability to enter into joint venture distribution and promotion agreements, which reduce our risk in investing in new unproven artists; o Fluctuations in the demand for recorded music sales and products associated with music and other entertainment events; o Extensive competition in the music industry, including direct competition for talent from major recording labels, substantially all of which have significantly greater capital resources and infrastructure than we have; o The general threat to the music industry posed by the dissemination of free music over the internet; o The amount and timing of operating costs and capital expenditures relating to expansion of our business, operations and infrastructure; and o General economic conditions and economic conditions specific to the music industry. Our executive officers, directors and major stockholders beneficially own approximately 60% of our outstanding common stock and consequently are able to exercise significant control over us. 23 Our executive officers, directors and holders of 5% or more of outstanding common stock together beneficially own approximately 60% of our outstanding common stock. These stockholders are able to significantly influence all matters requiring approval by our stockholders, including the election of directors and the approval of significant corporate transactions. This concentration of ownership may also have the effect of delaying, deterring or preventing a change in control of our company and may make some transactions more difficult or impossible to complete without the support of these stockholders. Our stock price may decline in the future, and a public market may not develop or exist for you to sell your stock. Our common stock is quoted on the Over-the-Counter Bulletin Board. Prior to the merger with 2KSounds, there was a limited trading market for our shares, because we had no business operations or revenues. An active trading market may not develop in the future, and if one does develop, be sustained. If an active trading market does develop, the market price of our common stock is likely to be highly volatile due to, among other things, the nature of our business and because we are a new public company with a limited operating history. The market price of our common stock may also fluctuate significantly in response to the following factors, most of which are beyond our control: o Variations in our quarterly operating results; o Changes in securities analyst's estimates of our financial performance; o Changes in general economic conditions and in the music retailing industry; o Changes in market valuations of similar companies; o Announcements by us or our competitors of significant new contracts with artists, acquisitions, strategic partnerships or joint ventures, or capital commitments; o Loss of a major artist, partner or joint venture participant or the failure to effectively exploit the catalogs of our musicians; and o The addition or loss of key managerial and creative personnel. The equity markets have, on occasion, experienced significant price and volume fluctuations that have affected the market prices for many companies' securities and that have often been unrelated to the operating performance of these companies. Any such fluctuations may adversely affect the market price of our common stock, regardless of our actual operating performance. As a result, stockholders may be unable to sell their shares, or may be forced to sell them at a loss. 24 PART II - OTHER INFORMATION - --------------------------- Item 1. Legal Proceedings On July 15, 2002, four individuals filed a lawsuit in the Superior Court of the County of Los Angeles, State of California against 2KSounds, Inc. and certain of our officers and directors. The complaint alleges breach of fiduciary duty against the named officers and directors and improper determination of the value of dissenting shares against 2KSounds. The complaint seeks damages in excess of $3.5 million together with punitive damages. The plaintiffs amended their lawsuit in response to a Demurrer filed by the Company, and have filed a First Amended Complaint seeking substantially the same relief which was sought in the Complaint. The Company has responded to the First Amended Complaint through another Demurrer which attacks the legal sufficiency of the allegations. A favorable ruling in connection with the Demurrer could result in the dismissal of some or all of the causes of action against the Company. While management intends to vigorously defend the Company's position there can be no assurance that a favorable outcome will be obtained. If the matter were resolved in favor of the plaintiffs, there would be a material adverse effect on 2KSounds. In July, 2002, the Company commenced a lawsuit in the Los Angeles Superior Court against a former joint venture partner seeking damages for the breach of a release agreement, negligence, breach of fiduciary duty, and fraud. Item 2. Changes in Securities. During the quarter ended September 30, 2002, the Company issued 813,987 shares of its common stock in connection with the exercise of previously issued stock options and warrants for total cash proceeds of $8,250. These shares were issued pursuant to Section 4(2) of the Securities Act of 1933, as amended. There was no underwriter involved in this issuance and no commissions were paid to any person. Item 3. Defaults Upon Senior Securities. None. Item 4. Submission of Matters to a Vote of Securities Holders. None. Item 5. Other Information. None. 25 Item 6. Exhibits and Reports on Form 8-K. Exhibits: 10.1 Credit Agreement between the Registrant and John Guidon and Bruce Gladstone, effective as of November 1, 2002 99.1 Certification pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley act of 2002 Reports on Form 8-K: None. 26 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. 2KSOUNDS CORPORATION Dated: November 14, 2002 By:/s/ John Guidon --------------------------- John Guidon Chief Executive Officer and Chief Financial Officer 27 CERTIFICATIONS -------------- I, John Guidon, certify that: 1. I have reviewed this quarterly report on Form 10-QSB of 2KSounds Corporation; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows or the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internals controls; and 6. The registrant's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. 28 2KSOUNDS CORPORATION Dated: November 14, 2002 By:/s/ John Guidon --------------------------- John Guidon Chief Executive Officer and Chief Financial Officer 29 Exhibit 99.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of 2KSounds Corporation (the "Company") on Form 10-QSB for the period ending September 30, 2002 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, John Guidon, Chief Executive Officer and Chief Financial Officer of the Company, do hereby certify, pursuant to 18 U.S.C. (S) 1350, as adopted pursuant to (S) 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ John Guidon ------------------------ John Guidon Chief Executive Officer and Chief Financial Officer November 14, 2002 30 EX-10 3 ex10-1creditag.txt CREDIT AGREEMENT CREDIT FACILITY AGREEMENT BETWEEN 2KSOUNDS, INC. AND JOHN GUIDON AND BRUCE GLADSTONE EFFECTIVE AS OF NOVEMBER 1, 2002 1 CREDIT FACILITY AGREEMENT This Credit Facility Agreement (the "Agreement") is effective as of the 1st day of November, 2002 by and between John Guidon ("Guidon") and Bruce Gladstone ("Gladstone"), (the "Lenders") and 2KSounds, Inc., a California Corporation (the "Borrower"). Lenders and Borrower are collectively referred to hereinafter as the "Parties". RECITALS WHEREAS, Guidon owns 84,568,924 shares of the issued and outstanding capital stock of Borrower; and, WHEREAS, Gladstone owns 15,080,173 shares of the issued and outstanding capital stock of Borrower; and, WHEREAS, the parties wish to make certain agreements regarding monies loaned by Lenders to Borrower. NOW, THEREFORE, in consideration of the mutual covenants and promises set forth herein, the sufficiency of which is hereby acknowledged, the Parties agree as follows: 1. Borrowing; Amount. ----------------- Pursuant to this Agreement, the Lenders agree to make loans to Borrower (a "Borrowing"), at any time and from time to time on and after the date hereof and until October 31, 2004 (the "Maturity Date") in an aggregate amount not to exceed $1,000,000.00 ("Lender's Commitment"). The Lender's commitment shall be at the ratio of 70/30 between Guidon and Gladstone, on a dollar for dollar basis. Thus, by way of example, Guidon's commitment shall be an amount not to exceed $700,000 and Gladstone's commitment shall be an amount not to exceed $300,000. As a further example, if Borrower requests $100,000, Guidon shall provide $70,000 and Gladstone shall provide $30,000. The Borrower may borrow, pay or prepay any amount up to the Lender's Commitment prior to the Maturity Date as set forth herein. 2. Borrowing Procedure. ------------------- In order to request a loan, the Borrower shall hand deliver or telecopy to the Lenders a written request not later than 10:30 a.m., Pacific time, three business days prior a proposed Borrowing. If the Borrower does not specify an interest period for the Borrowing, then the Borrower will have deemed to have selected an interest period ending immediately prior to the Maturity Date. The Borrower may not select a Borrowing if the interest period requested in connection therewith would end after the Maturity Date. 2 3. Repayment of Loans; Evidence of Debt. ------------------------------------ The Borrower agrees that the outstanding principal balance of each Borrowing shall be payable on the Maturity Date. Each Borrowing shall bear interest on the outstanding principal thereof in accordance with Section 4. The Lenders may maintain an account or accounts evidencing the indebtedness of the Borrower and the principal amount and interest due and payable under such loan and the amount of any sum received from the Borrower in payment therefor. The entries made in such account by the Lenders shall, to the extent permitted by applicable law, be prima facie evidence of the amount and existence of a Borrowing. The Borrower agrees that upon notice by the Lenders, after the initial Borrowing, to the Borrower to the effect that a promissory note or other evidence of indebtedness is required, the Borrower shall promptly execute and deliver to the Lenders a promissory note or notes, payable to the order of the Lenders. 4. Interest on Loans; Default Interest. ----------------------------------- A Borrowing shall bear interest (computed on the basis of the actual number of days elapsed) at the annual rate of seven percent (7%). Unless otherwise specified, interest on each Borrowing shall be due and payable on the Maturity Date. If the Borrower shall default in the payment of principal of or any interest on any Borrowing or any other amount becoming due hereunder, the Borrower shall on demand from time to time from the Lenders pay interest, to the extent permitted by law, on such defaulted amount up to the date of actual payment at a rate of ten (10%) percent per annum (computed on the basis of actual number of days elapsed). 5. Prepayment. ---------- The Borrower shall have the right at any time and from time to time to prepay any Borrowing, in whole or in part, upon giving telecopy notice to the Lenders prior to or on the same business day of prepayment. The Borrower shall exercise reasonable efforts to repay the Borrowing prior to the maturity date. Each notice of prepayment from the Borrower shall specify the prepayment date and the principal amount of each Borrowing to be prepaid. Each notice of prepayment shall be irrevocable and shall commit the Borrower to prepay such Borrowing (or portion thereof) by the date stated therein. Prepayment under this Section 5 need not include accrued interest on the principal amount being prepaid. 6. Indemnity. --------- The Borrower shall indemnify the Lenders against any out-of-pocket loss or expense which the Lenders may sustain or incur as a consequence of (a) any default by the Borrower in payment or prepayment of the principal amount of any Borrowing or any part thereof or interest accrued thereon, as and when due and payable (at the due date thereof, whether by scheduled maturity, acceleration, irrevocable notice of prepayment or otherwise) or (b) the occurrence of any Event of Default. 3 7. Taxes. ----- Any and all payments by the Borrower hereunder shall be made, free and clear of and without deduction for any and all present or future taxes, levies, imposts, deductions, charges or withholdings, and all liabilities with respect thereto imposed by the United States or any political subdivision or taxing authority thereof, excluding taxes imposed on Lender's (or any transferee's or assignee's, including a participation holder's (any such entity a "Transferee")) net income and franchise taxes imposed on the Lenders (or Transferee) by the United States or any political subdivision or taxing authority thereof (all such nonexcluded taxes, levies, imposts, deductions, charges, withholdings and liabilities being hereinafter referred to as "Taxes"). If the Borrower shall be required by law to deduct any Taxes from or in respect of any sum payable hereunder to the Lenders (or any Transferee), (i) the sum payable shall be increased by the amount necessary so that after making all required deductions such Lenders (or Transferee) (as the case may be) shall receive an amount equal to the sum it would have received had no such deductions been made, (ii) the Borrower shall make such deductions and (iii) the Borrower shall pay the full amount deducted to the relevant taxing authority or other Governmental Authority in accordance with applicable law. In addition, the Borrower agrees to pay any present or future stamp or documentary taxes or any other excise or property taxes, charges or similar levies which arise from any payment made hereunder or from the execution, delivery or registration of, or otherwise with respect to, this Agreement imposed by the United States or any political subdivision or taxing authority thereof (hereinafter referred to as "Other Taxes"). 8. Representations and Warranties. ------------------------------ The Borrower warrants and represents to the Lenders as follows: 8.01 ORGANIZATION; POWERS.The Borrower is a corporation duly organized, validly existing and in good standing under the laws of the jurisdiction of its organization, (b) has all requisite power and authority to own its property and assets and to carry on its business as now conducted and as proposed to be conducted, (c) is qualified to do business in every jurisdiction where such qualification is required, except where the failure so to qualify would not result in a material adverse effect, and (d) has the corporate power and authority to execute, deliver and perform its obligations under this Agreement and to borrow funds hereunder. 8.02 AUTHORIZATION. The execution, delivery and performance by the Borrower of this Agreement and the Borrowings by it hereunder (collectively, the "Transactions") (a) have been duly authorized by all requisite corporate actions and (b) will not (i) violate (A) any provision of any law, statute, rule or regulation or of its certificate of incorporation or other constitutive documents or by-laws, (B) any order of any governmental authority or (C) any provision of any indenture, agreement or other instrument to which it is a party or by which it or any of its property is or may be bound, (ii) be in conflict with, result in a breach of or constitute (alone or with notice or lapse of time or both) a default under any such indenture, agreement or other instrument or (iii) result in the creation or imposition of any lien upon any of its property or assets. 4 8.03 ENFORCEABILITY. This Agreement has been duly executed and delivered by the Borrower and constitutes its legal, valid and binding obligation enforceable against it in accordance with its terms. 8.04 GOVERNMENTAL APPROVALS. No action, consent or approval of, registration or filing with or any other action by any governmental authority is or will be required in connection with the Transactions. 9. Default Provisions. ------------------ The occurrence of one or more of the following events shall constitute an "Event of Default" of this entire Agreement: 9.01 Failure by the Borrower to pay amounts due, on or before the Maturity Date as specified herein or in any instrument evidencing the Borrowing, which failure has not been cured within 30 days of the Borrower's receipt of written notice thereof. 9.02 The institution by the Borrower of bankruptcy proceedings to be adjudicated a bankrupt or insolvent or the consent by it to the institution of bankruptcy or insolvency proceedings against it or the cessation of the primary business activity of the Company which has not been cured within ten business days. 9.03 The entry of a decree or order by a court having appropriate jurisdiction adjudging the Borrower bankrupt or insolvent, or approving as properly filed a petition seeking reorganization or liquidation of the Borrower under the Federal Bankruptcy Act or any other applicable federal or state law, or appointing a receiver, liquidator, assignee or trustee over any substantial portion of the Borrower's property, or ordering the winding up or liquidation of the Borrower's affairs, and the continuance of any such decree or order unstayed and in effect for a period of sixty (60) consecutive days. 9.04 The institution by the Borrower of proceedings to be adjudicated a bankrupt or insolvent, or the consent by it to the institution of bankruptcy or insolvency proceedings against it, or the filing by it of a petition or answer or consent seeking reorganization or relief under the Federal Bankruptcy Act or any other applicable federal or state law, or the consent by it to the filing of any such petition or to the appointment of a receiver, liquidator, assignee or trustee of the Borrower. 9.05 Any default in the obligation of the Borrower for borrowed money, other than this Agreement, which shall continue for a period of sixty (60) days, or any event that results in acceleration of the maturity of any indebtedness of the Borrower under any note, indenture, contract, or agreement. 5 9.06 Any representation or statement made or furnished to the Lenders by the Borrower or on the Borrower's behalf is false or misleading in any material respect. 10. Dispute Resolution. ------------------ Resolution of any and all disputes arising from or in connection with this Agreement shall be exclusively governed by and settled in accordance with the provisions of Section 4.6 of the Separation Agreement. 11. Miscellaneous. ------------- 11.1 COUNTERPARTS. This Agreement, including any attachments hereto and the other documents referred to herein, may be executed via facsimile or otherwise in counterparts, each of which shall be deemed to be an original but all of which shall constitute one and the same agreement. 11.2 EFFECTIVENESS. All covenants and agreements of the parties contained in this Agreement shall be subject to and conditioned upon the Distribution becoming effective. 11.3 BINDING EFFECT; ASSIGNMENT. This Agreement shall inure to the benefit of and be binding upon the parties hereto and their respective legal representatives and successors, and nothing in this Agreement, express or implied, is intended to confer upon any other Person any rights or remedies of any nature whatsoever under or by reason of this Agreement. Except as herein specifically provided to the contrary, neither party may assign this Agreement or any rights or obligations hereunder, without the prior written consent of the other party, and any such assignment shall be void; provided, however, either party (or its permitted successive assignees or transferees hereunder) may assign or transfer this Agreement as a whole without consent to an entity that succeeds to all or substantially all of the business or assets of such party to which this Agreement relates. 11.4 PERFORMANCE. Each party hereto will cause to be performed, and hereby guarantees the performance of all actions, agreements and obligations set forth herein to be performed by any subsidiary or any member of such party. 11.5 ADDITIONAL ASSURANCES. Except as may be specifically provided herein to the contrary, the provisions of this Agreement shall be self-operative and shall not require further agreement by the parties; provided, however, at the request of either party, the other party shall execute such additional instruments and take such additional acts as are reasonable, and as the requesting party may reasonably deem necessary, to effectuate this Agreement. 11.6 ENTIRE AGREEMENT. This Agreement shall constitute the entire agreement between the parties with respect to the subject matter hereof and 6 thereof and shall supersede all prior negotiations, agreements and understandings of the parties of any nature, whether oral or written, with respect to such subject matter. 11.7 DESCRIPTIVE HEADINGS. The headings contained in this Agreement, in any Exhibit or Schedule hereto and in the table of contents to this Agreement are for reference purposes only and shall not affect in any way the meaning or interpretation of this Agreement. When a reference is made in this Agreement to an Article or a Section, Exhibit or Schedule, such reference shall be to an Article or Section of, or an Exhibit or Schedule to, this Agreement unless otherwise indicated. 11.8 GENDER AND NUMBER. Whenever the context of this Agreement requires, the gender of all words herein shall include the masculine, feminine and neuter, and the number of all words herein shall include the singular and plural. 11.9 SEVERABILITY. The parties hereto have negotiated and prepared the terms of this Agreement in good faith with the intent that each and every one of the terms, covenants and conditions herein be binding upon and inure to the benefit of the respective parties. Accordingly, if any one or more of the terms, provisions, promises, covenants or conditions of this Agreement or the application thereof to any person or circumstance shall be adjudged to any extent invalid, unenforceable, void or voidable for any reason whatsoever by a court of competent jurisdiction, such provision shall be as narrowly construed as possible, and each and all of the remaining terms, provisions, promises, covenants and conditions of this Agreement or their application to other persons or circumstances shall not be affected thereby and shall be valid and enforceable to the fullest extent permitted by law. To the extent this Agreement is in violation of applicable law, then the parties agree to negotiate in good faith to amend the Agreement, to the extent possible consistent with its purposes, to conform to law and effect the original intent of the parties. 11.10 SURVIVAL OF AGREEMENTS. Except as otherwise contemplated by this Agreement, all covenants and agreements of the parties contained in this Agreement shall remain in full force and effect. 11.11 GOVERNING LAW. This Agreement shall be construed in accordance with and all Disputes hereunder shall be governed by the laws of the State of California. The Superior Court of Los Angeles County and/or the United States District Court for the Southern District of California shall have jurisdiction and venue over all Disputes between the parties that are permitted to be brought in a court of law pursuant to Section 10 above. 11.12 NOTICES. Any notice, demand, offer, request or other communication required or permitted to be given by either party pursuant to the terms of this Agreement shall be in writing and shall be deemed effectively given the earlier of (i) when received, (ii) when delivered personally, (iii) one business day after being delivered by facsimile (with receipt of appropriate confirmation), (iv) one business bay after being deposited with a nationally recognized overnight courier service or (v) four days after being deposited in the U.S. mail, First Class with postage prepaid, and addressed to: 7 If to the Lenders: Lord John Guidon 2933 Stafford Road Thousand Oaks, CA 91361 Bruce Gladstone 3937 Sumac Dr. Sherman Oaks, CA 91403 If to Borrower: 2KSounds, Inc. 21700 Oxnard Street, Suite 1030 Woodland Hills, CA 91367 Facsimile (818) 593-2230 Attn: Kenneth S. Ingber, Esq. General Counsel With a copy to: Gerald M. Chizever, Esq. Richman, Mann, Chizever, Philips & Duboff 9601 Wilshire Blvd., Penthouse Suite Beverly Hills, CA 90210 Facsimile: 310 274-2831 The parties may substitute a different address or facsimile number, from time to time, if such substitute is provided to the intended notice recipient in writing by notice given in the manner provided in this section. 11.13 WAIVERS; REMEDIES. No failure or delay by any party hereto in exercising any right, power or privilege hereunder will operate as a waiver thereof, nor will any waiver on the part of any party hereto of any right, power or privilege hereunder operate as a waiver of any other right, power or privilege hereunder, nor will any single or partial exercise of any right, power or privilege hereunder preclude any other or further exercise thereof or the exercise of any other right, power or privilege hereunder. The rights and remedies herein provided are cumulative and are not exclusive of any rights or remedies which the parties may otherwise have at law or equity. 11.14 FORCE MAJEURE. Neither party shall be liable or deemed to be in default for any delay or failure in performance under this Agreement or other 8 interruption of service deemed to result, directly or indirectly, from acts of God, civil or military authority, acts of public enemy, war, accidents, explosions, earthquakes, floods, failure of transportation, strikes or other work interruptions by either party's employees, or any other similar cause beyond the reasonable control of either party unless such delay or failure in performance is expressly addressed elsewhere in this Agreement. IN WITNESS WHEREOF, the Parties hereby execute this Agreement as of the date first written above. By: /s/ John Guidon ---------------------------- Lord John Guidon Its: Chief Executive Officer and Chief Financial Officer ---------------------------- Title By: /s/ Bruce Gladstone ---------------------------- Bruce Gladstone Its: Executive Vice President ---------------------------- Title 2KSounds, Inc. By: /s/ Kenneth S. Ingber ---------------------------- Kenneth S. Ingber Its: General Counsel, Vice President of Business Development ---------------------------- Title -----END PRIVACY-ENHANCED MESSAGE-----